What Is Bitcoin Mining?

What Is Bitcoin Mining?

Bitcoin mining is the process of validating the information in a blockchain block by generating a cryptographic solution that matches specific criteria. When a correct solution is reached, a reward in the form of bitcoin and fees for the work done is given to the miner(s) who reached the solution first.

Over time, the reward for mining Bitcoin is reduced. This reward process continues until 21 million bitcoins are circulating. Once that number is reached, the Bitcoin reward is expected to cease, and Bitcoin miners will be rewarded through fees paid for the work done.

How Does Bitcoin Mining Work?

Here's a simplified example to explain the process. Say you ask friends to guess a number between 1 and 100. Your friends don't have to guess the exact number; they just have to be the first to guess a number less than or equal to your number. If you think of the number 19 and a friend comes up with 21, another 55, and yet another 83, they lose because they all guessed more than 19. But they get to guess again, and the next guesses are 16, 41, and 67. The one who guessed 16 wins because they were first to guess a number less than or equal to 19.

In this case, the number you chose, 19, represents the target hash the Bitcoin network creates for a block, and the random guesses from your friends are the guesses from the miners.

Bitcoin mining is the same thing but at a much larger scale. It uses cryptography, encryption, distributed computing, and technology to verify and secure transactions. Here are the main ideas behind mining that make it work.

The Hash

At the heart of Bitcoin mining is the hash. The hash is a 64-digit hexadecimal number that is the result of sending the information contained in a block through the SHA256 hashing algorithm. This part of the process takes little time to complete—in fact, you can generate a hash in less than one second, pasting some content into an online SHA256 hash generator. This is the encryption method used by Bitcoin to create a block hash. However, decrypting that hash back to the content you pasted is the difficult part: a 64-digit hash can take centuries to decode with modern hardware.

A hash might look like this (this is the previous paragraph run through a hash generator):

a54f83a5db7371eeefa2287a0ede750ac623e49a8ba29f248eb785fe0a678559

If you change one value in that content, like switching one "t" to an "a," the hash changes. Here is the same paragraph, but the first word is misspelled as "Aa" instead of "At":

fbfa33ff980d1492b3a9275a1eb945d89bd6b699ca19c3c470021b8f253654af

This is the number called the block hash, which is used in the next block's header as part of the information run through encryption. Each block uses the previous block's hash, which acts to chain them together, thus creating the term "blockchain."

Target Hash

The target hash, used to determine mining difficulty, is the number miners are trying to solve for when they mine. This number is a hash generated by the network converted from hexadecimal to decimal form.

So, a block hash might look like this (block 786,729):

00000000000000000005a849c28eb24b8a5e04fcecc1ccb3eb2998e4730a456e

The target hash looked like this:

0x175c739

This number is a compacted representation of the difficulty target:

0...000005c73900000...0

So, miners needed to generate a number equal to or less than the above number.

Mining

Bitcoin mining requires the mining program to generate a hash and append another number to it called the nonce, or "number used once." When a miner begins, it always starts this number at zero. The nonce changes by one every attempt—first, it's 0, then 1, 2, 3, and so on. If the hash and nonce generated by the miner are more than the target hash set by the network, the attempt fails, and the miner tries again.

Every miner on the network does this until a hash and nonce combination is created that is less than or equal to the target hash. The first to reach that target has their proposed block added to the chain, receives the reward and fees, and a new block is opened. Once that block fills up with information (about one megabyte), it is closed, encrypted, and mined.

The Bitcoin network is made up of thousands of devices that mine 24 hours per day. Because the mining reward goes to the first to solve the problem, they are all competing. This competition led miners to create pools to gain an advantage over other miners because they needed more computational power to increase their chances of winning.

Proof-of-Work

The mining process is what you hear called proof-of-work (PoW)—the work done to generate the winning hash is viewed as proof the miner validated the transactions in the block, so it's called proof-of-work.

PoW is also sometimes called a consensus mechanism, but proof-of-work is only part of consensus. Consensus is achieved after the miner adds the block to the blockchain, and the rest of the network validates it using the hashes (reaching consensus). This doesn't require much energy or computational power because each mining node also does this while mining the latest block. As new blocks are added, the network confirms them.

Confirmation

Each block contains the hash of the previous block—so when the next block's hash is generated, the previous block's hash is included. Remember that if even one character changes, the hash changes, so the hash of each following block will change.

When you mine a block and close it, it isn't yet confirmed. The block isn't said to be confirmed until five blocks later, when it has gone through six total validations. With that said, it is possible to alter information in a block before reaching six validations, but it is highly unlikely because the network must be controlled by someone attempting to change information for it to work.

Rewards

The reward for successfully validating a block is bitcoin. In 2009, you'd receive 50 bitcoin for mining a block. But the block reward is halved every 210,000 blocks (or roughly every four years), so in 2013, the reward amount declined to 25, then 12.5, then 6.25. In Bitcoin's next halving event, the reward will change to 3.125.

Another incentive for Bitcoin miners to participate in the process is transaction fees. In addition to rewards, miners also receive fees from any transactions contained in that block. When Bitcoin reaches its planned limit of 21 million (expected around 2140), miners will be rewarded with fees for processing transactions that network users will pay. These fees ensure that miners still have the incentive to mine and keep the network going. The idea is that competition for these fees will cause them to remain low after halving events are finished.

Difficulty

Mining difficulty is how much work it takes to generate a number less than the target hash. Mining difficulty changes every 2,016 blocks or approximately every two weeks. The next difficulty level depends on how efficient miners were in the preceding cycle and how many miners are participating.

Bitcoin's network increases and decreases the hash rate (the amount of computing power) needed to mine the cryptocurrency. The more miners there are competing for a solution, the more difficult the problem will become. If computational power is taken off the network, the difficulty adjusts downward to make mining easier. This is done to keep block times averaging about 10 minutes.

The difficulty level for mining in March 204 was 83.13 trillion. That is, the chances of a computer producing a hash below the target is 1 in 83.13 trillion. To put that in perspective, you are about 285,000 times more likely to win the Powerball Grand Prize with a single lottery ticket than you are to pick the correct hash on a single try.

What Are the Economics of Mining Bitcoin?

Bitcoin mining is a business venture. Profits generated from its output—bitcoin—depend on the investment made into its inputs.

There are three main costs involved in Bitcoin mining:

• Electricity: This is the power that runs your mining systems 24/7. Mining can run up a substantial bill. When you consider that the process (network-wide) consumes as much electricity as certain countries do, the costs can be pretty high. It's also important to consider the costs of cooling the area your mining system is in. They produce a lot of heat while mining—the more units you have, the more heat they produce. These rigs need to be cooled, so the air conditioning you need can also add to the cost.
• Mining systems: Contrary to the popular narrative, desktop computers and regular gaming systems can be used to mine by joining a mining pool. But the returns are limited because most pools split the rewards based on the amount of work each miner contributes. These systems cannot compete with the ASIC mining machines, but it is possible to come out a few hundred dollars ahead after accounting for the energy used. If you want to be competitive, you'll need to buy several ASIC miners and join a pool—which can set you back between $4,000 to $12,000 per rig. The faster they can mine, the more you'll pay.
• Network infrastructure: Network speeds do not significantly affect the Bitcoin mining process, but latency does. Latency is the amount of time it takes to communicate with the rest of the network. Also, mining farms require multiple internal connections to connect each mining rig to a main router or server with a connection to the internet. However, if you're using your gaming rig to mine and join a pool, you shouldn't need any extra bandwidth—just low latency to the pool you joined.

The total costs for these three inputs should be less than the output—in this case, bitcoin's price—for you to generate profits from your venture. Considering the fluctuating—and often rising—price of bitcoin, the idea of minting your own cryptocurrency might sound like an attractive proposition.

But given the economic difficulties of Bitcoin mining, you may have to resign yourself to accepting lower profits and a longer time to break even after purchasing equipment to participate in the lottery that Bitcoin has become.

History of Bitcoin Mining

Two developments have contributed to the evolution and composition of Bitcoin mining as it is today. First, custom manufacturing of mining Bitcoin machines acted to centralize the network. Because Bitcoin mining is essentially guesswork, arriving at the right answer before another miner has almost everything to do with how fast your device can produce hashes.

In the early days of Bitcoin, desktop computers with ordinary CPUs dominated Bitcoin mining. However, they began taking a long time to discover transactions on the cryptocurrency's network as the algorithm's difficulty level increased with time. According to some estimates, it would have taken "several hundred thousand years on average" using CPUs to find a valid block at the early 2015 difficulty level.

GPU Mining

Over time, miners realized that graphics processing units (GPUs), or graphics cards, were more effective and faster at mining. But they consumed a lot of power and weren't designed for heavy mining. Eventually, manufacturers began limiting their mining abilities because the increase in demand for GPUs made their prices skyrocket and decreased availability.

ASIC Mining

Many miners now use custom mining machines, called Application-Specific Integrated Circuit (ASIC) miners, equipped with specialized chips for faster and more efficient Bitcoin mining. They cost anywhere from several hundred to tens of thousands of dollars. Today, Bitcoin mining is so competitive that it can only be done profitably with the most up-to-date ASICs. But even with the newest unit at your disposal, one is rarely enough to compete with mining pools.

Issues With Bitcoin Mining

Between one in 83 trillion odds, scaling difficulty levels, and the massive network of users verifying transactions, one block of transactions is verified roughly every 10 minutes. But it's important to remember that 10 minutes is a goal, not a rule.

Speed

The Bitcoin network can currently process between three and six transactions per second, with transactions logged in the blockchain about every 10 minutes. By comparison, Visa claims it can process about 65,000 transactions per second. Second-layer solutions and upgrades to the Bitcoin blockchain have attempted to address speed issues, but modern banking networks and other blockchains still dwarf the number of transactions the Bitcoin network can handle.

Scalability

The main issue at the heart of the Bitcoin protocol is scaling—the blockchain's ability to handle more work efficiently. Though Bitcoin miners generally agree that something must be done to address scaling, there is less consensus about how to do it.

Bitcoin has been adjusted by introducing upgrades and accepting input from layers that do much of the work off-chain, but it still has issues with scalability. When making adjustments, blockchain is surrounded by three central concerns: decentralization, security, and scalability. With current technology, one cannot be changed without affecting another. For example, if the Bitcoin blockchain were altered so that it could scale more effectively, it would likely decrease security and increase centralization.

Energy Use

For most of Bitcoin's short history, its mining process has remained an energy-intensive one. In the decade after it was launched, Bitcoin mining was concentrated in China, a country that relies on fossil fuels like coal to produce a majority of its electricity. Not surprisingly, in an age where all endeavors should have their environmental impacts evaluated and adjusted, Bitcoin mining's astronomical energy costs have drawn attention. According to some estimates, the cryptocurrency's mining process consumes as much electricity as entire countries.

However, Bitcoin proponents have released studies that claim that the cryptocurrency is powered largely by renewable energy sources. Some Bitcoin mining farms claim to lower capacity when there is a higher demand for energy. Another theory is that Bitcoin can be good for ESG because it drives green energy production, can stabilize energy grids, and can use methane as an energy source.

One thing to remember about these reports and studies is that they are based on conjectures, self-reported data from mining pools, and theory. This makes it difficult to be certain because the information is scarce and opaque.

The Bottom Line

Bitcoin mining is an energy-intensive process involving mining devices and software that compete to solve a cryptographic problem. The Bitcoin mining process also confirms transactions on the cryptocurrency's network. As an incentive to participate in the process, bitcoin is rewarded to those that win the competition.

Though individual miners using desktop systems played a role during the cryptocurrency's early days, the Bitcoin mining ecosystem is dominated by large mining companies that run mining pools spread across many geographies. Bitcoin mining is also controversial because it uses astronomical amounts of energy.

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