Why do we use the term ‘mining’ to describe the crypto mining process?
With cryptocurrencies, there’s no central authority or centralized ledger.
That’s because cryptocurrencies operate in a decentralized system with a distributed ledger (more on this shortly) known as blockchain. Unlike the traditional banking system, anybody can be directly connected to and participate in the cryptocurrency ‘system’.
But without a central banking system, how are transactions verified before being added to the ledger? Instead of using a central banking system to verify transactions, cryptocurrency uses cryptographic algorithms to verify transactions.
How crypto mining works
Mining equates to performing cryptographic calculations for each transaction and requires a huge amount of computational energy. Not only does blockchain work to protect transaction data through encryption, as well as store this data in a decentralized manner (i.e., on hard drives and servers all over the world) to keep a single entity from gaining control of a network, but the primary goal is also to ensure that the same crypto token isn’t spent twice.
In effect, “mining” is one means of making sure that cryptocurrency transactions are accurate and true, so that they can never be compromised in the future.
The revenues for a mining operation are based on the mining rewards – the ability to earn new tokens. In reality, miners are essentially getting paid for their work as auditors. They are doing the work of verifying the legitimacy of Bitcoin transactions. This convention is meant to keep Bitcoin users honest by verifying transactions and miners are helping to prevent the “double-spending problem”.
What is involved in the crypto mining process?
Cryptocurrency mining itself refers to a type of validation model known as proof-of-work (PoW). There are two common validation types, and we’ll look at the other, known as proof-of-stake (PoS), in a moment.
In the PoW model – which Bitcoin, Ethereum, Bitcoin Cash, and Litecoin use, to name a few – individuals, groups, or businesses compete with one another with high-powered computers to be the first to solve complex mathematical equations that are essentially part of the encryption mechanism. These equations correspond to a group of transactions, which is known as a block. The first individual, group, or business that solves these transactions, and in the process validates the accuracy of these transactions within a block, receives a ‘block reward’. This is paid out as digital tokens of the validated currency.
In the case of Bitcoin, only one megabyte of transaction data can fit into a single Bitcoin block. The 1MB limit was set by Satoshi Nakamoto, and this has become a matter of controversy as some miners believe the block size should increase to accommodate more data. This would effectively mean that the Bitcoin network could process and verify transactions more quickly.
In addition to lining the pockets of miners and supporting the Bitcoin ecosystem, mining serves another vital purpose: it is the only way to release new cryptocurrency into circulation. In other words, miners are basically ‘minting’ currency.
For example, as of January 2022, there were just under 19 million Bitcoins in circulation, out of an ultimate total of 21 million.
To earn new Bitcoins, you need to be the first miner to arrive at the right answer, or closest answer, to a numeric problem. This process is also known as PoW. To begin mining is to start engaging in this PoW activity to find the answer to the puzzle.
No advanced math or computation is really involved. You may have heard that miners are solving difficult mathematical problems – that’s true but not because the math itself is hard. What they’re actually doing is trying to be the first miner to come up with a 64-digit hexadecimal number (a ‘hash’) that is less than or equal to the target hash. It’s basically guesswork.
So it is a matter of randomness, but with the total number of possible guesses for each of these problems numbering in the trillions, it’s incredibly arduous work. And the number of possible solutions (referred to as the level of mining difficulty) only increases with each miner that joins the mining network. In order to solve a problem first, miners need a lot of computing power. To mine successfully, you need to have a high “hash rate,” which is measured in terms gigahashes per second (GH/s) and terahashes per second (TH/s).
Aside from the short-term payoff of newly minted Bitcoins, being a coin miner can also give you “voting” power when changes are proposed in the Bitcoin network protocol. This is known as a Bitcoin Improvement Protocol (BIP). In other words, miners have some degree of influence on the decision-making process for matters such as forking. The more hash power you possess, the more votes you have to cast for such initiatives.
How lucrative is Bitcoin mining?
The rewards for Bitcoin mining are reduced by half roughly every four years.
When Bitcoin was first mined in 2009, mining one block would earn you 50 BTC. In 2012, this was halved to 25 BTC. By 2016, this was halved again to 12.5 BTC. On May 11, 2020, the reward halved again to 6.25 BTC.
In 2020, one modern Bitcoin mining machine (commonly known as an ASIC), like the Whatsminer M20S, generates around $8 in Bitcoin revenue every day. The underlying cost of mining is the energy consumed. The revenue from mining has to outweigh those costs, plus the original investment into mining hardware, in order to be profitable.
What are the downsides of crypto mining?
The risks of mining are often financial, regulatory and environmental. Mining is a financial risk because one could go through all the effort of purchasing hundreds or thousands of dollars worth of mining equipment only to have no return on their investment. That said, this risk can be mitigated by joining mining pools. If you are considering mining and live in an area where it is prohibited, you should reconsider. It may also be a good idea to research your country’s regulation and overall sentiment toward cryptocurrency before investing in mining equipment.
Bitcoin and other similar public blockchains and the way their transactions are secured and trusted is highly energy intensive.
Blockchains currently account for 0.58% of global electricity consumption, while Bitcoin mining alone consumes almost as much energy as the entire US Federal Government. It just goes to show that there are environmental and sustainability implications that those with interests in crypto will need to resolve in the future if more mainstream adoption is to occur.