For thousands of years, men have gone beneath the dangers of the earth to extract minerals and precious metals such as gold, copper, platinum, and the like. The evolution in technology and finance has led to a new but different form of mining – Bitcoin mining. And given that Bitcoin is not a physical entity, many people are understandably wondering how Bitcoin mining works.
Bitcoin has so far been likened to gold in many regards. Some consider the digital asset a better hedge against inflation and may even replace gold as a potential store of value. While the world is yet to get there, the nature of mining bitcoins may have been borrowed from gold mining.
We know that gold exists underground and it’s the job of brave men and women to bring it out the world. The same goes for Bitcoin which exists in the network’s design but needs computing power and miners to extract bitcoins from code and bring them into circulation.
Bitcoin mining, though done differently, achieves the same thing as gold mining – bringing new units onto the market.
Some bit of background information
We will look at some of the reasons for mining before delving deeper into how Bitcoin mining works. Bitcoin mining serves the following purposes:
- Minting new coins
- Confirming transactions on the network
Mining is also very important because it prevents double spend. Double spending is the equivalent of using counterfeit money.
It goes without saying that Bitcoin is underpinned by blockchain technology. The new technology allows entities to transact in a trustless manner without the need for third parties. Bitcoin was designed to be a currency just as much as the Japanese Yen is.
The difference between fiat and cryptocurrency is (de)centralization. Fiat currencies are issued, controlled, and governed by central authorities such as central banks. The central banks can print more money whenever they want and there is nothing that the public can do about it.
Bitcoin is completely different as it thrives on decentralization. This means that there is no single entity that controls the network but a pool of computers spread across the globe does so. Each computer on the protocol is known as a node and is required to run the Bitcoin software.
Mining is simply the process by which nodes mint new digital coins and maintain the network by validating transactions. Nodes comes and go without disrupting the functioning of the network.
Bitcoin mining has become an industry so massive that companies with high capital are buying highly expensive and specialized mining equipment. Gone are the days when desktops and laptops were good enough to participate in Bitcoin mining.
How Bitcoin mining works
We have already highlighted that Bitcoin involves bringing new digital coins into circulation. But how does this happen?
Bitcoin mining involves solving a mathematical puzzle. Thousands, if not millions, of computers on the network, compete to come up with the solution. Whoever gets the correct outcome first is declared the winner and rewarded with freshly minted bitcoins. The miners get to create new blocks which are then added to a chain of blocks. The longer the chain is, the more secure it is.
The miners rely on guesswork to solve the puzzle. This is a time sensitive contest and miners with faster and more powerful equipment stand a higher chance of solving the puzzle. The first miner to guess the correct outcome informs other miners who immediately stop working on this block. They then turn their focus and energy on the next block and the cycle continues.
Economics of how Bitcoin mining works
Miners are rewarded for creating new blocks. The reward is currently 12.5 Bitcoins (BTC) and is expected to halve every four years or so. The next halving is expected to occur in May 2020 and the reward to will shrink to 6.25 BTC. The price of bitcoin normally rallies towards halving.
The economics of Bitcoin mining go beyond the reward. Factors such as Bitcoin price, electricity costs, costs of hardware, climate, and more have to be taken into account.
Bitcoin was initially a geek thing which allowed computer programmers and anyone with a computer to take part in the mining process. The industry grew and deep-pocketed players came into the picture and forced the small guys out of the equation.
Companies such as Bitmain, Canaan Creative, Ebang International – all Chinese companies – have developed specialized equipment that increases the chances for miners to solve the puzzle. This has forced the industry to be slightly centralized – something that Bitcoin and blockchain technology intended to fight from the beginning.
People with lesser computing power decided to pool their computing resources together to form mining pools. They do so to increase their chances of winning the bitcoin creation arms race and get new coins in return. However, their profits from the sale of bitcoins are slightly reduced because they have to be shared among all the pool members.
Mining farms are mostly concentrated in areas where electricity is cheap and the weather conditions allow for natural cooling of mining equipment.
Bitcoin mining difficulty
The Bitcoin mining difficulty changes so that the Bitcoin network maintains a block time of ten minutes. Block time is defined as the amount of time required to process a block and mint new coins. Bitcoin’s code was programmed to allow a maximum of 21 million coins which will only be completely mined after 2140.
More than 17.7 million BTC were mined in a decade but the remaining 3.3 million coins will only be mined in more than a century. This has everything to do with Bitcoin halving.
Proof-of-work (Pow) system
This article would be incomplete without mentioning the Proof-of-work (PoW) consensus algorithm used in the Bitcoin protocol. The PoW is implemented to ensure that the Bitcoin network does not suffer from denial of service attacks and to prevent spam from clogging the network. Other blockchain networks implement their own consensus algorithms.
Many have argued that Bitcoin’s PoW is killing the environment because of high energy requirements. The concept of PoW was initially brought to public attention in 1993.