Education

What Is Bitcoin Mining?

12 Mar 2021 | by: Rupert Hargreaves

What is Bitcoin mining?

Four years ago, a new asset class called Bitcoin exploded onto the scene. Since then, a whole sector has developed around cryptocurrency and the process of Bitcoin mining.

Bitcoin mining industry

While Bitcoin and the idea of a social cryptocurrency had been around for nearly two decades, Bitcoin hadn’t really attracted much attention until 2017.

That year, investors worldwide started to buy up the cryptocurrency, and institutional investors followed suit. Since then, a whole network and infrastructure has started to build around Bitcoin and other cryptocurrencies.

As the infrastructure required to support the cryptocurrency has grown and developed, so has the value of Bitcoin as more and more investors and institutions have bought into the idea of the decentralized currency.

After watching my portfolio in usd drop by over 50% in one day I realized it wasn’t usd that is important, it is the btc ratio. You see, I’m holding all altcoins, which help me gain more bitcoin as they rise in price. End of the day, I believe Bitcoin is king. This photo represents Bitcoins ratio to altcoins (seen in the trading chart behind).
Photographer: André François McKenzie | Source: Unsplash

However, while investors worldwide are trading and buying products in Bitcoin, few genuinely understand the infrastructure that supports the cryptocurrency and the Bitcoin mining process.

The history of Bitcoin

The first real mention and concept of a so-called cryptocurrency was published in 1998. The cypherpunks mailing list’s Wei Dai suggested the idea of a new form of money that uses cryptography to control its creation. It took a decade for this idea to gain traction and become a workable idea.

The first Bitcoin specification was published in 2009 on a cryptography mailing list by Satoshi Nakamoto. This author left the project in 2010 without revealing much about himself. To this day, speculation remains as to the true identity of this individual.

A common misunderstanding is that Nakamoto is Bitcoin’s core architect, and as a result, this individual controls the network. That’s not the case. All of the cryptocurrency’s users are responsible for its success. One individual cannot influence or develop it alone.

Bitcoin can only work correctly with a complete consensus among all users, which means all of its users have a strong incentive to protect the consensus and ensure its longevity.

For most users, Bitcoin is nothing more than a mobile app or computer program. However, behind the scenes, the technology that supports the asset is incredibly powerful. The core of this technology is the Bitcoin mining network.

The Bitcoin network

The Bitcoin network shares a public ledger called the “blockchain.” This ledger contains every transaction processed, which allows the user’s computer to verify the validity of each transaction. Digital signatures corresponding to addresses confirm the authenticity of each transaction. That means users have full control over sending Bitcoins from their own addresses.

The blockchain network gives cryptocurrency payments several advantages over traditional payments. Bitcoin transactions are secure, irreversible, and do not contain sensitive personal information. Transactions are also reversible. It’s impossible for users to force unwanted or unnoticed changes.

What’s more, all the information concerning the Bitcoin money supply itself is readily available on the blockchain for anybody to verify and use in real-time. By cryptographically encrypting the data, it can be trusted entirely.

As noted above, one of Bitcoin’s most attractive qualities is the fact that any single government or body does not control it. Therefore, no single individual, corporation, or government can decide to create new Bitcoins.

Bitcoin mining is the process that creates the cryptocurrency and it is resource-intensive, to control the number of Bitcoins in circulation.

The Bitcoin mining process

The process starts with the blockchain, where all Bitcoin transactions are recorded. Each time a trade is made through a cryptocurrency trading platform, the transaction details are broadcast to Bitcoin miners. The miners compete to mine crypto, but they’re also there to help dependently verify and record every transaction made.

Miners race to analyze the transactions and compete to add the next block to the chain. To do this, they bundle up transactions into so-called “blocks.” They then have to solve a computational problem called “proof of work,” which assigns the block an identifying code. That code is called a “hash”.

Proof of work is a process that ensures the information for a new block is difficult and time-consuming to make. It requires computing power, a high amount of energy, and time. It takes about 10 minutes to process the proof of work. The winning miner is awarded the block.

Bitcoin mining energy intensity

The fact that miners require so much energy in solving these problems is starting to attract significant negative publicity.

It’s unclear exactly how much energy Bitcoin uses, but one study estimates that Bitcoin’s total energy consumption is somewhere between 40 and 445 annualized terawatt-hours (TWh) with a central estimate of about 130TWh. That’s around the same level of power consumption as the Netherlands. In comparison, Google uses just 12.4TWh every year.

And the bigger the Bitcoin network grows, the more power it will consume.

The proof of work concept means that as the number of miners is increasing, the puzzle gets harder, and more computing power needs to be thrown at it. Adding new blocks to the blockchain is the only way to release new Bitcoin into circulation.

When Bitcoin mining first started, the reward was 50 Bitcoin. But as dictated by the coin’s creator, the reward is cut in half every time 210k new blocks are added to the chain — or roughly every four years. Today, the reward stands at 6.25 Bitcoin for each block.

Arms race

It’s estimated that today there are more than 1 million Bitcoin miners in operation, all competing for that next block to add to the chain every 10 minutes. This has sparked a bit of a Bitcoin arms race where companies worldwide are spending more and more money to develop faster chips and faster mining equipment.

It’s also consuming enormous amounts of energy. Energy consumption is growing every day and in the regions where it probably shouldn’t, such as China which has a large volume of coal power plant capacity driving its Bitcoin mining operations.

It remains to be seen how much longer the tech industry can chase returns from Bitcoin mining. With so many machines competing for an increasingly small return, mining is becoming a lottery.

But with the price of Bitcoin increasing almost daily, the potential payoff is growing higher as well. However, the increasing cost of mining equipment is eating away at potential returns.

Rising cost

Every single miner wants to find the next block, which means they have to be bigger and faster than that competition. This is driving demand for faster, more advanced mining equipment.

It’s also leading to a considerable amount of fraud in the sector. Buying high-quality Bitcoin mining equipment has always been risky. Purchasing a high-quality Bitcoin mining rig can cost several thousand dollars, that’s if you can find one. Most retailers are consistently sold out, with new stock being bought out almost immediately.

Another option is to mine Bitcoin in the cloud. This requires less upfront capital and space, but it’s also riskier. Fraud is rife in the industry.

The process of Bitcoin mining ensures Bitcoin remains trustworthy and reliable, but as a way to make money, it’s becoming increasingly challenging for the average person. The mining arms race has driven up the price of equipment while pushing down the chances of success.

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This article does not provide any financial advice and is not a recommendation to deal in any securities or product. Investments may fall in value and an investor may lose some or all of their investment. Past performance is not an indicator of future performance.

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