What Is Bitcoin Mining?

By Lipsa Das

What is Bitcoin Mining? 

Bitcoin mining is the process of adding new transaction blocks to the Bitcoin ledger by miner nodes that solve complex hashing problems and claim newly minted Bitcoins as mining rewards.

How does Bitcoin Mining work? 

Bitcoin mining is a central concept of Bitcoin’s proof of work (PoW) consensus mechanism, which helps “mine” new bitcoins to the system while validating transactions. 

As its name suggests, PoW literally translates to proof of “work being done”. In this case, that translates to powerful computers crunching the numbers required through sheer computational brute force to validate transactions and produce new bitcoins.

Core to the PoW consensus protocol are two main network participants: miners and nodes. A node is a network computer that provides the first layer of checks to determine whether a transaction is valid. Valid transactions are then added to a memory pool or, in other words, a queue of transactions that don’t have any blocks assigned to them. That’s where miners come in.

Miners compete against each other to find a secret phrase, called “nonce”, which, when combined with the transaction data, grants them the right to validate blocks. The winning miner determines which transactions need to be prioritized for the next block, put them together in a block and add it to the blockchain. 

Miners can also function as a node, because they have a copy of all transactions. However, nodes cannot operate as miners.

 Since miners need to have a copy of all transactions to do this, they can, by default, operate as a node, but vice versa is not necessary.

Which Miner Gets To Decide the Next Block?

As of writing, Bitcoin has over 14,000 miner nodes who compete with each other for the right to add to blocks to the chain, therefore earning the block reward.

This competition is where things get interesting.

Think of the proof-of-work problems as the combination of a complex safe. You know some of the access codes for the safe, but you have to guess the rest of the digits. And you’ve to do it faster than other people. 

In bitcoin terms, the miner’s computing equipment competes with other miners on the network to guess the nonce. Since there are billions of permutations, it’s a matter of trial and error until a miner guesses the correct one. 

The nonce combines the transaction information in the block to produce an encrypted series of alphanumeric characters, or the “hash”. The miner that provides this hash to the Bitcoin network can add the new block to the network. They get rewarded a fixed amount of Bitcoins generated by the system (the block reward).

How To Be the Miner That Decides the Next Block?

The quality of your mining hardware makes a huge difference to your effectiveness as a miner. The better the hashrate (computing speed) of your hardware, the more guesses it can compute per second and eliminate incorrect answers quickly. 

Therefore, miners who invest in advanced hardware or pool their resources together have a higher chance of guessing the correct nonce faster.

Statistically, though, the probability of the same miner getting it right every time is pretty low, which is good for the network. The more miners the network has, the more decentralized and secure the Bitcoin blockchain is.

Why Does Bitcoin Need Miners?

Bitcoin miners ensure the safety of the network by addressing a problem unique to crypto — double-spending. Double spending refers to trying to use the same currency more than once.

In a traditional financial system, this isn’t possible. In the cash economy, you can’t spend the same $100 bill at two places: Simply, once you spend it, since you don’t possess it any longer. With digital transactions too, banks can easily track the flow of funds, since they have a centralized database. In other words, you will never be able to spend the same money twice.

However, since Bitcoin is a digital currency with no central authority verifying transactions, the process for tracking your spending (and maintaining accurate records) is distributed across the network.

Miners act as decentralized “bankers” of the Bitcoin network and play a key role in preventing double-spending of Bitcoin. 

When unconfirmed transactions are pulled out of the memory pool for validation, the transaction with the most confirmations gets added to the block. Accordingly, any other transactions will fail. Typically, if a block gets over six node confirmations, it is valid. 

Meanwhile, individual miners themselves are incentivized to confirm transactions accurately and, honestly, the block reward is only valuable as long as the Bitcoin network remains accurate and trustworthy. 

Why Mine Bitcoin?

1. Financial Incentive

As of 2020, for each block a miner solves, they receive 6.25 Bitcoins as mining rewards. So while mining is not as profitable as it used to be a decade ago, Bitcoin mining is still lucrative. 

Bitcoin mining profitability, though, depends on various other factors — electricity bills, the price of Bitcoin, mining competition, etc.

2. Autonomy 

Bitcoin and other cryptocurrencies are about autonomy – they allow you to be your own bank, storing value and transacting independently of a central authority.

Mining takes this to the next level. As a miner, you maintain a copy of Bitcoin’s entire transaction history on your computer, so you become your own source of truth.

Further, mining bitcoin also grants you “voting power” proportional to the hash rate you commit to the network. Therefore, you can influence fundamental network changes such as forks to the Bitcoin network.

3. Maintaining the Bitcoin Network

Becoming a Bitcoin miner means the satisfaction of knowing you’re preventing manipulation of the Bitcoin network. For those who are enthusiastic about a decentralized monetary system, contributing to its function has a lot of appeal.

How To Start Mining Bitcoin?

Technically, anyone can start mining Bitcoin. However, over the years of Bitcoin evolution, the sophistication of bitcoin mining has significantly increased — going from GPUs (the ones you find in gaming laptops) to mining rigs. 

It’s still possible to mine with a GPU, but you’ll likely earn in pennies even if your hardware runs for months straight. And that is if you’re able to join a mining pool that accepts a low hash rate.

If you’re going the independent miner route, you’ll need specialized mining hardware, preferably ASICs (application-specific integrated circuit). ASICs are specialized hardware components with fast processing power, ranging from $500 to thousands of dollars.

You’ll also need to handle technical details yourself — for instance, deciding whether to purchase a secondhand machine, configuring the software that will run your miner, etc.

This process can quickly become complicated. Two of the simplest ways for beginners to start mining Bitcoin are; mining pools and cloud mining.

What Are Mining Pools?

Mining pools are groups of cryptocurrency miners who pool their computational resources to solve the proof of work problems and share the rewards of the mined bitcoin. This tackles two problems.

Independent miners can be up against entire mining farms, which makes your chances of success relatively low as an individual. So pooling your resources with a mining group gives the whole group a better chance of collecting the block reward.

Further, investing in mining hardware is expensive and has a sunk cost due to hardware deterioration at high temperatures. Mining pools allow you to hack your way into mining success by utilizing the power of the group to solve problems faster.

With mining pools, miners have a higher probability of securing the prize with lower costs. Of course, in doing so, they have to sacrifice some of the autonomy with respect to mining strategies and a portion of the rewards. But hey — it’s better than being empty-handed, right? 

Mining pools come in three types: 

1. Proportional Mining Pools

In proportional mining pools, each miner receives a share proportional to their hardware’s computing power to the entire pool. Once a block is found, the miner receives their payout.

2. Pay-per-share Mining Pools

In pay-per-share mining pools, each miner receives an instant payout based on the hardware power they have committed to the pool. Here, the pool owner takes on the risk of providing a steady stream of income to miners, even if they do not find a block.

3. Peer-to-peer Mining Pools

Peer-to-peer mining pools take a decentralized approach to mining, where pool decisions are made on the blockchain.

What Is Cloud Mining?

Cloud Mining extends the concept of cloud computing by allowing users to rent computing power from companies that mine Bitcoin on their behalf. 

It’s similar to how cloud services like Google Drive store and share your files instead of running your own storage server. In cloud mining, you pay the company a fee, they allocate hash power proportional to that fee, and you’re free to use that power to mine your Bitcoins.

The direct benefit of cloud mining is that you don’t have to worry about buying or maintaining hardware and dealing with storage, electricity, or cooling costs. You also need little to no technical know-how while using cloud computing. 

Cloud mining is also highly flexible. Depending on the market conditions and your mining strategies, you can scale up or down with a few clicks. Further, since most of these cloud mining companies run large-scale mining operations in inexpensive countries, you typically have access to state-of-the-art equipment at a fraction of the cost.

However, involving a third party in mining operations always comes with a risk. It’s important to choose a reliable and transparent cloud mining supplier — since you don’t own any hardware and are entirely dependent on the mining company.

Bitcoin Mining Vs Energy Consumption 

The proof-of-work consensus mechanism uses energy as the key resource for securing itself.

All miners use energy as they compete to solve the hash puzzle, but only one miner gets to add each new block; thus, energy expenditure by other miners serves purely to prevent a bad actor from manipulating the validation process, which in turn preserves the value of Bitcoin.

As a result, Bitcoin energy consumption is one of the core debates in the crypto space. But to fully grasp the “cost/benefit analysis” of Proof of Work, the facts must also be considered in context. 

Yes, Bitcoin does consume significant energy; but doing so guarantees the security of the system and, therefore the value of the currency as a whole. This is what allows it to pose an alternative to centralized banking, something that brings enormous possibilities in itself. 

Energy consumption remains a hotly-debated issue. However, as long as Bitcoin continues to function effectively and securely as a decentralized ledger, there’s a valid argument to be made in favor of Proof of Work.

Ready to Start Mining Bitcoin?

Mining bitcoin is a lucrative option for many people, but it takes some planning to make it a success.

For instance, you should do a cost-benefit analysis of mining Bitcoin relative to its price. Take into account the full stack infrastructure needed to run your mining operations profitably— mining hardware, energy costs, book-keeping, tax implications, accounting, etc. 

If you’re new to Bitcoin and mining, starting with a lower-end investment like cloud mining or mining pools would make sense. Test the waters before you go all in.

Let’s get mining!

Knowledge is power