Updated: Dec 10, 2020
Like gold mining, bitcoin mining is uncertain, unglamorous and complicated. It is accomplished by high-powered computers, solving intricate computational problems. The hard work (and gain) entailed in solving one of these problems is the same as a miner striking gold in the ground. The likelihood of a computer solving one of these problems is around 1 in 13Trillion...we'll get to this soon.
Bitcoin mining has twofold results:
First, computers (after solving complex computational problems on the Bitcoin network) produce new bitcoins.
Second, miners make the Bitcoin payment network secure and credible by verifying transaction information.
Let’s look at bitcoin mining from a process that’s more relatable to our current reality: the systematisation of printed money.
THE BASICS: Difference Between Conventional and Bitcoin Currency
The majority of consumers trust printed currency because your currencies are usually backed by the federal or state central bank. In the US, for instance, the Federal Reserve manages and controls the production of new money; and the use of counterfeit money is brought to trial by the federal government. Digital payments are also backed by a central authority, such as when making online purchases using credit or debit cards. These transactions are processed by a payment company like Visa or Mastercard. They record transaction histories and verify that transactions aren’t phony –which is why debit/credit cards are suspended when account holders are traveling.
There’s no central authority that regulates Bitcoin. It is instead backed by millions of computers throughout the globe called ‘nodes.’ This computer network has similar functions to Visa, MasterCard, and Federal Reserve, but with a few crucial differences. Nodes store information about previous transactions and verify their legitimacy but, unlike the central authorities, these nodes are spread across the world and record transaction details in a public list that anyone can access.
CRYPTOCURRENCY: The Basics of Bitcoin Mining
When consumers make in-store or online transactions, these are documented by banks, physical receipts, and point-of-sale systems. Bitcoin miners do the same (WITHOUT these institutions) by lumping together these transactions in ‘blocks’ and storing them to a public record: blockchains. Nodes maintain records of these blocks so they can be verified into the future.
Bitcoin miners make sure the transactions are accurate when they add a new block to the blockchain. In particular, they make sure that bitcoin isn’t duplicated – a unique trait of digital currencies called ‘double-spending.’ Duplication isn’t an issue with printed money. In a store, once you’ve paid $15 for an item, the money is in the clerk’s hands, but digital currency is a different story.
Reproduction of digital information is relatively easy. With digital currencies, like Bitcoin, there’s a risk that a spender can make a duplicate bitcoin, send it to another party and hold onto the original. Let’s go back to printed money for a second and say that someone duplicated $10 in order to spend both the counterfeit and original at a grocery shop. If a clerk knew that shoppers were duplicating money, all they need to do is look at the bills’ serial numbers. If they are identical, the clerk could tell the money had been duplicated. This comparison is similar to what a bitcoin miner is doing when they validate transactions.
However, verifying each transaction can be a load of work for miners when there’s as many 500,000 sales and purchases occurring each day. This brings another crucial difference between the reserve and bitcoin miners: as compensation, miners win a bitcoin whenever they add a new block of transactions to the blockchain. The new bitcoin generated for each mined block is called ‘block reward.’ This reward is halved roughly every 4 years (or every 210,000 blocks). The block reward was 50 in 2009, 25 in 2013, 12.5 in 2018, and 6.25 sometime in mid 2020. At this rate, the number of bitcoin in circulation will reach a limit of 21million –which will make the currency more scarce (and valuable), but also more costly for miners to produce.
Bitcoin Mining: How It Works
Two things have to occur first before bitcoin miners could actually earn bitcoin from verifying transactions:
The easy part: they must verify 1 MB worth of transactions – which in theory can be as small as 1 transaction but is sometimes several thousands, depending on how much data is stored per transaction.
Miners have to solve a complex computational problems called ‘proof of work’ in order to add a block of transactions in the blockchain.
What this means is that miners are trying to come up with a ‘hash’ or a 64-digit hexadecimal number (which is less than or equal to the target hash). Miners have to guess all possible 64-digit numbers until they come to a solution. The guessing bit makes this whole process essentially a gamble. As of this writing, the level of difficulty of the most recent block is over 13Trillion. Hence, the chance of a computer producing a hash below the target is 1 in 13 T. Luckily, mining computer systems spit out much more hash possibilities than 1:13T, however, bitcoin mining entails sophisticated computing rigs and massive amounts of energy.
The level of difficulty is modified every 2016 blocks - roughly every 2 weeks - which supposedly keeps mining pace/rates constant. So if more miners are competing for a solution, the more difficult the problem becomes. In contrast, if computational power is taken off of the network, the difficulty levels goes downward, making mining easier.
Bitcoin for Dummies
To make it easier to understand, here’s a simple analogy:
You ask three friends to guess any number between 1-100 and write that number on a piece of paper and seal it in an envelope. Your friends don’t have to guess the right exact number, they just have to be the first one to guess any number that’s less than or equal to the number you’re thinking. There’s no limit to how many guesses they make.
For instance, you’re thinking of no.20
If Friend X guesses 21, they lose because 21>20. If Friend Y guesses 18 and Friend Z guesses 11, they’ve both arrived at viable answers because 18 and 11 are less than 20. There’s no “exact credit” for Friend Y eventhough their answer is closer to the target answer of 20.
Imagine you’re posing the guess-what-number-I’m-thinking-of-question, but you’re not just asking 3 friends and you’re not thinking of a number between 1-100. Instead, you’re asking a million would-be miners and you’re thinking of a 64-digit hexadecimal number. Now you realize that it’s going to be immensely hard to guess the right answer.
How to Compete with a Million Other Miners?
If 1:13Trillion isn’t difficult enough, here’s the deal: Not only are bitcoin miners required to give the right hash, they also have to be the first to give the right answer.
Since bitcoin is in essence guesswork, getting the right answer before another miner does have mostly to do with how fast your computer can produce hashes. 10 years ago, bitcoin mining can be competitively performed on usual desktop computers. However, as time passes, miners discovered that graphics cards (those commonly used for vid games) were more effective at mining than desktops. So then GPU (graphics processing units) came to dominate the game. In 2013, bitcoin miners began using Application-Specific Integrated Circuits (ASIC) or computers specifically designed for mining cryptocurrency as efficiently as possible. This can cost you several hundred dollars to tens of thousands. But, considering that the current bitcoin price is roughly $9,330 (and the reward for completing a block is 12.5 coins or roughly $117,000.), and upfront investment in an inexpensive ASIC is worth the while.
Nowadays, bitcoin mining has become so competitive that it can only be profitably done with the most up-to-date ASIC. When you use desktop computers, older models of ASICs, or GPUs, expenses on energy consumption far exceeds the revenue generated. Even if you have at your disposal the newest unit, one computer is hardly enough to compete with ‘mining pools’ (mining pool is a group of miners who merge their computing power and split the bitcoins they mined among members). An excessively large number of blocks are mined not by individual miners, but by pools. At some point in the history of bitcoin mining, companies and pools make up between 80-90% of bitcoin computing power.
Is Bitcoin Mining Sustainable?
With the odds of 1:13Trillion, surmounting difficulty levels, and the extensive network of users who verify transactions, a block of transaction is verified at roughly every 10minutes, (where 10minutes isn’t a rule but a goal).
The bitcoin network processes about 7 transactions per second, with transactions stored in the blockchain every 10minutes. As comparison, Visa processes roughly 24,000 transactions per second. But as the bitcoin network continues to grow, the current number of transactions per 10minutes will eventually surpass the number of transactions processed within 10 minutes.
At the heart of bitcoin processing there’s an issue called ‘scaling.’ While miners agree that something must be done to improve scaling, there’s not a consensus about how to do it. Two major solutions have been proposed so far to address the scaling trouble: developers suggested 1) to decrease the amount of data required to verify each block, or 2) to increase the number of transactions that each block can store.
With less data to validate per block, Solution #1 makes transactions cheaper and faster for miners. Solution #2 deals with scaling problem by allowing more data to be processed per 10minutes by widening blocksize.
In July 2017, mining pools/companies that comprise 80-90% of the network’s computing power voted Solution #1: incorporate a program that will decrease the volume of data needed to validate each block. This program which was voted and added to the bitcoin protocol is called ‘Segregated Witness’ which means to separate (segregate) transaction signatures (witness) from a block and affix them as extended block. While Solution #1 may not seem like much, signature data has been estimated to comprise 65% of the data processed in each block.
In less than a month, in August 2017, a group of developers and miners launched a hard fork which compelled the bitcoin network to create new currencies using the same codebase as bitcoin. Although this group agreed there’s a need to solve the scaling problem, they’re concerned that using Segregated Witness tech wouldn’t fully solve it. They instead went with Solution #2. From this resulted the ‘bitcoin cash’ which saw an increase in blocksize to 8 MB in order to expedite the validation process to allow 2million transactions per day. As of late 2019, Bitcoin Cash value is roughly $302 while Bitcoin’s is about $9,330.
note: ‘Bitcoin’ doesn’t have a capitalized letter when referring to individual coins, quite similar to when mining operations extract gold from the ground.
Don't worry if you interested in a bitcoin mining investment and want to get involved but don't have the computational power or know-how. There are mining pools you can join to get involved. Have a look at the bitcoin wiki for a comparison.
Keep up to date on all things Bitcoin and Blockchain by registering for news updates here.