Cryptocurrency Mining 101

Bitcoin as Digital Gold

For the purpose of explaining mining, we’re going to be referring to Bitcoin most often. Bitcoin has commonly been referred to as digital gold for a number of reasons. Bitcoin has a supply of 21 million Bitcoin, and this supply is fixed, meaning there will never be any more than 21 million Bitcoin. The reason why this finite number is important, is because it makes Bitcoin digitally scarce. Comparatively, gold is a scarce and valuable resource.

The next point to raise, is how many of the 21 million Bitcoin are currently in circulation, and how does more Bitcoin make it into circulation? As of the time of writing this article about 18.2 million of the possible 21 million are currently in circulation. New Bitcoin enters circulation through a process called mining. The analogy of digital gold holds up in this instance, as gold is also brought into circulation through a process of mining it from the earth.

We can now introduce the idea of difficulty. Over time, it becomes more and more difficult to mine gold. This is because initially, gold mines were more abundant, and contained rich deposits. So with relatively little effort we could mine the gold from the earth. Now, the rest of the gold still left un-mined is in places that are difficult to extract, such as deep in the ocean, or beneath many layers of rock. Bitcoin was designed to mimic this principle. Over time, Bitcoin becomes more difficult to mine, and more energy is required to bring locked Bitcoin into circulation.

The Process of Mining

There are two ways of defining mining with respect to Bitcoin, both of which are true:

• Mining is the process in which new blocks are added to the blockchain
• Mining is the process in which locked Bitcoin is released into circulation

Let’s explore how this happens.

The creator of Bitcoin, Satoshi Nakamoto, had to figure out how to get a network of anonymous individuals, who don’t trust one another to agree on the state of a shared ledger, the Bitcoin ledger. The solution that Satoshi decided to implement is a process called proof-of-work.

Let’s start at the beginning. When the Bitcoin network began on January 3rd, 2009, Satoshi was running the only computer in the network. There was zero Bitcoin in circulation, and so, there were no Bitcoin to transact with. However, the process of mining can still take place. Bitcoin is designed to publish a difficult problem to solve every single block.

Bitcoin dynamically adjusts this difficult problem so that on average, this problem will take any number of computers an average of 10 minutes to solve. If you’re running a computer that correctly gets the right answer to the problem, then you are rewarded by the network with Bitcoin in the form of Bitcoin. Bitcoin previously locked by the network, is deposited into your Bitcoin address. This is the process in which new Bitcoin enters circulation. The process of solving this problem is what we know as mining. It is also easy for others in the network to check your answer, and prove you’ve done the work to solve the problem. Thus proof-of-work. Once the problem is solved, it triggers the Bitcoin network to solidify the transactions that took place in the last 10 minutes inside of a block. The block is added to the end of the blockchain, and the process repeats.

To summarize:

1. Bitcoin publishes a difficult problem to solve that takes an average of 10 minutes.
2. Miners are competing to be the first to solve the difficult problem.
3. The first miner to find the answer triggers the creation of a new block, which in turn rewards the miner with Bitcoin.

This process is repeated indefinitely.

The Finite Limit of Bitcoin

Different blockchains implement mining in different ways. As discussed earlier, there are only 21 million Bitcoin. If there is a Bitcoin reward every block, then how is there a finite limit?

Let’s explore.

Satoshi decided to implement a deflationary mechanism into the Bitcoin network, so less and less Bitcoin is released into circulation as time progresses. If your computer solves the difficult problem for a given block, then you are rewarded with Bitcoin, but how much?

If you were mining in 2009, then the reward was 50 Bitcoin, in 2012, then reward shrunk to 25 Bitcoin, in 2016 the reward became 12.5 Bitcoin, and in May 2020, the reward will become 6.25 Bitcoin. So the amount of new Bitcoin coming into the system is decreasing by half roughly every 210,000 blocks, or roughly every 4 years. This deflationary model was also intended to mimic gold, in the sense that it becomes more and more difficult to extract less and less gold from the earth.

So when will the last Bitcoin come into circulation? Not until around the year 2144.

What Are the Problems with Mining?

Imagine that the Bitcoin network is comprised of 1000 miners. Every miner is attempting to solve the current problem. Each miner is putting in 100% of their effort. For any given block, only a single one of the 1000 miners is able to solve the problem and claim the reward. In that sense, the other 999 miners wasted whatever energy they spent trying to solve the problem. So it’s not necessarily the fact that the Bitcoin network uses that much energy, its that it seems like the Bitcoin network is designed to “waste” energy. This is certainly one, perfectly valid way of looking at things. Let’s present other sides of the argument.

Adding more computers to the network increases the difficulty of the problem, and this in turn increases the amount of competition within the network. The more computers that in the network, the more difficult it is to disrupt the network in what is known as a 51% attack. The idea is that if any one entity owns 51% of the network, they can convince the other 49% of the network that something that didn’t happen, did happen. So in effect, the more computers in the network, owned by a greater diversity of individuals, the more secure the network becomes. So even though a single miner gets the reward, everyone is participating in the security of the network. Those who see this perspective do not see the electrical input as a waste.

The other way to look at this, is from a global financial perspective. The question is, how much energy does it take to maintain the USD, or the EUR, or CNY. We need to consider the computers running our country’s financial infrastructure, the energy required to run the printing presses, the thousands of individuals required to secure, and facilitate the maintenance of money. Furthermore, physical cash needs to be replaced as little as every 18 months, creating a recurring need to run those printing presses. An interesting fact about this is how frequently the bill needs to be replaced depends on the denomination of the bill. So $1 bills need to be replaced every 18 months, whereas a $100 bill only needs to be replaced every 9 years. Every country that has their own currency needs to have their own financial infrastructure, whereas the Bitcoin network is already global by design. Furthermore, every Bitcoin transaction is essentially equal on the network, it doesn’t cost any more to send $10 than it does $10 million. Moving $10 million in cash is a massive undertaking.

So while the Bitcoin network consumes more electricity than the country of Ireland, this may be the price we pay to experiment with new forms of money. This may just be the cost of building, securing, and distributing a global financial internet.

Do all Blockchains Need to be Mined?

Not all blockchains require the process of mining. After the genesis of the Bitcoin network, many mathematicians, cryptographers, and economists began examining the way in which Bitcoin functions, and discovered the underlying technical infrastructure. They named the underlying technology Blockchain. They realized that Blockchains in general are made up of a couple of different parts. A simple way to break up the Blockchain is to break it into the part that processes transactions, and the part that allows participants of the network to agree upon what took place. The later part is called the consensus mechanism. Proof-of-work in the case of Bitcoin.

After the parts were discovered, people started inventing other ways of securing the network. They were creating other consensus mechanisms. The other two most common consensus mechanisms are proof-of-stake (POS), and delegated-proof-of-stake (DPOS). These consensus mechanisms are much more energy efficient, however there is much debate as to the security of these other methods. The important thing is that we’re not locked into using proof-of-work for every blockchain. We can pick the best consensus mechanism for the job, based on the use case.

Can I Participate in Mining?

Anyone can participate in the mining process. The question is whether or not it will be profitable for you to do so. You can make a couple of dollars every month with an ordinary computer, but probably not by mining Bitcoin. Instead, you can download a program that allows you to mine on any number of other proof of work-based blockchain networks. The easiest way of participating in mining is by downloading HoneyMiner or MinerGate. These services do all the hard work for you, allowing you to just download the program and turn it on. They then will give you a payout for your mining contributions.

Graphics cards, typically used by gamers to run high performance video games are also commonly used for cryptocurrency mining. So if you own a couple of graphics cards because you’re a video game hobbyist, then while you sleep, you can turn on a miner on your computer and make a couple of bucks. Beware, this will decrease the life of your graphics cards.

Finally, there is specialized hardware called application specific integrated circuits or ASICs that can be purchased wherein the only purpose of these machines is to mine Bitcoin. These are for serious miners only. The profitability of mining is entirely dependent on how much you pay for electricity. So if you have access to cheap electricity, then perhaps mining is something that you’d like to explore.