How Does Bitcoin Mining Work

Bitcoin is nicknamed ‘digital gold’ in the community of users partially because its value is defined by scarcity, therefore the process of generating new Bitcoins is named mining while the people participating in it are called miners. Miners are shaping a decentralized network by means of their computers with installed bitcoin-mining software. This software contains the copy of an entire network on each computer. In this way the records of the entire network are stored and secured. The data of every transaction taking place within the network is time-stamped and recorded as a chain of blocks, or data units. This form of organizing decentralized data storage is organization is named the blockchain, which represents a public distributed ledger storing data in its essence.

The scarcity of Bitcoin is prescribed by the code or the algorithm that limits the total supply of Bitcoin to 21M it also makes the mining process slower and more difficult computationally with the time. In this respect, Bitcoin is only prone to manipulation in terms of its supply when a single entity owns over 51% of its total supply, which is only likely to happen in case a single miner comes into possession of the entire network.

How does Bitcoin mining work?

Mining is a computational process in the first place and it has nothing to do with digging the ground as it works with gold. Instead, the computers of the miners make mathematical calculations that are deliberately made difficult not only for human beings, but also for computers, so that the average time it takes to solve a puzzle is about 10 minutes. That’s what it takes for a single Bitcoin transaction to be verified by the network and for the new block to be produced. A new block is produced each time the puzzle is solved. Such an algorithm also known as proof-of-work was deliberately made time-consuming, so that no one can mine all Bitcoins and come into their possession at once.

Remember, in the Bitcoin system there’s no centralized authority verifying users’ transactions (unlike the traditional banking system). In a way, the network is self-governed and the participants trust the verification to the miners: to verify each transaction they are required to run their computers to solve the puzzles. For their efforts miners receive rewards in the form of transaction fees charged from the party sending a transaction. Additionally, they are awarded with a fraction of the newly-mined Bitcoins.

Mining reward

In the early days of Bitcoin the mining reward was 50 BTC (2009) per block. As the difficulty increased together with the computational power and energy demands, the reward was halved to 25 BTC (2013) and then 12,5 BTC in 2016. It doesn’t mean that a single miner receives this entire amount, because in the majority of the cases the miners are teaming to solve the puzzles together, and therefore, share the reward. With years the reward will diminish to zero making mining bitcoin less profitable, however, it is estimated that once all Bitcoins are mined by 2140 the value of Bitcoin will increase due to its scarcity.

Security

The joined efforts of the miners help to secure the network from hacker attacks. Although the people in the network do not reveal their real names, a malicious action on the blockchain can be easily tracked by everybody, because the blockchain is transparent by design so that any changes applied to it can observed by everybody and the decision about these changes is reached via consensus. Hacking a blockchain will require immense computational power and amount of money to cover the costs of the energy consumption, so that even the stealth of all existing Bitcoin will not compensate for such expenses.

Summing all of the above-mentioned up, the functions accomplished through Bitcoin mining are:

  • Transaction history record keeping
  • Generation of new Bitcoins
  • Transaction validation
  • Security

 

 

 

Profitability

The profitability of mining is one of the most vital questions for the community members. Solo mining with a standard/average PC is certainly not a profitable endeavor, because the capacity of such computers is not enough for solving the puzzle. What makes mining profitable is when the computing power of several machines is  combined with cheap or free electricity and the availability of cooling equipment. Currently, many industrial-scale Bitcoin mining farms are located in the areas with cheapest electricity costs and availability of huge amounts of power directly from power stations, e.g. hydroelectric power stations, on which the water from the river is used for cooling of the equipment.  

Types of mining

To achieve profitability, miners have worked out several ways to mine Bitcoin.

Hardware mining

Hardware mining is associated with the use of one of the following types of equipment: CPU, GPU, FPGA and ASIC. CPU is a regular processor that may be fit for mining some other less power-consuming cryptocurrencies, but certainly not Bitcoin. The same is true about GPU mining that can be utilized to mine ether, for instance. FPGA-mining is better than the previous two, although it requires installing special chips to increase your computer’s performance. ASIC-mining is the most efficient of all due to the use of the powerful, but costly equipment. This equipment is currently used by the majority of the large-scale mining farms. The demand for it has spiked within the last few years together with the market price of Bitcoin.

Cloud mining

Cloud mining is another popular way of mining Bitcoins and other cryptocurrencies that is less costly for individual miners, because it doesn’t require them to manage the hardware. A company offering cloud mining services would normally have a remote data-center from which the hardware is managed. The cloud mining platforms also heavily rely on the computing power of a distributed network.

Cloud mining has several advantages, for instance, it can be done with standard CPU; the electricity demands are moderate; you don’t need to own any specialized equipment niether for mining, nor for cooling. Among the weak points of cloud mining are low profitability and centralized governance by the service provider who receives most of the profit.  

Industrial-scale mining

With the increasing network difficulty and the popularity of Bitcoin individual or solo mining has almost completely become extinct. It has been replaced by the industrial-scale mining carried out by mining pools and farms equipped with immense amounts of hardware and cooling equipment, and located close to an electricity-producing source such as power station. The most widely-known country, in which the majority of the Bitcoin mining is done is China, where the costs of electricity and the hardware equipment allow to achieve the highest mining profitability. Anyway, the daily electricity bills of a giant mining factory in China even would amount to several thousand dollars daily. Apart from a mining factory, a mining pool is a server that allows several miners to join efforts and the computing power to crack the proof-of-work puzzles. They share the mining reward proportionately to the amount of power that they contributed.   

At the moment the legal status of Bitcoin mining in the majority of countries is very unclear. Some of the governments are loyal to it, the other are not. So if you consider participating in it, make sure to check out the legislation of your country of residence.

Use mining calculator to account the profitability here.

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