Mining cryptocurrencies is a process that not only rewards miners with coins but also helps a blockchain network process transactions. Similar to extracting a real resource, mining is critical for the functioning of a healthy market. In this industry, it is also necessary for crypto to work on a fundamental level.
Bitcoin mining is a hot topic as of recently. On the one hand, newcomers invest in mining farms to capitalize on the growing cryptocurrency market, which, because of its heightened activity, hands out better rewards than usual. On the other hand, individuals who are not a part of the market are concerned about Bitcoin’s extreme power consumption, which is now higher than in some countries like Argentina, the United Arab Emirates, and the Netherlands.
In this lesson, we will shed light on cryptocurrency mining, how it works, why it is necessary, and what needs to be considered by using Bitcoin as an example.
Before explaining how to mine Bitcoin, we will first provide a brief summary of what happens behind the scenes during the mining process. For this, we will need to go over how blockchain technology works.
Each blockchain network is a digital ledger containing a history of timestamped transactions. Before being confirmed, groups of transactions are piled into what we call a block, and each block is chronologically ordered based on its creation date. Moreover, all blocks contain a small piece of information that allows it to be tracked and connected with the very first genesis block mined in 2009.
The information in question is called a hash, and it is used cryptographically to ensure the stability and authenticity of a blockchain network. Since each block has a hash that contains a trace of the previous block’s hash, it is impossible to send false data or create a fake version of the ledger’s history without it being easy to figure out.
The end result is that such a digital environment completely destroys the risk of double-spending, an event in which a user simultaneously spends the same coins more than once.
The previously described course of action is based on Proof of Work (PoW), a consensus model used among miners on a blockchain network to establish a universally agreed-upon transaction history.
On Bitcoin’s version of PoW, new blocks are created every 10 minutes, and each one distributes 6.25 BTC in block rewards. The network additionally possesses a four-year cycle in which block rewards are periodically halved. Bitcoin’s last halving event occurred in May 2020 when rewards dropped from 12.5 BTC to 6.25 BTC.
In practice, mining revolves around spending computing power and electricity. Each miner uses his computer to solve complex mathematical problems in an effort to find the next block’s hash. If successful, the user will be the first one to mine the block and connect it with the previous block of transactions.
Considering that the mining scene is highly competitive and that everyone competes for the same block, miners standardly operate 24/7.
To conclude, receiving a block reward requires a miner not only to verify a block of transactions, (which is usually one megabyte) but to be the first one to find a hash.
Bitcoin has a maximum token supply of 21 million coins. To prevent miners from mining the entire supply in a very short time, Nakamoto introduced mining difficulty to counteract the pressure.
The higher the number of miners present in the Bitcoin network, the faster a hash should be found, theoretically at least. But since mining difficulty exists, the chance to find block hashes naturally adjusts with the number of competing miners. If more users mine Bitcoin, they will comparatively have a harder time solving the puzzle.
Since mining difficulty increases drastically as the years pass by, only miners with extremely good hardware are rewarded as they have a better chance to receive block rewards. Obviously enough, miners are forced to invest in better equipment and gear - which is usually graphics cards given that mining is a GPU-intensive process.
However, this does not mean that individuals with mediocre hardware cannot participate. The emergence of mining pools helps these users compete by joining their powers and forming a pool in which their computing power is combined. If the mining pool in question is the one to receive block rewards, it will distribute them to every participant based on their contribution. On that account, mining is still inclusive as long as users are willing to join pools and pay a small fee ranging from 1% to 4%.
Mining pools vary by numerous characteristics. Most notably, they differ by their size, type of mining, and payout model.
Size-wise, users can join large or small mining pools depending on whether they want to increase their probability of earning block rewards, or increasing the amount of rewards.
For example, larger pools have a better chance of finding block rewards as they have more computing power. But since there is a large number of miners, the payout is smaller as a result.
In contrast, smaller pools mine blocks less often, but their rewards are significantly higher as there are fewer people in it. So even if you do not earn money for a while, the next block reward will ultimately make up for it.
Most of the time, miners encounter single coin pools that mine only one cryptocurrency, like Bitcoin. However, there are also cases in which pools change their desired network based on its profitability. If Ethereum suddenly provided better rewards than Bitcoin at one moment, the pool would switch to mining ETH. If Bitcoin is more profitable again, the pool switches back.
Traditionally, users mine locally on their own personal computer. However, since mining requires technical expertise and enough room for the hardware, it is impossible for some to host a mining farm at home. The alternative is to use cloud mining by hiring a company and its equipment to mine in your stead. However, the problem is that such service providers have a notorious reputation in the industry as some often scam their customers.
Mining pools have two kinds of payout models. In one version, pool participants receive rewards based on their shares, which is a representation of their offered power. Users do not have to solve the ‘math problem.' They are instead simply rewarded for their active contribution.
This model exposes the pool operator to additional risk due to the fact that rewards are distributed even if the pool does not solve the puzzle and receive a block reward. As a result, it is far more common to find a proportional model in which rewards are distributed proportionally to each user - based on the computing power contributed - only after successfully finding a hash.
Those who are interested in mining Bitcoin or any other cryptocurrency should first investigate whether it is profitable to do so or not. Even if profitable, it is important to figure out if mining is worth the time.
Investing in cryptocurrencies is near-instant. After purchasing any asset, the investor waits several months before selling for a profit. During that period, there is nothing needed to be done with the investment.
When mining, the situation is completely different. Miners have to set up mining rigs, observe them on a daily basis, and maintain them. If the operation lasts for more than one year, it is also needed to replace the mining equipment in order to stay competitive.
Both options have their advantages and disadvantages. It is up to the user to sufficiently analyze whichever option suits them best.
If a lack of technical knowledge and time do not represent obstacles, it is recommended to visit platforms like CryptoCompare to calculate how much profits one can earn from his equipment. These tools usually utilize metrics such as hashing power, power consumption, power costs, and pool fees to calculate profits for daily, weekly, monthly, and yearly timeframes.
If you find the results favorable, we recommend that you start your journey without any further consideration. Profits are all that matter at the end of the day, so there is nothing else to analyze apart from environmental concerns.
Mining is the blood of every blockchain network. Without it, transactions would not flow, and crypto enthusiasts could not transfer coins.
Mining is beneficial to both the miner and the network. While there are environmental concerns rising as a result of PoW’s inefficiency, we still have to consider that the issue is unavoidable with the current level of technological progress within the blockchain industry.
Proof of stake, a consensus model that thrives on the act of staking existing assets, might be a healthy alternative. Major networks like Ethereum are already migrating to PoS, and others might do the same for the purpose of achieving scalability.
For retail users, the main concerns of mining Bitcoin are the level of profitability, technical expertise, and time required to mine. With an increasing mining difficulty, the world of mining is becoming ever more exclusive, and in the future, it might become completely unprofitable to mine without an ASIC machine.
Considering the rise of other healthy passive investment opportunities like staking and yield farming, traditional mining can potentially die out. If either alternative succeeds in distributing higher rewards at a stable rate, crypto markets will forget about mining and turn to DeFi and Ethereum.
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