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Bitcoin is one of the best-performing cryptocurrencies. Launched in 2009, the value of this digital currency has reached astonishing heights to date, creating hundreds of bitcoin millionaires.
But despite the broad appeal of bitcoin mining to entrepreneurial investors, most people have no idea how this potentially lucrative crypto mining process works.
Bitcoin mining works when miners complete blocks of verified bitcoin transactions, forming a fresh supply of bitcoins for the blockchain. They use high-powered computer systems to solve complex mathematical problems and get bitcoin tokens as a reward for their labor.
In this article, you will find a detailed account of how bitcoin mining works. You will also find useful information related to this topic, including:
- What bitcoin mining is all about.
- Understanding bitcoin reward system.
- What you require to mine bitcoins.
- Bitcoin mining and the law.
- The risks in mining bitcoins.
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Bitcoin Mining Involves Complex Math Computations
Bitcoin mining is the process through which newly mined bitcoins are put into circulation. The crypto mining process uses highly sophisticated computers to solve extremely complex computational math puzzles.
This process also forms a crucial element in the growth and maintenance of the blockchain ledger, which is a form of public record.
Bitcoin runs on a decentralized exchange, and since no centralized authority or regulator, such as the government or central bank, oversees bitcoin operations, mining helps maintain bitcoin's ecosystem by verifying transactions.
Therefore, bitcoin mining results in not only new bitcoins but also the creation of a secure bitcoin payment network. Additionally, it helps to legitimize bitcoin transactions, thereby ensuring their validity.
Network Security Is Like the Federal Reserve
A network of computers, or nodes, located across the globe back bitcoin. Functioning like a Federal Reserve, the nodes store information relating to previous transactions and also assist in verifying their authenticity.
The only difference being that bitcoin nodes record transactional data in a public ledger so anyone can access it.
Now, let's have a look at how bitcoin mining actually works.
How Do Bitcoin Miners Create Bitcoins?
Bitcoin miners create bitcoins by completing blocks of verified bitcoin transactions, which then form a fresh supply for the blockchain. To solve the complex computational math puzzles, bitcoin mining operations use Graphics Processing Units and Application Specific Integrated Circuits.
These are special mining-specific machines.
As a reward for their hard work auditing thousands of daily transactions, the miners earn crypto tokens or bitcoin as well as transaction fees. But to reap their bitcoin reward, miners have to fulfill certain conditions first:
- They must verify a block (1 MB) of bitcoin transactions. Using a complex system of computers, bitcoin miners calculate mathematical equations resulting in a 64-digit hexadecimal code referred to as a hash.
- Be quick to solve the puzzle. Miners compete in the race to solve mathematical puzzles. However, you need to be the first to get the correct answer or get pretty close, to receive payment. This proof of effort helps prevent fraudulent bitcoin sales while serving as an incentive to make miners exert more effort in solving complex mathematical problems.
Here is a video explaining how bitcoin mining works in a much simpler way:
Mining Bitcoins is Hard Work
Bitcoin mining is far from easy.
What's more, the difficulty level continues rising, or the chance of solving the numerical puzzles becomes slimmer as more miners compete for the prize. That's why miners require a lot of energy plus high-powered computer systems with the ability to spit out thousands of hash possibilities in split seconds.
This level of operation is a far cry from when bitcoin mining started. Then, miners could use laptops or desktop computers, earn bitcoins, and still remain competitive.
Being a digital currency, it's relatively easy to reproduce bitcoin tokens. The only problem is that bitcoin users could try to recreate multiple bitcoin copies, thus making more transactions than permitted.
This practice is known as double-spending, an illegal activity similar to creating counterfeits in the traditional fiat system.
Consequently, the miners' most significant task is to ensure there are no duplicates and that only a single version of a bitcoin token exists within the bitcoin ecosystem.
Bitcoin Reward System
The bitcoin reward system rewards miners who are successful at solving computational math puzzles. Let’s take a look at this system.
Only One Answer Wins
Simultaneous answers are a frequent occurrence, but only one answer wins. Miners who solve the problems but fail to verify multiple transactions do not get a reward. The bitcoin reward only goes to the miner with the largest number of verified transactions.
The losing block becomes an orphan block and cannot gain entry into the blockchain.
Bitcoin Caps Reduce How Many Rewards are Given
Bitcoin protocol or source code caps bitcoin mining at 21 million bitcoins. Although the rate of bitcoin mining is pretty high—with a new puzzle solved every 10 minutes—the last bitcoin will most likely enter circulation in 2140.
After every four years, a new bitcoin released per every mined block splits in half, which accounts for 210,000 blocks. This halving system started in 2009, when, after mining a single block, you would earn 50 bitcoins.
By May 2020, the bitcoin mining reward had halved to 6.25, and the process will continue until 2140. After this point, miners will continue auditing transactions and receive fees as a reward for maintaining bitcoin's network integrity.
Bitcoin halvings or reductions are essential as they help reduce the speed at which miners create new bitcoins. This lowers the supply of bitcoins in circulation, thus the numbers available for trading, and also helps reduce inflation.
The net effect of this reduction is that bitcoin's market price mirrors it, with the scarcity leading to a rise in bitcoin's value.
The Reward System Adjusts the Mining Difficulty
Another feature of the bitcoin reward system is that it evaluates and adjusts the levels of mining difficulty approximately every two weeks or after 2,016 blocks. As mentioned earlier, this level depends on the available computing power with larger amounts, leading to higher difficulty levels and vice versa.
For instance, at bitcoin's launch in 2009, the difficulty level was 1, but by November 2019, it had risen to 13+ trillion. This system helps to stabilize block production.
In addition to bitcoin rewards, miners also earn voting rights. As such, you can take part in proposals to change bitcoin's network protocol.
What You Need to Mine Bitcoins
Now that you understand how bitcoin mining works, let’s take a look at the resources you need to complete the mining operation.
Sophisticated Mining Machinery
You need ultra-modern, high-powered machinery that can work at great speed, plus the skills to operate the same.
This is an expensive undertaking, as it means setting up a mining rig, complete with a GPU or an ASIC. But for your setup to be profitable, you need more than a single computer. After all, you'll be competing with mining pools.
Mining pools are groups comprising miners who combine their mining efforts, then split the bitcoins amongst themselves.
Such pools represent the largest chunk of bitcoin's massive computing power.
Unlimited Electrical Power
The mining machinery consumes a lot of energy as it works to generate vast numerical combinations in a bid to try to guess the target hash. As a result, you need to have access to enormous amounts of electric power to operate the machinery.
What the Law Says About Bitcoin Mining
Bitcoin mining is not illegal, but then again, it depends on your geographical location.
Some governments fear that bitcoin threatens their control of fiat currencies, and the financial markets in general ban bitcoin mining, declaring it an illegal activity. Therefore, countries like Pakistan, Algeria, Bolivia, Egypt, and Morocco prohibit bitcoin mining and usage.
Still, mining and owning bitcoin is legal across most countries.
El Salvador became the first country in the world to declare bitcoin as a legal tender in June 2021. That said, you might want to confirm that bitcoin mining is legal in your country before you set up a mining rig.
Risks Associated With Bitcoin Mining
Bitcoin mining, though immensely profitable, comes with its own pitfalls. Let’s take a look at some of the risks you need to be aware of if you are considering mining this crypto.
High Energy Usage a Threat to the Environment
Bitcoin mining is arduous work.
Solving complex numerical problems consumes massive amounts of computing power, resulting in high energy usage. The most commonly used source of energy is coal, but this cheap fossil fuel poses an enormous threat to the environment.
The digital currency's huge carbon footprint is a major concern to environmentalists. It has also caused avid bitcoin supporters like Tesla to suspend further use of Bitcoin as payment for its vehicles, citing environmental concerns.
Meanwhile, bitcoin supporters are quick to point out that mainstream financial systems also consume lots of fossil-generated electricity. The electricity is necessary for use in ATMs and across multiple banking halls.
How to Counteract This Threat
One way to counter the risk of contributing to environmental degradation is using renewable or green energy sources. Some of these sustainable sources include solar and geothermal power.
Fortunately, several companies in the bitcoin mining industry are ready to embrace these greener energy options. El Salvador is also considering tapping into its vast geothermal reserves as it experiments with bitcoin mining.
There’s Risk of Double-Spending
Since bitcoin has no central authority or governing body to verify its operations, the possibility of double-spending is relatively high. Bitcoin's network relies on the blockchain, a digital transactions ledger, to record and verify transactions.
While the blockchain helps prevent double-spending, it is not entirely foolproof.
Bitcoin Can Be Highly Volatile
As an investment, bitcoin can be incredibly volatile, with its value rising and falling wildly because of various market factors. Nonetheless, investors with a long-term investment outlook find that this volatility lends the crypto great potential to deliver incredibly high returns.
You Might Not Recoup Your Investment
Bitcoin mining could turn out to be an unprofitable venture if you fail to weigh your costs carefully. In addition to the investment in expensive mining machinery, special cooling fans, and the high energy costs, you also need to be first in solving the puzzle or target hash.
Unfortunately, a single miner with limited computing power has fewer chances of regularly finding the next block, unlike mining pools, which boast massive amounts of computing power. Not only would it take you longer to find a block, but the difficulty level keeps going up, making it even harder.
The best option would be to join a mining pool.
Another option would be to set up your mining operation in a location with low energy costs, such as Georgia, Iceland, or Venezuela.
Yet another thing that could affect your profitability is the fee applicable when selling your mined bitcoin. For small-time miners, a retail exchange such as Binance is the most common place to sell your coins, but their fees go pretty high.
This could mean you end up not earning as much as expected from your bitcoin. Large mining operations have more leverage, though, so they tend to get better deals.
Security Breaches and Bitcoin Theft
As bitcoin's maturity renders its mining increasingly challenging for bitcoin entrepreneurs, security threats have taken a turn for the worse as well. This is because some miners use malware to compromise public Wi-Fi networks, thus gaining access to users' devices for mining.
And since bitcoin mining consumes tremendous amounts of computer processing power, the devices often grind to a halt.
Attackers could also infiltrate websites by loading mining software, a process known as cryptojacking. If your computer becomes a victim of such an attack, your electricity bill will soar, and the computer could even get destroyed.
Bitcoin theft can also occur indirectly due to double-spending, but in most cases, it happens because bitcoin owners fail to secure their bitcoin.
This could result from losing wallet passwords or if a bitcoin owner passes on without disclosing the details of their wallet's password.
Bitcoin mining is a potentially rewarding financial investment that can turn your fortunes around. However, since it is a resource-intensive venture, it can also be costly to carry out.
But even with access to resources needed to mine bitcoin profitably, it's advisable to tread carefully in order to avoid the various risks associated with bitcoin mining.
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