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You may have heard the term mining in relation to Bitcoin or cryptocurrency in general – but it isn’t quite obvious what it means in that context.
Mining in the crypto world is the process of keeping blockchain data in check. It involves hard work (done by computers) and results in a slow accumulation of resources – just like mining for minerals.
Anyone can become a miner, but mining is not for everyone. Over 70% of Bitcoin mining happens in China, where dirt cheap electricity makes running mining computers extremely profitable.
Should you become a miner? Or is there a better way to make money from mining?
Why Mine Cryptocurrency?
Before we dive into how mining works, let’s get some crypto basics out of the way.
The 1st important thing to keep in mind is that cryptocurrency transactions are recorded on a blockchain. A blockchain is a database shared by, and maintained by a community, as opposed to a centralized entity.
- Blockchain. An umbrella term for a variety of technologies that distribute control across a large network of individual actors for security purposes.
- Decentralized. Anything that is not controlled by a single, central entity or group.
Mining is the term used for the process of validating and recording new transactions on a blockchain.
What’s the Incentive?
Validating and recording all the new transactions that come across the network is not an easy task. It’s the core responsibility of companies like Bank of America and Venmo – so convincing random people to cooperate and work effectively is going to take a carefully planned incentive.
The rules of any successful decentralized system must be created in such a way that it is in the best interest of random people around the world to help maintain it.
Satoshi Nakamoto incentivized people to maintain Bitcoin’s blockchain by rewarding them with newly-minted Bitcoin. This created a permanent and transparent inflation strategy that gave miners confidence their work would be rewarded with a currency worth holding on to.
Who Mines Cryptocurrency?
Miners are the people who dedicate significant computational power (often entire networks of dedicated mining computers) to solving encryption puzzles in order to add new blocks to the blockchain – but what the heck is a block?
Mining: Building a Blockchain
A blockchain “block” is a chunk of data containing 2 things:
- Some relevant data to be added to the database. (For example, all the bitcoin transactions that occurred within the last 10 minutes.)
- The ID of the block before it in the chain.
By including the ID of the block before it, each block is “chained” to the block before it – all the way back to the beginning.
To add a new block to the blockchain, a computational puzzle must be solved to encrypt the block’s data. Mining is the act of solving this puzzle.
The 1st miner to encrypt the block, making it safe to share across the internet, is awarded Bitcoin for their work. The winner shares their results with all the other miners, who verify the encryption is safe and the work is done. This is called “proof of work.”
Once verified by the other miners, the winner securely adds the new block to the existing chain.
You many have heard of the Bitcoin “halvening”. Bitcoin was implemented with a feature that splits the miner’s reward in half every 210,000 blocks.
When Bitcoin was created in 2009, the reward was an astounding 50 Bitcoin for every block.
Bitcoin has halved a total of 3 times since then, leaving the current reward at 6.25 BTC as of May 2020. Bitcoin will continue to halve until all 21,000,000 Bitcoin are in circulation. Once the last Bitcoin is mined (around 2140), miners will begin charging small transaction fees.
Many individual miners lack the necessary equipment to ever mine a block on their own. To still have a chance at making some profits, they join mining pools.
Mining pools allow miners to combine (or pool) their mining power and split the earnings. Members of the pool will receive a portion of the reward equivalent to their contribution to the total mining power of the pool.
Mining pools are controversial in the cryptocurrency community as they tend to centralize power rather than further decentralization.
The rules of the incentive system dictate that those with the fastest computers make the most money. This has started a computational arms race across the world.
Most computers are capable of mining Bitcoin but aren’t efficient enough to profit (earn a reward more than the cost of the electricity required to attain it.) This is why areas with the cheapest electricity costs have the highest concentration of mining power.
Nearly any computer can run crypto mining algorithms, but some are much better than others. A modern computer has a CPU (central processing unit) and a GPU (graphics processing unit). If the CPU is the brain of the computer, the GPU is the muscle used for mining.
Modern GPUs like the GTX 3080 are powerful and efficient enough to make mining profitable – even in the United States, where electricity costs are typically really high.
As Bitcoin mining grew in popularity, companies like Bitmain and Antminer emerged to build and sell specialized computers that could only perform 1 operation: mining.
These ASIC (application specific integrated circuit) computers began to dominate the network power, and people began to collect hundreds of them to start mining “farms”.
ASIC computers are so specialized that they can often only mine 1 specific cryptocurrency. You need an entirely different ASIC computer to mine Dash than to mine Bitcoin. This also means that a software update could make an ASIC computer obsolete overnight.
ASIC vs. GPU Mining
ASIC computers are entirely useless for anything other than crypto mining – but they smoke every GPU on the market. Mining with ASIC computers carries more risk than GPUs, but it’s much more cost effective. ASIC computers comprise the majority of mining power on most blockchains, including Bitcoin.
Certain miners and mining pools with the largest ASIC operations tend to centralize mining power on the network. For this reason, Ethereum and many other cryptocurrencies are designed to prevent ASICs from mining on their network. By only allowing GPU mining, it becomes much more expensive to dominate the network.
Should You Mine Cryptocurrency?
Cryptocurrency mining is not for everyone. Unless you live in China, your electricity is probably too expensive for you to turn a profit.
But don’t lose hope, there might be another way to profit off of your newfound mining knowledge.
- Proof-of-stake. Ethereum 2.0 promises to eliminate the need for expensive mining equipment. Instead of a race between the miners to secure the data, miners will stake Ether in order for the right to secure a portion of the transactions.
- Rent mining power. NiceHash is 1 of the largest mining pools in the world. They offer a service to rent mining power produced by machines in countries with low electricity costs. This way you can mine without ever getting technical.
- Invest in the industry. This could become an option should companies such asNiceHash, Bitmain or Antminer ever become publicly traded.
The cryptocurrency industry is still young, and mining has a long way to go before reaching maturation. Whether or not you should pursue an investment related to mining is up to your risk tolerance. Nearly any industry this new and underdeveloped is likely to contain a lot of uncertainty, but with uncertainty comes the potential for profit. Just be careful.
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