Newsbit 25-05-2022 11:37 leestijd 7 - 10 min

How does Bitcoin mining work? Everything you need to know

It’s not hard to argue that Bitcoin miners are the most important members of the Bitcoin industry, economy and ecosystem.

They work for a financial incentive: the opportunity to discover shiny new Bitcoin, just like miners who scour for gold.

But when it comes to the Bitcoin ecosystem, they have another title that is far, far more important: validators.

That was the great invention of Bitcoin’s pseudonymous creator Satoshi Nakamoto.

They are responsible for adding new information to the Bitcoin blockchain — confirming that transactions are valid and bundling them into a “block” that is added to the end of the blockchain, making it immutable and unchangeable.

What is Bitcoin mining?

Instead of backhoes and pickaxes, Bitcoin mining is done with specialised, high-powered computers that solve math problems for the right to create the next block, which comes with a reward of new BTC.

All public blockchains like Bitcoin are basically digital ledgers that have a special feature: once a transaction — sending BTC from one address to another — is recorded on the blockchain, it cannot be erased or changed in any way. And once a block of those transactions have been added to the blockchain, no new transaction can be added to that block, or any block that came before it.

This makes information on a blockchain “trustless” — what the rest of us would call trustworthy. That’s because you don’t need to rely on a human being for the transaction to be executed properly. The blockchain’s cryptography ensures that, once the payment is made, it cannot be cancelled or reversed by either party.

So what does mining Bitcoin mean? Well, it’s the way the records of those transactions are added to a blockchain. It is also the way new BTC are added to the ecosystem. That’s because the miner who creates a new block is rewarded with a cache of newly created Bitcoin.

The role of Bitcoin mining

The Bitcoin miner has two roles in the ecosystem: The first is gathering Bitcoin transactions into a block that can be recorded on the blockchain — while validating that they are accurate. This is what creates that trustlessness. Validators are vital because they prevent what’s called “double spending”. 

Electronics chain Best Buy, for instance, had the same problem when internet commerce arose. The company delayed its gift card program rollout because of the potential for double spending: a person with a gift card could make an online purchase for pickup in a store while simultaneously buying something at checkout. The company’s systems had to be rewritten to prevent this.

In blockchain, it means making sure someone doesn’t send the same Bitcoin to two addresses in two separate transactions at once — after all, each new block is only added every 10 minutes, leaving plenty of time to make multiple purchases with the same digital currency. Miners ensure that doesn’t happen by making sure the block does not have multiple transactions for a single Bitcoin.

In exchange for this work, miners are rewarded in two ways: mining rewards and transaction fees. The first is by far the most lucrative. 

The miner’s second role is adding new supply to the Bitcoin economy. There’s a hard limit of 21 million BTC, and once this supply has been exhausted, no more will ever exist. About 19 million have been mined — or created — since the blockchain went live on 3 January 2009. 

That maximum is key to Bitcoin’s value, especially now that it is seen less as a digital currency and more as a store of value that can protect assets against inflation and economic downturns — digital gold to traditional finance’s yellow metal. Because only a limited amount of Bitcoin will ever exist, it will not be inflationary. That’s in contrast to fiat currency, which can lose value if a government prints more. 

While new blocks are being minted, there is still some inflationary pressure on Bitcoin. The reason is that the block reward is cut in half every 210,000 blocks — roughly every four years — in what is called a “halving”. 

In 2009, each block came with a 50 BTC reward. In November 2012, that was reduced to 25 BTC — falling to 12.5 BTC in July 2016 and 6.25 BTC in May 2020. That will keep happening until about 2140.

At that point, miners will rely solely on the fees charged for every transaction they validate and put in the blockchain.

Transaction rewards come with their own potential problem, as miners can select which transactions to include in each block — and they naturally favor those with higher fees. That’s a problem when the Bitcoin network is congested, which is happening more frequently as BTC becomes more popular and valuable. If a Bitcoin sender sets the fee too low, miners will ignore the transaction until there is free space in a block, which can cause long delays in finalising transactions. 

But if the fee is too high — and the average transaction fee spiked to more than $60 in April 2021 — it makesFu Bitcoin less useful as a currency used for the day-to-day payments Nakamoto intended. In late 2021, the average fee was $2 to $3, making buying a cup of coffee impractical. (Remember that each Bitcoin is divided into 100 million satoshis, so very small purchases are possible.) 

How does mining Bitcoin work?

The way Bitcoin ensures that the correct miner is the only one adding transaction blocks to the blockchain is through a process called Proof-of-Work. It also makes the process fair by randomizing the selection of which miner will win the right to that block and its rewards.

Proof-of-Work is essentially a mathematical contest, in which the first one to get the right answer wins. And the nature of the puzzle makes guessing one possible answer after another the only way to win. 

What’s noteworthy is that the difficulty of the problem changes every two week to ensure that solving each puzzle and mining the block takes about 10 minutes, regardless of the hash rate — computing power — thrown at it. 

That’s how Bitcoin mining works. And in 2009, it sounded like a great idea. 

The problem is Nakamoto didn’t consider what would happen when Bitcoin’s value skyrocketed — first to $100, then $1,000, $10,000 and $20,000 in 2017, and $60,000 in 2021. 

With potential rewards of hundreds of thousands of dollars up from grabs every 10 minutes, an arms race began, with well-funded companies first buying and then building specialised computer chips designed specifically for Bitcoin mining. It got so bad in mid-2021 that the makers of graphics chips for high-end computer gaming started altering their chips specifically to make them useless for Bitcoin mining, as miners were causing a shortage.

Effectively, the vast majority of mining was consolidated into fewer and fewer companies running server farms. Which brought another problem, which although highly unlikely is not impossible: the 51% attack. 

A 51% attack refers to the fact that, if more than half of the miners validating transactions agree, they can stop the blockchain and rewrite transactions made while they are in charge. That is, they can double-spend Bitcoin in those transactions. 

While it’s very unlikely to happen to Bitcoin as the number of miners is still quite large, smaller Proof-of-Work blockchains can be realistically threatened by this — and several have actually been hit by successful 51% attacks. Doing that to Bitcoin would likely gut the project, tank the Bitcoin price, and enormously damage crypto as a whole.  

A big response to these problems, among others, has been to find other validation techniques. The main one is Proof-of-Stake, in which validators essentially put up a bond for good behavior and are randomly chosen to mint a new block based on the size of their stakes. This also solves Proof-of-Work’s scalability problem as it means new blocks can be created far faster, increasing the number of transactions per second possible by orders of magnitude. 

Proof-of-Stake would also solve Bitcoin’s environmental dilemma. Simply put, the power sucked up by those mining computers is enormous — equal to the amount used by whole countries. Aside from the staggering cost, it’s making mainstream investors nervous, politicians upset and environmentalists outraged.

How to start mining Bitcoin

If you’re thinking about getting in on the bonanza — asking yourself what does mining Bitcoin mean — there’s two ways to go about it: on your own, or by joining a mining pool. 

The first mining pool, Slush, began in early 2010, when Bitcoin’s value was measured in pennies.

The idea is that by pooling resources and sharing rewards, you can build a combined hash rate that has a far better chance of actually winning a block validation race. Of course, when you’re pooling with thousands of other miners, the return on a 6.25 BTC reward — even at a mid-five figures price — starts getting fairly small.

So the best way to figure out how to mine Bitcoin could well be to investigate pools and see what their rate of return is. If you’re going to splash out several thousand dollars on a serious gaming PC from a company like Alienware or a dedicated mining rig you can’t play Halo on, you need to add up the cost of the hardware, electricity and taxes — don’t forget them — and make certain it’s worth it. 

What do I need to mine Bitcoin?

So: how and where do you get Bitcoin without buying it? 

First off, you can make a serious investment in custom-built mining rigs like Bitmain Antminers that cost anywhere from thousands to tens of thousands of dollars each. These ASIC — application specific integrated circuit — rigs are what is mining Bitcoin on a grand scale today. They are designed specifically for mining Bitcoin and can do nothing else. 

You’ll also have to learn some complex software and invest a fair bit in electricity — enough that you’ll want to be sure you live somewhere with cheap power.

More realistically, you can spend a couple of thousand dollars on a high-end gaming computer like an Alienware with a top-notch graphics card, highly specialised software, and join a mining pool. Graphics cards are good at the repetitive nature of Proof-of-Work mining, and have the speed and efficiency to beat CPUs.  

Less expensive ASIC computers can be found on Amazon that are equal to or less expensive than a gaming computer. But then, they don’t play Halo or stream YouTube.

Is Bitcoin mining secure?

What does mining Bitcoin mean from a security perspective? Well there’s a couple of answers. The first is you’ve got to protect your system from hacks — after all, if a hacker, phisher or ransomware blackmailer finds out you’re mining crypto, they have a pretty good idea that there might be something valuable on your computer. Because of this, an external cold storage wallet is a good idea. 

That means starting with an HTTPS Everywhere extension and a virtual private network, or VPN, to prevent anyone from tracking your computer. This has several other benefits, starting with the fact that many ISPs do not like Bitcoin mining because it is a bandwidth hog. Some cities and regions have banned Bitcoin mining due to environmental concerns or power shortages. Both were at least partially responsible for China’s mid-2021 decision to boot Bitcoin and other cryptocurrency miners out of the country. Many companies and universities also ban mining as theft of electricity and bandwidth hogging. And without protection, a hacker could even hijack your hashrate. 

The flipside of the hacking security problem is Bitcoin mining malware. An individual computer alone doesn’t have much chance at making money by mining, but a vast network of zombie computers is just like having your very own mining pool, but not having to share.

This is a stark contrast from Bitcoin’s decentralised ethos, which is about making a shared digital currency that is by the people and for the people, free from the strictures and costs of traditional finance and government-issued fiat currency. 

Bitcoin mining is the foundation of that ethos, doing the work that makes the first cryptocurrency go, while earning good money and working as an individual within a community to build a “trustless” shared ecosystem.