Bitcoin mining is the process of creating new units of Bitcoin. At the most basic level, this process is at least somewhat straightforward. Some compare it to mining gold, in that there is only so much gold in the earth and mining it comes at a cost. Also, as more mine gold from the earth, the cost of mining will increase.
While this may sound simple enough, the details of Bitcoin mining can be a bit more complex and involve mathematics and cryptography.
Bitcoin (BTC) is a digital currency that was designed to allow people to make transactions without having to go through third parties like banks. Instead of relying on these intermediaries to determine which transactions are valid, Bitcoin relies on the blockchain, a distributed ledger system. In order to determine which transactions should be added to the blockchain, Bitcoin relies on mining.
The blockchain consists of a series of blocks, and each of these blocks contains several Bitcoin transactions. Roughly once every 10 minutes, the Bitcoin network produces a new block. The miner who created the block receives the mining reward, which is 12.5 BTC at the time of this writing (August 2018). Miners also receive transaction fees for processing transactions into blocks.
To get started mining, a person needs to only download the proper software to their computer and run the program. Doing so means sacrificing space on the computer and devoting processing power.
A total of 21 million units of BTC can be mined under the Bitcoin Protocol. It is estimated that this total eventual supply will exist by roughly 2140.
Once a person has downloaded the Bitcoin software, they can get started. Every 10 minutes, the computers involved in mining take a large number of Bitcoin transactions and put them into a puzzle.
Then, nodes compete with other devices in order to be the first hardware device to solve the puzzle. To find a solution, nodes need to leverage SHA-256, a cryptographic hash function.
If a miner opts to use this hashing function to process transactions into a specific block, then the Bitcoin network may select that particular block and add it to the blockchain. If this occurs, the miner will receive the mining reward.
While the mining reward was originally 50 BTC, this incentive has decreased over time. In 2012, the mining reward decreased to 25 BTC and in 2016, it was reduced to 12.5 BTC. Ultimately, 64 halving events will take place as a result of the way the Bitcoin Protocol was created.
The mining reward was set up to be cut in half every four years in order as part of Bitcoin's monetary policy. Basically, this mechanism was established to help keep inflation under control. The cost of computer processing power is expected to decline over time, so reducing the mining incentive can help manage the expense of producing new bitcoins.
In addition to receiving the mining reward, people involved in mining can earn transaction fees. When sending Bitcoin from one wallet to another, wallet holders have the ability to pay these fees. The more they are willing to pay, the more rapidly a transaction will take place.
The benefit of having a system set up this way is that it is very difficult to compromise.
Every new block references the last block in the blockchain. In order to compromise the blockchain, nefarious parties would need to rewrite it completely, a process that would require immense computing power. Anyone looking to rewrite the blockchain would need to control the majority of the Bitcoin hashing power.
There is a major risk associated with this situation, which comes from miners grouping together into mining pools. The rationale behind forming these pools is that if a group of nodes come together, they can increase the odds that they will successfully mine a block and receive the mining reward.
Because of this trend, some are concerned that a group will indeed obtain this processing power and use it to meet their own objectives.
Another concern that has come up in regards to Bitcoin mining is its consumption of energy. Varying estimates have been provided for just how much electricity the Bitcoin network requires. One report estimated that Bitcoin miners consume 2.55 gigawatts (GW) of electricity every year. This figure is more than 80% of Ireland's average annual power usage, which is 3.1 GW.
Mining is a crucial activity for the Bitcoin network. Without it, the network would be unable to produce new units of the digital currency. This process, which is executed by computer hardware, involves processing Bitcoin transactions into blocks.
Bitcoin miners are rewarded with the mining incentive, and in some cases transaction fees, for contributing their processing power. While this system is reasonably safe and poses a significant difficulty for those looking to compromise it, the system has its weaknesses. One of them is its high power consumption.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…