What is Bitcoin Mining?

24 Feb 2021  Read 453 Views

We live in a digital age of technology. Many things that we did physically can now be done digitally with the help of technology. The COVID-19 pandemic and the consequent nationwide lockdown forced people to work from home and even the children to take their classes online. 

So, when we think of things that can be done digitally, mining is the last thing to hit our minds, right? What comes to your mind when you hear mining? Pickaxes? Heat? Dirt? Dark mines? You mine to extract minerals, say gold. What if we told you mining could be done digitally to extract digital ‘gold?’ Oh! You read that right. The digital gold we’re referring to is bitcoin.

To understand what bitcoins are, refer to our previous article that explains the bitcoins and their associated risks and legal status. In today’s article, we will be discussing the mining of bitcoins (akin to gold).

Let’s get started.

What do you mean by bitcoin mining?

In simple terms, bitcoin mining refers to the process of creating new bitcoin by solving computational puzzles. Bitcoin mining is performed on high-powered computing devices that solve complicated and complex computational mathematical problems. When we say complex problems – it means these problems cannot be solved by hand with a pen and paper. You need incredibly powerful computers to solve these problems.

The bitcoin mining process is made difficult on purpose. The process is deliberately made so that it consumes large amounts of resources and is challenging. The process is made difficult so that the number of bitcoin blocks found by the miners each day remains stable. To be valid, individual blocks must comprise proof of work. The proof of work is then validated by other Bitcoin nodes each time they receive a block using a hashcash proof of work function.

The outcome of bitcoin mining is two-fold:

  • Produce new bitcoin: New bitcoins are introduced into circulation when computers solve complex computational math problems on the bitcoin network.
  • Verification of transaction information: The bitcoin payment network is made trustworthy and secure when the miners verify the transaction information by solving the computational math problems.

Some common terms used in bitcoin mining

Transactions

Transaction refers to the transfer of value between bitcoin wallets that gets included in the block chain.

Blockchain

Bitcoin miners clump transactions together in ‘blocks’ and add these blocks to public records known as the blockchain.

Nodes

Nodes maintain the records of the blocks to maintain their future verifiability. 

Block reward

  • The amount of bitcoin created and released with every mined block is known as the block reward. 

  • Block rewards are halved every 210,000 blocks (or roughly every four years).

  • The block reward in 2009 was 50, which was halved in 2013 to 25. In 2018 it was halved again to 12.5, and as of May 2020, the reward stands at 6.25.

Mining pool

  • Bitcoin miners combine their computational prowess to mine bitcoin blocks.

  • The mined blocks are split between the pool members.

  • There is a vast disproportion between the bitcoin mined by pools than by individual miners.

  • Mining pools and companies represent a significant percentage of bitcoin’s computational power.

Understanding bitcoin mining through an analogy

Example

Analogy with bitcoin mining

  • Let’s say you tell three of your friends that you are thinking of a number between 1 and 100. Suppose the number you thought of is 18. You write it on a piece of paper and seal it in an envelope.

  • Your friends have to guess a number that is less than or equal to the number you thought of.

  • They get unlimited guesses.

  • If friend A guesses 24, they lose because 24 > 18

  • If friend B guesses 15 and friend C guesses 11, then theoretically, they both have arrived at viable answers because 15 < 18 and 11 < 18

  • Friend B gets no extra credit for guessing closest to the number you initially thought of.

  • Bitcoin mining is similar to this ‘solve the puzzle’ – only that it is played with not three but with millions of players (would-be-miners).

  • The choice of numbers is not between 1 and 100 but a 64-digit hexadecimal number.

  • The bitcoin miners not only have to guess the right hash, but they also have to be the first to pick.

  • In cases where there are simultaneous answers (that are less than or equal to the target), the Bitcoin network decides by a simple majority (51%) – which miner to honor.

 

So, what is this 64-digit hexadecimal number?

Let’s try to understand with an example of such a number:

0000000000000000057fcc708cf0130d95e27c5819203e9f967ac56e4df598ee

As you can see above, the 64-digit hexadecimal number is alphanumeric. When mining bitcoins, you do not have to calculate the exact total value of the 64-digit number (the hash). When the miners solve the complex problems on their huge computers, they generate what is known as a nonce (number only used once) which is the key to generating the 64-digit hexadecimal number. 

So, the first miner whose nonce generates a 64-digit hash which is less than or equal to the target is granted the credit for completing the block, and he is awarded 6.25 BTC (the current blockchain reward).

All target hashes begin with zeroes – at least eight, which can go up to 63. There is not a set minimum target, but the bitcoin protocol has set a maximum target which means that there cannot be a target greater than this number:

00000000ffff0000000000000000000000000000000000000000000000000000

So, we see that essentially it is a numbers game. The difficulty levels are regularly adjusted to control the generation of new bitcoins. Patterns are hard to guess, and predictions based on previous target hashes seldom reap positive results.

Closing remarks

From our discussion above, it is clear that mining bitcoins is a game of guessing numbers. However, before starting to mine bitcoins, it is to consider the following essential factors:

  • High costs of equipment used to pump out viable nonces to generate the appropriate hashes, and
  • Costs associated with significant power consumption for running the high-powered computers.

There are online tools and calculators available to punch in values of your hash speed and electricity costs. They tell you an estimate of the costs and benefits based on which you can make a call whether bitcoin mining is profitable for you.

So, are you thinking of mining bitcoins?

Stay positive, test negative!

Happy investing.

About the Author: Shrey Salwan | 42 Post(s)

Shrey Salwan is an MBA student at FLAME University, Pune, majoring in Marketing. He is also pursuing CA and CS. He is a creative thinker, a grammar nazi, and social media enthusiast seeking to work in the dynamic world of social media and content marketing to transform technical and digital information and processes into influential stories. He has a knack for telling stories and does so through his quirky way of writing.

 

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