How Does Bitcoin Mining Work?

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Bitcoin, like traditional fiat currencies, requires a validation and verification system to control rightful ownership and facilitate electronic transfers. It requires a way to tell whose Bitcoin is whose and ensure no two parties can ever hold the same money at once. However, unlike fiat currencies, the Blockchain system, upon which Bitcoin is based, is decentralized. The whole idea is that these checks and balances are inherent in the technology that powers Bitcoin, which removes the need for central authorities such as banks and governments to validate transactions.

Miners provide the computational power to perform the checks and balances and validate transactions on the Blockchain. The mining process allows for a decentralized verification that A user has sent X number of Bitcoin to B user, that B is now the rightful owner, and ensures that A does not also send the same Bitcoin to C user.

The process is referred to as mining (a gold mining metaphor) because it involves the dedication of hardware and software to the difficult process of extracting a finite commodity – Bitcoin. One of the key qualities of Bitcoin is that the total number of units that can ever enter circulation is capped at 21 million. And just like real life mining, the more Bitcoin that has already been extracted, the more difficult it becomes to get the rest out.

Bitcoin mining is achieved by committing computer processing power to solving mathematical equations that add new blocks to the chain. When one party sends Bitcoin to another, they create a transaction and sign it with their ‘key’. The wallet, or client, then broadcasts this transaction over the peer to peer network. Each peer that receives the broadcast transaction will check if the signature is uniform and there is no attempt to double-spend the Bitcoin. These peer clients then also broadcast the transaction back over the Blockchain. It eventually reaches Bitcoin miners whose job it is to package these transactions up into neat ‘blocks’ which can then be added to the Blockchain. The Blockchain is the historical ledger of every Bitcoin transaction that has ever taken place.

When a miner has a bundle of transaction data of the correct size to create a full block it then converts that block into a ‘hash’. A hash is a sequence of letters and numbers, which at first glance is random. This hash is a one-direction encryption of the data contained in the block to which there is no key. As such, it’s very hard to reverse engineer the hash back into the original data. As well as the transaction data, each new block added to the Blockchain ledger also contains the hash of the last block added. This acts as a wax seal, securing the contents of the block and verifying it as well as future blocks that come after it.

Protection Against Hackers

Faking a Bitcoin transaction would involve tampering with blocks already locked into the Blockchain. This would lead to the tampered-with block’s hash changing and no longer matching the rest of the blocks down the chain, which also include the original ‘real’ hash of the tampered with block. Since there are so many copies of the same information, it is impossible to hack the Blockchain from any single entry point. The chain would be thrown out of sync, instantly alerting the network to the fact that one block is fake.

Bitcoin Mining Software and Hardware

The miners’ job is to create the hash for a new block of transactions data to be added to the Blockchain. They do this using specialist software. However, because creating a hash out of data is easy, Bitcoin’s software intentionally makes it more difficult to slow the process down. The protocol insists that the hash created by miners must look a certain way. For example, to start with 4 zeros. It’s impossible to tell how a hash will look before it’s created and just using the data from the transactions will mean the hash created will always look the same. So, an extra bit of random data is always added. This is called the ‘nonce’. The miner will have to try up to millions of combinations of the core transaction data and different ‘nonce’ additions before a hash that matches the requirements set by Bitcoin’s protocol is produced.

Miners compete with each other to be the first to manage to create a hash that meets the criteria set by the protocol. The first to do so, once the solution has been confirmed as valid by the network, adds the new block to the Blockchain and receives a payment of newly created Bitcoin. That’s how new Bitcoins are released into the network, up until the point the total cap is reached. Miners also receive a small transaction fee from all of the transactions contained within the block as an additional payment for their services. This means, once all the Bitcoin units set by the original cap are in circulation, miners will still receive the transaction fees as compensation.

How to Become a Bitcoin Miner

In Bitcoin’s early days, the route to becoming a miner had significantly lower barriers to entry than is the case today. Using a high-performance PC or laptop with elite CPU or a high-speed video processor was all that was required. However, that is no longer the case and specialized hardware is not required. Also, anyone who lacks a huge hardware budget will realistically have to join a mining ‘pool’, which combines hardware resources of multiple individuals.

The reason for this is that in order to maintain a steady supply of Bitcoin entering circulation, to prevent inflation, the amount of Bitcoin awarded to miners is gradually reduced. This is automated by the software protocol behind Bitcoin. Fewer Bitcoin being awarded for mining has increased competition between miners.

Now, to mine Bitcoin, a would-be miner must invest heavily in hardware containing custom Bitcoin ASIC chips that have processing power many multiples of that of standard processors. An alternative approach is to buy Bitcoin cloud mining contracts. This is essentially leasing cloud computing power dedicated to Bitcoin mining. While it simplifies the mining process set-up, it also increases the risk. You do not own or control the physical hardware and have limited means to verify what is actually going on. There have been many scandals around fraudulent Bitcoin cloud mining schemes so this approach should be taken with caution and backed up by solid research into the provider.

How to Make Money Bitcoin Mining

Once the hardware has been purchased and set up to run free Bitcoin mining software, you’ll have to find a ‘Bitcoin Mining Pool’. Because there are now companies that have whole Bitcoin mining ‘farms’ set up in regions with low electricity costs, it is now very hard to be competitive mining Bitcoin. Arguably the only realistic way to get in on the action is through joining a pool, where miners combine their efforts by linking their hardware online like a decentralized ‘mining farm’. The mining work and rewards are then split among the pool’s members.

Again, you’ll have to research online to find mining pools that are open to accepting new members. It is also important to understand what the pool’s record is in successfully mining Bitcoin. This is a ‘chicken and egg’ scenario as it is more difficult to get accepted into an already successful Bitcoin mining pool. However, there is a risk that a new or developing pool, that it is easier to become part of, doesn’t become successful.

Of course, you can try to go it alone but there is a very high chance that your efforts won’t be successful. The most likely scenario is that one or two years down the line you will not have mined any Bitcoin and will have run up huge electricity bills.

How Much Can You Make Mining Bitcoin?

Right now, the honest answer is probably not a lot. The profitability of mining Bitcoin depends upon a number of changing variables such as the cost of the hardware, mining pool fees, your electricity rates, miner competition levels and the current exchange value of Bitcoin.

Without some top level, expensive mining hardware and very low electricity costs, you’re not going to make a lot of money mining Bitcoin under current conditions. And there’s a reasonable chance of incurring a loss. Profitability would be very much tied to further increases in Bitcoin’s value and if you’re relying on that, you might as well just buy some Bitcoin and save yourself the trouble!

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