$BTC What is mining and how does it work?
Summary
Mining cryptocurrencies verifies and validates transactions on the blockchain and involves the process of creating new units of cryptocurrency.
The work performed by miners requires immense computational resources, as it is the factor that maintains the security of the blockchain network.
What is cryptocurrency mining?
Cryptocurrency mining ensures the security and decentralization of cryptocurrencies like Bitcoin that rely on the proof-of-work (PoW) consensus mechanism. It is the process through which the validity of transactions between users is verified and added to the public records of the blockchain. Thus, mining is a key element that allows Bitcoin to operate without a central authority.
Mining operations are also responsible for adding new coins to the existing currencies available in the market. However, cryptocurrency mining follows rules governing the mining process to prevent anyone from arbitrarily creating new coins. These rules are embedded in the core protocols of cryptocurrencies and are enforced by a complete network of thousands of nodes.
To create new units of cryptocurrency, miners use their computing power to solve complex cryptographic puzzles. The first miner to solve the puzzle has the right to add a new block of transactions to the blockchain and broadcast it to the network.
How Cryptocurrency Mining Works
When new transactions are made on the blockchain, they are sent to a pool called the memory pool. The miner's job is to validate these pending transactions and organize them into blocks.
A block can be considered a page from the blockchain ledger, where several transactions (along with other data) are recorded. Specifically, a mining node is responsible for gathering unconfirmed transactions from the memory pool and assembling them into a candidate block.
The miner attempts to convert this candidate block into a valid and confirmed block. To do this, the miner must solve a complex mathematical problem that requires a lot of computing resources. However, with each block mined successfully, the miner receives a block reward consisting of newly created cryptocurrencies, in addition to transaction fees. Let's take a look at how it works:
Step One: Hashing Transactions
The first step to mining a block is to take the pending transactions from the memory pool and send them, one by one, using the hash function. Each time a piece of data is run through the hash function, a fixed-size output known as a hash value is generated.
The hash value of each transaction, in the context of mining, consists of a series of numbers and letters serving as an identifier. The transaction hash value represents all the information contained in that transaction.
In addition to hashing each transaction and including them individually, the miner also adds a special transaction that sends a block reward to themselves. This transaction is referred to as a coinbase transaction, and it is what creates entirely new coins. In most cases, this transaction is the first recorded transaction in any new block, followed by all pending transactions waiting to be validated.
Step Two: Creating a Merkle Tree
After hashing each transaction, the hash values are arranged in what is known as a Merkle tree (also known as a hash tree). A Merkle tree is created by pairing hash values of transactions and then hashing them.
The new hash outputs are then paired and hashed again, and this process is repeated until a single hash value is created. The last hash value is also known as the root hash (or Merkle tree root), which is essentially the hash value that represents all the previous hash values used to generate it.
Step Three: Finding a Valid Block Storage Section (Block Hash Value)
The block storage section acts as an identifier for each block, meaning that each block has a unique hash value. When a new block is created, miners combine the previous block's hash value with the root hash of the candidate block to generate a new block hash value. They also need to add a random number known as the nonce.
Thus, when the miner tries to validate their candidate block, they must combine the root hash, the previous block's hash, and the nonce, and hash them all together using the hash function. Their goal is to do this repeatedly to create a valid hash value.
The root hash value and the previous block's hash value cannot be changed, so miners must change the nonce value multiple times until they find a valid hash value. The output (block hash value) must be less than a specific target value defined by the protocol to be considered valid. In Bitcoin mining, the block hash value should start with a specified number of zeros — this is known as mining difficulty.
Step Four: Broadcasting the Mined Block
As we saw earlier, miners must repeatedly hash the block storage section using different values for the nonce. They continue this process until they find a valid block hash, after which the miner who found it broadcasts this block to the network. All nodes verify whether the block and its hash value are correct, and if so, will add the new block to their copy of the blockchain.
At this stage, the candidate block becomes a confirmed block, and all miners move on to mine the next block. All miners who did not find a valid hash value in time discard their candidate block and the mining race begins again.
What if two blocks are mined at the same time?
Sometimes, miners broadcast two valid blocks at the same time, leading to the network ending up with two competing blocks. Then, all miners start mining the next block based on the block they received first, causing the network to temporarily split into two different versions of the blockchain.
The competition between these two blocks continues until the next block is mined on either of them. When a new block is mined, the block that preceded it is considered the winner. The discarded block is known as the orphan block or invalid block, causing all miners who chose that block to mine the chain of the winning block again.
What is Mining Difficulty?
Mining difficulty is regularly adjusted through a protocol that ensures a steady rate of new block creation, which in turn leads to the issuance of new coins at a steady and expected pattern. The difficulty is adjusted based on the amount of computing power (hash rate) dedicated to the network.
Thus, every time new miners join the network and competition increases, the difficulty of hashing increases — preventing a drop in average block time. Conversely, if many miners decide to leave the network, the hashing difficulty will decrease, making it easier to mine a new block. These adjustments keep the block time steady regardless of the overall hashing power of the network.
Types of Cryptocurrency Mining
There are many different ways to mine cryptocurrencies. Equipment changes, and the process evolves with the emergence of new devices and consensus algorithms. Miners typically use specialized computer units to solve complex cryptographic equations. Let's take a look at how some of the most common mining methods work.
Mining with Central Processing Units
Mining with Central Processing Units (CPUs) involves using a CPU from a computer to perform the required hash functions of the proof-of-work model. In the early days of Bitcoin, mining costs were low and barriers to entry into the mining world were few, allowing an ordinary CPU to handle mining difficulty, so anyone could try to mine BTC and any other cryptocurrencies.
However, as more people started mining BTC and increasing the network's hash rate, profitable mining became more difficult. Furthermore, the emergence of specialized mining devices with greater computational power made CPU mining nearly impossible. Today, CPU mining is no longer a practical option as all miners use specialized hardware.
Mining with Graphics Processing Units
Graphics Processing Units (GPUs) are designed to handle a wide range of applications concurrently. Although these units are typically used for video games or creating graphics, they can also be used for mining.
Graphics Processing Units (GPUs) are relatively inexpensive and more flexible than commonly used ASICs for mining. Although they are used to mine some altcoins, their efficiency depends on the mining difficulty and the algorithm.
Mining with ASICs
Application-Specific Integrated Circuits (ASICs) are designed to serve a specific purpose, referring in the cryptocurrency field to a specialized device designed for mining. ASIC mining is known for its high efficiency, but it is also costly. Since ASIC mining devices lead mining technologies, the cost per unit is much higher than CPUs or GPUs.
Moreover, the ongoing developments in ASIC technology quickly render older versions unprofitable, thus requiring regular updates. Even excluding electricity costs, mining with ASICs is one of the most expensive mining methods.
Mining Pools
Since the first successful miner receives the block reward, the likelihood of finding the correct hash value becomes very low. Miners with a small share of the mining power have very little chance of discovering the next block on their own. Mining pools provide a solution to this problem.
Mining pools are groups of miners who combine their resources (hashing power) together to increase the likelihood of winning block rewards. When the pool successfully finds a block, the miners in the pool share the reward based on the amount of work each has contributed.
Mining pools can benefit individual miners in terms of hardware and electricity costs, but their control over mining raises concerns about a 51% attack on the network.
What is Bitcoin mining? How does it work?
Bitcoin is the most well-known and clear example of a mineable cryptocurrency, and Bitcoin mining is based on the proof-of-work (PoW) consensus algorithm.
Proof of Work (PoW) is the original consensus mechanism of the blockchain created by Satoshi Nakamoto, as presented in the Bitcoin whitepaper in 2008. In short, proof of work defines how the blockchain network reaches a consensus among various distributed participants without external mediation, requiring considerable computing power to deter malicious actors.
As we have seen, miners validate transactions on networks using proof of work and are verified by some miners who compete to solve complex cryptographic puzzles using specialized mining hardware. The first miner to find a correct solution can broadcast their block of transactions to the blockchain and receive the block reward.
The amount of cryptocurrency in the block reward varies from one blockchain to another. For example, miners on the Bitcoin blockchain received a block reward of 6.25 BTC until March 2023. Given the Bitcoin halving mechanism, the amount of BTC in the block reward halves every 210,000 blocks (approximately every four years).
Is cryptocurrency mining profitable in 2023?
Although there is potential to make money through cryptocurrency mining, it requires careful study and risk management, as well as research. This process also involves some investments and risks such as hardware costs, cryptocurrency price fluctuations, and changes in cryptocurrency protocols. To mitigate these risks, miners engage in risk management activities and assess potential costs as well as the benefits of mining before starting the process.
The profitability of cryptocurrency mining depends on several factors. One of these factors is the changes in cryptocurrency prices. When cryptocurrency prices rise, the value of the local currency used for mining rewards also increases. Conversely, profitability levels can decline when prices fall.
The efficiency of mining hardware also plays an important role in determining the profitability of the mining process. A mining device can be expensive, so miners should balance the costs of the device against the rewards they can obtain. Another factor to consider is electricity costs. If these costs become too high, they may exceed profit levels, making mining unprofitable.
Additionally, mining hardware may need some relative upgrades occasionally, as they tend to become obsolete very quickly. Newer models can outperform older hardware, especially if miners lack the budget to upgrade their equipment, making it challenging for them to maintain competitiveness.
Last but not least, there are some changes at the protocol level. For example, Bitcoin halving can affect mining profitability as it reduces the rewards for mining blocks by half. Additionally, the Ethereum network fully transitioned from a proof-of-work (PoW) consensus mechanism to proof-of-stake (PoS) in September 2022, contributing to making mining unnecessary.
Closing Thoughts
Cryptocurrency mining is an important element of the Bitcoin network and other blockchains that use the proof-of-work mechanism, as it helps maintain the security of the network and issues new coins in a stable manner. Moreover, miners can earn passive income from mining. You can learn more step-by-step instructions in our article on how to mine a cryptocurrency.
Mining has specific advantages and disadvantages, primarily the potential for income from block rewards. However, mining profits are affected by a number of factors, including electricity costs and market prices. Therefore, before rushing to mine cryptocurrencies, you should do your own research and assess all potential risks.
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