We explain how cryptocurrencies such as Bitcoin are actually made
- How is cryptocurrency mining related to the blockchain?
- How are new coins mined?
- The limits of cryptocurrency mining
Shutterstock
Cryptocurrencies have risen in popularity over the last few years to become one of the most widely talked about forms of investment and payment methods for online shoppers. The emergence of Bitcoin over the last ten years has attracted a following of technology enthusiasts as well as speculators drawn to its tendency to fluctuate wildly in value. This digital token, however, is just one of many cryptocurrencies out there.
This blockchain-based form of currency has become more and more viable over time, despite its tendency to create unpredictable highs and lows in value, with organisations like PayPal letting users pay for goods using Bitcoin. The value of cryptocurrencies, however, is still a major stumbling block to widespread adoption and use, but this ever-changing reality is favourable for those seeking to use cryptocurrencies as an investment vehicle as well as for cryptocurrency miners.
It’s actually quite difficult to create cryptocurrency relative to how traditional money is printed by a central bank. These legacy currencies, also known as fiat currencies, are managed centrally, with the central bank of any particular country issuing new physical notes and coins to replace older variants in circulation, which are removed from the economy. Cryptocurrency, on the other hand, is generated through a process called ‘mining’.
How is cryptocurrency mining related to the blockchain?
Digital tokens like Bitcoin can’t be printed like money as we know it, and the only way to generate new cryptocurrencies is through the process of mining, although the term 'mining' is perhaps misleading. It stems directly from the specific blockchain that powers each individual cryptocurrency, from Bitcoin to Ether.
Each particular distributed public ledger supports the operation of a corresponding cryptocurrency and records all transactions across the extent of its network. For our guide on how blockchain technology works in more detail, check out our explainer.
The blockchain records every time cryptocurrency is traded, with these records being compiled into an endless line of blocks that are all connected. For transactions to be validated, they will need to be verified by other users on the network. This process is key to the way that cryptocurrencies work and avoids instances whereby individuals try to initiate several transactions using the same units.
Cryptocurrency mining is effectively a process of rewarding network users with Bitcoin for validating these transactions.
How are new coins mined?
When a slew of transactions is assembled into a block, it is then appended to the blockchain. However, in order to be rewarded with Bitcoin, a ‘mining’ user, or ‘miner’, needs to perform two tasks: validate 1MB worth of transactions as well as be the first to find out a unique 64-digit hexadecimal number – also called a hash.
Similarly to the blockchain, the network user, or 'node', also holds a record of every transaction. As it is notified, the transactions are validated with a series of checks in order to make sure they are legitimate. The checks include scanning the transactions for a unique cryptographic signature, which is created at the beginning of the process, and confirming whether it is valid or not.
In order to be within a chance of securing new Bitcoin, every miner seeks to validate 1MB worth of these transactions. If successful, they then also have to solve a numeric problem which is otherwise known as 'proof of work'. Users who are able to triumphantly generate the correct 64-digit hexadecimal number, or 'hash', which is either less than or equal to the target hash associated with the block, are then remunerated with Bitcoin.
Due to the difficulty of the task, the only feasible way to find the right hash is to calculate as many combinations as possible, and then wait until a match is found.
In order to stand a chance in being the first one to guess a hash, a user needs to have a high hash rate, or hash-per-second, and the more powerful setup, the more hashes a user can sift through – such are the high computing costs of mining. In order to visualise it, imagine a competition where contestants have to guess the correct weight of a cake. Participants have an unlimited number of guesses and the first one to submit the correct weight wins. In this competition, the winner is most likely to be the contestant who is capable of making the most guesses at the fastest rate.
The limits of cryptocurrency mining
What this means is that mining for cryptocurrencies is a matter of competing in a highly competitive race against other participants, all hoping to land the winning ticket and grab a payout.
However, that’s not the only challenge you will face if you attempt to mine yourself. The difficulty of calculating each hash also increases artificially in order to maintain a steady flow of newly created blocks. This means that as the block count rises, so too does the processing power required to solve each calculation, and therefore the harder it is to mine as a hobbyist. There’s also the issue of hard limits on total circulation. For example, within the Bitcoin blockchain, there will only ever be 21 million coins created in total, a deliberate design to prevent inflation.
In the early days of each cryptocurrency, it’s perfectly possible for everyday users to participate in mining, but given the issues outlined above, the maturity of cryptocurrencies such as Bitcoin means that it’s no longer possible to use standard PCs. The complication of the calculations involved, coupled with the sheer number of other people on the network, means that Bitcoin mining can now only be done with large scale processing ‘farms’ – multiple specialised GPUs working in tandem on a 24-hour basis.
In fact, these days it’s almost impossible to create a return on investment from mining as the energy costs required to power GPU farms typically outweighs the value of the currency itself. Either that, or you’ll be forced to funnel the majority of what you earn into the running and maintenance of the equipment.
As the Bitcoin hype is more or less fully nestled in the wider public consciousness, organisations have invested increasingly considerable sums into it, effectively industrialising cryptocurrency mining. Large warehouses packed to the brim with floor-to-ceiling racks of expensive graphics cards, working towards the sole aim of mining new units of Bitcoin, Ether, Litecoin, and so on, have become the norm.
The Bitcoin network – to add some context – processes 5.5 quintillion hashes per second, which means that unless you have the equipment capable of processing a massive quantity of calculations in a very short space of time, the chances of you being able to compete with the more industrial operations are minuscule.
For this reason, miners often band together and pool resources to maximise their chances of profiting from the cryptocurrency mining game – creating 'mining pools' – sharing their power, as well as any returns their efforts may generate between them.
Keyword: What is cryptocurrency mining?