Cryptocurrency mining is the process by which new crypto coins are created. Different cryptocurrencies have different mining process, but they all involve two things:
- Verification of transactions involving the cryptocurrency
- Addition of these verified transactions to the cryptocurrency’s Blockchain platform
It all sounds easy, but it also helps to understand precisely how cryptocurrencies work and their relationship with Blockchain technology to get a clear insight into cryptocurrency mining.
Understanding How Cryptocurrencies and Blockchain Technology Work
Cryptocurrencies are defined as virtual currencies. However, they do not exist in any shape or form. Instead, they are simply records on a Blockchain platform – you can think of it as a ledger of all of the cryptocurrency’s transactions. Entries on this platform cannot be altered in any way unless certain conditions are met – these conditions are essentially conducting another legitimate transaction.
Verification and Authorization of Transactions
Cryptocurrencies exist in a decentralized ecosystem. Unlike traditional financial systems, there is no single third party tasked with overseeing all activities, including verifying and authorizing transactions. However, verification and authorization still have to be done. This is where mining comes in.
Cryptocurrency Blockchains are maintained by networks of thousands or millions of computers and developers, depending on the cryptocurrency’s size. Those responsible for monitoring, verifying, and authorizing transactions are called miners. They do this in several steps:
- Verification that transactions are indeed valid
- Bundling the verified transactions into a block
- Taking the most recent block’s header and inserting it into the new block as its hash number
- Solving a complicated mathematical program – this will be expounded upon later
- Getting the solution to the mathematical problem and adding the new block to the Blockchain
It takes a considerable amount of time, effort, and resources to verify and authorize new cryptocurrency transactions – additionally, this depends on the size of the cryptocurrency. Miners are rewarded for their efforts using new cryptocurrency coins that they can trade for main-steam cryptocurrencies or fiat currencies.
Proof of Work
As mentioned, one of the steps of cryptocurrency mining involves solving a complex mathematical problem. Solving this problem results in a Proof of Work (PoW) that you have indeed verified and authorized a transaction. However, the PoW is designed to serve more than just verification purposes – it is also intended to regulate mining, hence controlling the creation, circulation, and valuation of cryptocurrencies.
Consider Bitcoin, the largest cryptocurrency by market capitalization. Bitcoin was initially mined by a handful of people. Back then mining Bitcoin was easy, and anyone could do it with a basic desktop computer. Today, however, it is a complicated and energy-intensive affair. This is by design.
Excessive mining of cryptocurrencies can result in its loss of value. Bitcoin’s developers placed counter-measures to this problem during its creation. These measures include:
- A production cap of 21,000,000 Bitcoins: No more Bitcoins will be created once this limit is reached – however, this cap can always be reviewed if necessary.
- A consecutive decrease in rewards: As mentioned, miners are rewarded for their efforts using the cryptocurrency’s coins. For Bitcoin miners, the current reward is 12.5 coins for every block created. The initial reward amount was 50 coins. This amount has been halved after every four years – the next reduction is expected to take effect between 2020 and 2021.
- A consecutive rise in mining difficulty: As mentioned earlier, Bitcoin could initially be mined using a standard desktop computer. However, the challenge rises with each new block created. Considering that hundreds of thousands of blocks have been produced so far, it is no longer easy to mine Bitcoin. Today it takes sophisticated technology including powerful Graphic Processor Unit (GPU) chips or ASICs and mining software.
Combined, all these factors ensure that mining is done at a steady pace to avoid inflation – it should also be noted that only one block can be created every ten minutes.
Cryptocurrency Mining Going Industrial
There are numerous miners today compared to several years ago. In fact, there is so much excitement about mining that a whole industry has emerged from it. This shift from small-scale mining to industrial mining has been characterized by the emergence of large corporations dedicated entirely to cryptocurrency mining.
As mentioned earlier, mining is much more complicated today. The hardware and software required to solve the complex mathematical problems for the PoW are expensive – for instance, a new GPU goes for about $3,000. These machines also utilize a lot of energy, thus resulting in substantial power bills. Considering that mining is essentially a competition involving thousands and even millions of miners, prudence calls for investing in the most advanced mining equipment. Unfortunately, only corporations have the necessary resources to do this.
To this end, several companies have dominated the cryptocurrency mining industry. Individual miners have been either edged out of the sector or forced to join mining pools – mining pools get miners to combine their equipment for more mining power to compete with major corporations.
Cloud Mining – The Solution to Entrance Barriers
As concluded, cryptocurrency mining is too expensive for individuals owing to the precious resources required. However, mining has gone virtual – so to speak – as data centers are now renting their resources out to miners. They offer all the mining equipment, mining software, internet connectivity, and everything else needed to mine new cryptocurrencies. All clients have to do is pay for the resources and collect their rewards periodically.
Cloud mining is convenient. However, it is also riddled with risks including fraud by some of these service providers as well as strict terms and regulations that can see investors lose their money without notice.
The Future of Cryptocurrency Mining
Cryptocurrency mining is an essential part of the cryptocurrency markets – mining will always occur as long as there are transactions. If you are interested in mining, then you should consider starting with small cryptocurrencies such as LiteCoin and hope that their value appreciates just like that of Bitcoin.
Interestingly, one cannot help but wonder what will happen once Bitcoin’s supply cap is reached as miners are mainly motivated by the Bitcoin rewards.