Bitcoin is now a household name. For an invention that is just over a decade old, this is certainly remarkable. A mysterious entity by the name Satoshi Nakamoto launched Bitcoin in 2008 as an alternative to central bank currency. Bitcoin mining is an alternative to obtaining Bitcoin through the open market.
Decentralization is a central tenet of Bitcoin. Essentially, no single person controls either the issue or functioning of Bitcoin. This system can, therefore operate and transfer funds from one account to another without centralized control.
Centralized control of a financial system is pretty easy. How then, does a decentralized ecosystem like Bitcoin work? The important question therefore is; how does the ledger automatically update transactions without giving either entity power to control to entire blockchain?
How Bitcoin Mining Works
The basic feature of Bitcoin is the open-source nature of the Bitcoin protocol. This means that anyone can access and update the Bitcoin code. Similarly, anyone can update the Bitcoin ledger of transactions. All that needs to be done is for your computer to guess a random number that solves an equation from the system.
The more powerful your computer is, the more guesses it can make per second. Accordingly, having a powerful computer exponentially increases your chances of “guessing right”. This allows you to add the next “block” of bitcoin transactions to the existing chain.
A more complicated representation is as follows. On the one hand, you have your miner that makes “guesses”. If your mining equipment makes the right guess, you get the right to add the next block of transactions to the blockchain. The block you create is sent to other computers so that they can validate it. At the same time, other computers in the network validate the block and update their copies of the Bitcoin blockchain. More computing power translates to greater frequency of making the right guesses. However, in line with natural rules of probability, it is virtually impossible for one computer to get it right all the time.
This process is what Bitcoin mining entails in a nutshell. Computers compete to add the next block and in the process generate new blockchain which automatically goes into the network. The computer that solves the block earns a “block reward” and some transaction fees on the transactions entered into the blockchain. Uniquely, the process of validation is automatic and does not rely on centralized control. Miners can decide to hold the bitcoin they create or trade it to other bitcoin community members.
Perhaps, you are thinking, if it’s that straightforward, what makes Bitcoin valuable? Well, Satoshi Nakamoto in anticipation of this made mining difficulty increase as computing power increased. The mining difficulty automatically adjusts to the increase in cumulative network computing power as more miners get involved.
The reason for this is to keep Bitcoin inflation in check. See, if there is a steady stream of Bitcoin, it is easier to have stable rollout process. When Bitcoin was first launched, you could profitably mine Bitcoin using a personal home CPU. As Bitcoin became more popular, miners moved to GPU (Graphics processing Units) to carry out more calculations. A GPU can enhance a computer’s computing power to the equivalent of 30 regular PCs.
Later, ASICs (Application Specific Integrated Circuits) came about. These were hardware equipment specifically to mine Bitcoin. Currently, they represent the gold standard in Bitcoin mining equipment and have occasional updates themselves. These ASICs have a higher “hash rate”, measured in hashes per second. Hash rate is the number of “guesses” the device can make per second. Consequently, the higher the hash rate, the higher the chance of earning bitcoins.
Check out our video below to learn more about Bitcoin mining devices!
Even with top of the line mining equipment, the current mining landscape is incredibly competitive for individual miners. This has given rise to mining pools where miners combine computing power to compete effectively. If the pool successfully adds a block to the public chain, the pool spreads the reward among its members.
Currently, about a dozen large mining pools dominate Bitcoin mining. Mining pools charge you pool fees for participating which is something that can affect your profitability.
Electricity is a major factor in Bitcoin mining. Bitcoin mining is certainly an electricity-intensive affair. This is because ASIC rigs have high computing power which the process of mining Bitcoin requires.
The high power consumption is in both powering the miner and cooling the machines which get really hot. This is why mining farms have cropped up in cold areas like Iceland to take advantage of natural cooling.
So, Is Mining Profitable?
This is a question that needs perspective. Mining on a personal PC is definitely not going to be profitable. This is because simple computers simply cannot compete with ASIC rigs and mining pools in terms of making more “guesses”.
So, the more computers you have and the faster your computer is- the greater your chances of generating the correct number and earning Bitcoin. Thus some people have entire farms of expensive computers to increase their chances.
Currently, the block reward is 12.5 BTC for every block mined. Thus, you can only profitably mine Bitcoin with sophisticated equipment. Bitcoin mining farms are popular mining method to gain some of the block reward.
One more obvious factor as to whether mining is profitable is the price of Bitcoin at any given time. Miners need to balance this with the expense of mining Bitcoin itself.
In summary, the following are factors which affect the profitability of mining Bitcoin:
- Hash rate;
- Block reward;
- Mining difficulty;
- Power consumption;
- Pool fees; and
- Bitcoin’s price at any given moment.
Bitcoin mining is, therefore, a complicated task.
However, investing significantly in a large mining pool is the most efficient way to go about it. The current circumstances make individual mining simply a waste of time when done on a small scale.
Nonetheless, it is still an activity that many investors have a significant stake in. The reality, however, is that the task will get progressively difficult with time and a select few with significant hashing power and cheap electricity will thrive.