What is Bitcoin Mining / Proof of Work?
Definition
Bitcoin Mining aka the Proof of Work method is the process by which Bitcoin’s network is maintained & secured without the need for a bank.
Understanding Bitcoin Mining/Proof of Work
The Proof of Work method, more commonly known as Bitcoin mining, is the complex cryptographic process at the heart of Bitcoin & other decentralised digital currencies.
Proof of Work & Bitcoin Mining involves solving complex mathematical puzzles with powerful computers and serves two primary purposes:
- To validate the legitimacy of a transaction, helping to avoid fraudulent transactions & the problem of double spending in a decentralised manner (without the need for a bank)
- To create new cryptocurrency by rewarding ‘miners’ for performing the previous task
Bitcoin Mining in a nutshell
Before we breakdown the important aspects of mining, let’s take a look at what goes on behind the scenes when you make a Bitcoin transaction.
- Transactions are made and grouped together into ‘blocks’
- Miners verify that transactions within each block are legitimate
- This is done by solving a complex mathematical puzzle using specialised mining equipment
- Once the solution is correctly solved by a miner (and the transactions validated), they broadcast it to the entire network so their ‘Proof of Work’ can be checked against everyone else’s copy of the ledger
- A cryptocurrency reward is given to the miner who solves each block’s mathematical puzzle first
- All verified transactions are stored in the new block on the Blockchain, and everyone’s copy of the ledger is updated in real-time
The complex mathematical puzzles behind mining are also known as cryptographic hash puzzles, hence the name cryptocurrency. While this can all seem a bit confusing at first (none of this information is actually needed to own & use Bitcoin), in order to truly understand Bitcoin mining, it helps to understand the basics of Blockchain, which you can do here.
Cryptocurrency mining is not an easy concept to wrap you head around, but stick with it – we’re confident you’ll have an understanding of all the need-to-know info by the end of this article!
The problem of double spending
Double spending is one of the main challenges faced by all cryptocurrencies – and it’s the reason why cryptocurrency Blockchain’s need a ‘consensus mechanism’ like Proof of Work. Double spending is essentially:
- Where a unit of crypto can potentially be spent twice, meaning false and illegitimate transactions could occur
- If double spending occurs on a network, it completely undermines the security & trust of the entire network, destroying any value that digital currency has
Bitcoin was the first digital currency to solve the problem of double spending through its Blockchain’s Proof of Work mechanism, which is more commonly known as ‘Bitcoin mining’.
Bitcoin mining today
Bitcoin mining is the process of creating new Bitcoins and maintaining the legitimacy of the network’s transactions by solving mathematical puzzles with powerful computers. This might sound like a great way to earn free Bitcoin – but mining is no easy task.
While you could once mine Bitcoin from your laptop, the dramatic increase in Bitcoin’s value, and thus the number of miners wanting to earn Bitcoin as a reward, has meant that mining now requires specialised mining hardware (a GPU or an application-specific integrated circuit (ASIC) miner) and A LOT of computing power & electricity – we will explore the issue of Bitcoin’s energy consumption later on or you can read a deep dive into this important & controversial topic here.
How does Bitcoin Mining work?
To clarify, the main goal of mining is to maintain the ledger of transactions in a decentralised manner – the rewards you get for performing this function are actually just a side effect which incentivises people to become miners and maintain the security of the network.
Bitcoin mining has a number of elements that contribute to the cryptocurrency’s ability to remain secure, reliable and highly valuable without any single entity controlling it. Here’s how it works in a nutshell:
- Transactions are verified and grouped into blocks through the solving of a complex mathematical puzzle (guessing a very long random number)
- A cryptocurrency’s ledger involves many blocks of transactions being ‘chained’ together in one long unbreakable line, hence ‘Blockchain’
- Once a miner solves the puzzle and compiles their block of verified transactions, their ‘Proof of Work’ is broadcasted and verified by the rest of the miners or ‘nodes’ in the network
- Once the block is verified by at least the majority of nodes in the network, the block is added to the chain, and everyone updates their copy of the ledger to include the newly verified block of transactions
- For the effort of purchasing mining equipment, validating transactions and adding verified blocks to the chain, miners are rewarded with a ‘block reward’ in the form of a fixed amount of Bitcoin
- These mathematical puzzles (aka cryptographic hash puzzles) are set up so they can only be solved by using trial & error or ‘brute force’, which is why the elaborate mining equipment & huge amounts of electricity is required
- Every 10 minutes a new puzzle is released and the difficulty of solving this puzzle auto adjusts based on the amount of mining power that the network has at any given time. This ensures a steady flow of Bitcoin no matter how many miners are trying their luck, acting as an in-built control for inflation (pretty cool, right?)
- The more powerful your mining equipment, the more guesses you can make and the faster you will solve the puzzle, however, Bitcoin’s algorithm ensures that the chances of a single miner winning the reward over and over again is very low, keeping the network decentralised as everyone is incentivised to help maintain the network
Through this process, Bitcoin is able to be the first decentralised digital currency the world has ever seen. In a way, everyone involved gets to ‘be the bank’ and have a chance to update the ledger, removing the need for any central controlling authority.
What is a Bitcoin halving?
An explanation about Bitcoin mining is incomplete without taking into account the very important Bitcoin halving process that is built into the system.
A Bitcoin halving refers to the fact that after every 210,000 blocks of transactions mined, or roughly every four years, the block reward given to Bitcoin miners for validating transactions is cut it half, which:
- Halves the rate at which new Bitcoin is released into circulation, limiting its supply
- Combats inflation, theoretically making the value of Bitcoin rise over time
But what about the miners, you might ask? Aren’t they still working hard to process transactions and now only getting paid half of what they used to? Not exactly.
- As each Bitcoin halving event reduces Bitcoin’s supply, historically this has led to a significant price increase in the value of Bitcoin, which is why Bitcoin halvings are commonly associated with the price of Bitcoin surging to dizzying new heights.
- For miners it’s worth continuing to play the game because even though the reward for mining decreases, the value of Bitcoin, in theory, should increase. Put simply, Bitcoin is valuable by design.
Since Bitcoin began in 2009, there have been 3 halving events (all of which have led to the MASSIVE crypto bull runs that has made so many regular people overnight millionaires):
- The initial reward was 50BTC per block
- This halved to 25BTC per block in 2012
- Then it halved again to 12.5BTC in 2016
- And finally it halved to 6.25BTC per block in May of 2020
The next halving is predicted to take place in 2024 and will keep occurring roughly every four years until around 2140 when there will be no more Bitcoin left to mine.
Is Bitcoin mining bad for the environment?
For Bitcoin to operate, massive amounts of energy and electricity is needed. This is undeniable and a serious issue. However, many of the statistics and headlines around this issue are often very misleading. Doing your own research on this important and often misinformed conversation is crucial. Here’s a few key points we have garnered from researching the topic:
- Many of the statistics about Bitcoin’s energy consumption (one Bitcoin transaction costs the same as 500,000 Visa swipes, Bitcoin uses more electricity than most small countries, etc.) do not stand up to scrutiny.
- Studies estimate the percentage of Bitcoin mining powered by renewables to be between 39% & 74%.
- Bitcoin miners have a strong incentive to move their energy-intensive mining operations to places where there is an excess of cheap, renewable energy.
- Until the recent ban, most of the largest Bitcoin mining operations have been located in rural regions of China where hydro energy production far outstrips local demand and would otherwise be wasted.
- Bitcoin’s ability to turn ‘stranded’ & excess renewable energy into economic value could have a positive impact on both the financial system & the environment.
- Other cryptocurrencies are now using, or switching to, an alternative to mining called ‘Proof of Stake’, which serves the same function but with NONE of the electricity costs.
You can read our article on Bitcoin’s energy consumption explained or do a bit of Googling and make up your mind for yourself! There are some compelling points on both sides and you’ll be surprised by what you find.
Key Takeaways
- Bitcoin mining aka the Proof of Work method is the process of validating transactions and creating new Bitcoin by solving a mathematical puzzle with powerful computers
- The Proof of Work method solves the problem of double spending, enabling trust in the network
- Bitcoin miners receive Bitcoin as a reward for completing ‘blocks’ of verified transactions, which are permanently added to the Blockchain’s ledger. Block rewards incentivise miners to maintain the network
- A Bitcoin halving involves the reward for mining Bitcoin being cut in half
- A lot of specialised equipment is needed to mine Bitcoin, making the process very resource intensive, though Bitcoin mining’s environmental impact is far from what the media often portrays it as
- There are other ‘consensus mechanisms’ similar to PoW/mining which are more efficient & sustainable, namely Proof of Stake
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Why is proof-of-anything needed?
We’ve heard about Proof of Work and Proof of Stake, but why do we need these ‘consensus mechanisms’ in the first place? In the traditional centralised banking system:
- All transactions & balances are kept on a private ledger that is controlled & approved by the bank.
- We are completely dependent on third parties who we trust to maintain the integrity of the ledger, despite not everyone trusting banks to responsibly protect their savings (as seen in the global financial crisis of 2008).
- The bank’s ledger is managed by a single organisation, which means there is a single point of failure, making it vulnerable to attack.
And then there’s the world of cryptocurrency and decentralised finance. For a long time, the idea of decentralised money that was owned and powered by people was impossible for a number of reasons, namely the problem of double spending.
However, Bitcoin’s Proof of Work method changed the game by providing:
- A reliable & trustworthy way for a ledger of transactions & balances to be maintained among a huge number of people who don’t know each other
- A solution to the problem of double spending, where users could attack the network & spend the same coin twice
- A banking network & ledger that was collectively owned & maintained by people all over the world, making a cyber-attack virtually impossible
A way for trust to be built into the network itself, removing the need for banks, enabling decentralised money and changing finance forever.
How does Blockchain prevent double spending?
To prove that no attempts to double spend have occurred, Bitcoin’s Blockchain provides a way for all miners/nodes in the network to be aware of every transaction. With a network like Bitcoin’s, all transactions are publicly announced to everyone in the network so they can then agree on a single history of the ledger and the order in which transactions were received. The order is key here.
- Given that all transactions made are time-stamped and cryptographically ‘hashed’ to previous blocks, you can’t simply change the record as all new blocks must contain the correct ‘hash’ (a unique code) from the previous block.
- To change a single block of transactions you would have to change ALL the blocks in the chain, which would be incredibly time consuming and not viable.
- Essentially, Blockchain’s solution to double spending is based on the fact that if the majority of the nodes in the network agree which transaction was first to be received, any later attempts to double spend or attack the network will be quickly found out and voided from the network.
From the very start of the Bitcoin network, there has been a complete record of every transaction ever made. As all transactions are agreed upon by the majority of the network and then cryptographically hashed to the previous block, this makes changing the record or putting through a false transaction virtually impossible.
EXAMPLE
Let’s say that you are an attacker wanting to double spend an entire Bitcoin.
- First you make a purchase with that Bitcoin to one of the many merchants that accept Bitcoin, let’s say you buy something from Shopify.
- Now, what if you attempted to send the same Bitcoin to another Bitcoin address that belonged to a friend? In theory this would work as there is nothing stopping you from submitting two transactions like this on the network.
- However, once submitted, as always, both your transactions would go into a pool of ‘unconfirmed transactions’. And this is where Blockchain works its magic.
- Your first transaction (for Shopify) would be validated and then put into a block and broadcasted to the entire network
- It would then be confirmed by Bitcoin miners all around the world and added to the next verified block
- As this transaction would be stored with a timestamp and a ‘hash’ from the previous block, when your second transaction came through it would be seen as invalid as it would not line up with the order of events that took place
- The entire network would know that you no longer own this Bitcoin, so your second transaction would not be confirmed and processed by the network which would swiftly discard it
What are the flaws of Proof of Work & Bitcoin mining?
The main flaw of Proof of work is that it is notoriously inefficient, demanding a large consumption of energy as well as a significant cost to pay for electricity and the mining equipment. While there is a lot of misinformation surrounding Bitcoin’s real impact on the environment, Proof of Work is undoubtedly a hardware & power-heavy solution to the challenge of creating a decentralised monetary system. Which is where Bitcoin’s younger, hipper cousin, Proof of Stake, comes in to save the day.
Instead of needing massive amounts of computational power to solve mathematical puzzles, the Proof of Stake model leverages the amount of cryptocurrency users have in their wallet, paying out validators of the network in the network’s transaction fees rather than hefty block rewards. A huge number of cryptocurrencies are now using PoS, or switching to PoS, so let’s take a moment to understand what this new and more efficient method actually is.
What is Proof of Stake (PoS)?
Proof of Stake is an alternative consensus mechanism (a reliable way of reaching an agreement in a group) to the Proof of Work model. PoS uses a more efficient and sustainable process to achieve the same function as mining (validating transactions, securing the network, preventing double spending and putting new coins into circulation).
Cryptocurrencies essentially pay people in their own coin to keep the network secure. In the Proof of Stake method users are rewarded with cryptocurrency for validating transactions by ‘locking up’ or ‘staking’ their coins on the Blockchain and contributing to the network’s security & legitimacy.
- The reward a person earns is linked to the amount staked on the network and is usually paid out from the network’s transaction fees.
- If a staker tries to hack the system or approve invalid transactions, they will be penalised & lose some or all of their staked coins.
- The core idea behind PoS is that those who stake/lock up their crypto on the network will want to help keep the network secure because their staked crypto depends on it.
In a nutshell, this is why PoS works – The more you stake, the more you earn. But at the same time, the more you stake, the more you lose if you go against the system.
Why is Proof of Stake better than Proof of Work?
Energy Consumption
You’ve probably heard about how Bitcoin mining sucks as much power as some small countries. While there is a lot of unfounded and misleading statistics on this topic, the energy consumption of Bitcoin mining is no joke – even if many mining rigs do run on renewable energy.
Proof of Stake does not require complex mathematical problems to be solved by super computers. It takes its consensus mechanism completely virtual by requiring validators to lock up their coins in the network in order to validate transactions and earn their crypto reward. It is far more environmentally friendly and accessible for the everyday person, which is why so many cryptos are moving to the PoS model.
Less Centralisation
Proof of Work blockchains give people who purchase powerful hardware devices a greater chance of winning the mining reward, which opens the system up to be manipulated and centralised. For example, centralised organisations have invested in a huge amount of high-tech mining equipment to create ‘mining pools’, which allow them to pool their resources together to get the highest chance of solving the puzzle first.
On top of the centralisation of what should be a decentralised system, PoW runs the risk of certain mining pools owning a large portion of the total mining power, however this has not yet become an issue.
This means regular people have very little chance of earning the mining reward, which is hardly what Satoshi Nakamoto had in mind when Bitcoin was first created! Proof of Stake on the other hand does not allow this kind of centralisation to occur as people are individually rewarded proportionate to the amount they have staked. No monopolies here!
Protection against 51% attacks
A 51% attack is when a group or single person gains more than 50% of the total mining power , allowing them to authorise invalid transactions and alter blocks and essentially steal money.
When using a Proof of Stake consensus mechanism, for this to be achieved, the attacker would need to stake at least 51% of the total amount of that cryptocurrency. The only way to do this is to purchase the coins on the open market which does not make financial sense.
Given that buying an amount this substantial on the market would also send the price of the asset up, the amount they would need to spend would far outweigh what they could gain from trying a 51% attack! On top of that, if the network realised that the attacker was approving invalid transactions they would lose their entire stake.
While it would be difficult and expensive to acquire 51% of a reputable cryptocurrency, someone with a 51% stake in the coin would not have it in their best interest to attack a network that they hold a majority share in.
Could Bitcoin Change to Proof of Stake?
There is debate over whether it would be possible for Bitcoin to change to Proof of Stake because of the technical challenges involved in the transition, much of which would hurt those that have put the most effort into mining Bitcoin right now.
However, theoretically, many notable names in the crypto space have predicted that eventually Bitcoin will make the shift to a Proof of Stake model, but this transition does not seem likely in the immediate future. Some others believe that having so much hardware and resources dedicated to maintaining the network adds a level of security to Bitcoin, and is well worth the energy cost of creating a truly decentralised, global currency.
Why ‘mining’?
Bitcoin mining is the name that is used for the Proof of Work process because it resembles the mining of other finite commodities from the earth, like gold. Bitcoin, like many natural resources, is a finite resource (21 million in total) that can only be acquired through time and effort, so it is a handy analogy.
HOWEVER, there are a few reasons the ‘mining’ analogy is not entirely accurate. An important difference is that the supply of Bitcoin does not depend on the amount of mining, as the Bitcoin you get for mining gets less and less as time goes on (due to the Bitcoin halvings).
What happens when all 21 million Bitcoins have been mined?
The final Bitcoin halving, which will finish its 21 million supply, is set to occur in 2140. After this, no block rewards will remain so miners will be rewarded with fees from people using the network. The competition to earn these fees is designed to continue incentivising miners to keep processing transactions and maintaining the network.
Is Bitcoin mining profitable?
For most regular people, probably not. However, if you’re serious about Bitcoin mining, it is possible to make Bitcoin mining extremely worthwhile. Profitability depends on a number of factors, including:
- The hash rate of your mining equipment – how quickly it can solve the mathematical puzzle
- The block reward – how much BTC you earn for solving the puzzle
- Mining difficulty – how difficult the puzzle is to solve
- Electricity cost – how much electricity costs in your area
- Power consumption – how much power you are consuming to mine
- Mining pool fees – the fees you pay if you are part of a mining pool
- The price of Bitcoin – this greatly determines whether mining BTC is actually worth it
- The difficulty increase per year – the hard to predict factor of how much harder mining will become (based on the rate of miners joining the network)
Once you have taken these factors into consideration, you can use a mining calculator to enter in your figures and get an estimate of how profitable mining will be for you.
What is a mining pool?
Mining pools are where miners pool their resources and computing power together in order to get a better chance at consistently solving the cryptographic hash puzzle and earning the mining reward.
Even if you had several high-powered ASICs, you would still only have a small portion of the whole mining network, and the chances of you actually mining a block successfully would be fairly low, not to mention the upfront costs of the hardware and electricity.
This is not tenable for many miners who would prefer a more consistent income rather than the off-chance of earning A LOT of Bitcoin every once in a while. You never know when you’re going to be successful at solving the puzzle and adding the next block, so if consistent revenue is what you’re looking for, you’ll be far better off in a mining pool.
Note: The inconsistency of mining block rewards is another issue addressed by the newer and more efficient Proof of Stake model, where you are able to earn a steady, passive income off your crypto investments. Your can learn more about this from our articles on Proof of Stake and staking your cryptocurrency.
How does a mining pool work?
- You sign up with a mining pool.
- You will be asked to download & install the mining pool’s software on your computer.
- The software on your computer speaks with the mining pool’s servers, effectively adding your computer as an extension of the mining pool’s node.
- Your computer aids in the mining process, contributing spare processing power to the pool’s Proof of Work hashing function (increasing the rate of its attempts to guess the answer).
- When your pool guesses the answer correctly and wins the right to add a block to the chain, your pool earns the block reward!
- The total block reward (and the transaction fees from that block) are shared amongst the miners in the pool based on how much processing power they contributed.
- Periodically, the pool transfers the crypto to your wallet address. You’re usually paid in the cryptocurrency you helped mine, or that cryptocurrency is converted to another crypto (usually Bitcoin), and the converted amount is sent to you.
What equipment do you need to mine Bitcoin?
Back when Bitcoin first began you could compete for blocks and earn Bitcoins with a regular laptop or desktop computer. However, as the Bitcoin network has grown, mining equipment has had to improve with the increasing difficulty of the mathematical puzzles.
Nowadays, in order to make mining profitable, miners must invest in more powerful equipment like a GPU (graphics processing unit) or more realistically an application-specific integrated circuit (ASIC) miner. These are often specifically made for the purpose of mining crypto and can cost easily up to tens of thousands of dollars.
There are also other forms of mining like mobile mining or cloud mining but given the specific specialised equipment that serious miners use, these other options are rarely profitable. If you are not willing to invest a lot of money in mining equipment, you might consider mining for other cryptocurrencies besides Bitcoin or staking your cryptocurrency through the Proof of Stake model to earn passive income instead.
What cryptocurrencies can be mined from a home computer?
There are a number of lesser known cryptos that are far more accessible (and potentially profitable) for regular people looking to mine some cryptocurrency. Some of the most notable examples include:
- Dash – a form of digital cash
- Zcash – a leading privacy-centric digital currency
- Dogecoin – a meme token that shows no signs of slowing down
- Litecoin – an offshoot of Bitcoin with many advantages
- Raven Coin – enabling instant payments seamlessly
- Ethereum Classic – a crypto aiming to maintain the original Ethereum Blockchain
- Monero – a crypto focused on privacy & anonymity
What stops Google or another tech-giant from mining Bitcoin?
You might think a tech-behemoth like Google could step in with all its computing power to monopolise the Bitcoin mining scene. Luckily, this would not be financially viable for Google as Bitcoin mining requires specialised hardware that is far more efficient at mining than what specific non-mining companies like Google or Microsoft own. No issues there!
Digital Surge is the easiest way for Australians to buy, sell & store over 250+ cryptocurrencies. With extremely low fees, a uniquely user-friendly interface and a customer-support team you can rely on, getting involved in crypto has never been easier. Sign up today and enjoy safe, stress-free trading.
Crypto-curious? The time you spend here will be the best investment you ever make.
Enjoy effortless trading today
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