Bitcoin was created as a decentralized alternative to the banking system. This means that the operation can operate and transfer funds from one account to the other without any central authority.
With a central authority, transferring money is easy. Just tell the bank you want to remove $50 from your account and add it to someone else’s account. In this case, the bank has all the power. Since the bank is the only one who’s allowed to update the ledger that holds the balances of everyone in the system. But how do you create a system that has a decentralized ledger? How do you give someone the ability to update the ledger without giving them so much power that they’ll become corrupt or negligent in their work?
Well, the rules of the bitcoin system, known as the protocol, solve this in a creative way: “who wants to become a banker?”
Anyone who wants to update the ledger of bitcoin transactions, known as the blockchain, can do so. All you need to do is, guess a random number that solves an equation generated by the system. All these guessings are all done by your computer.
The more powerful of a computer you have, the more guesses you can make per second, thus increasing your chances of winning this game. If you managed a guess right, you earn bitcoins and get to write the next page of bitcoin transactions on the blockchain.
Here’s a more detailed breakdown of the mining process:
Once your mining computer comes up with the right guess, your mining program determines which current pending transactions will be grouped into the next block of transactions. Compiling this block represents your moment of glory as you have now become the temporary banker of bitcoin, who gets to update the Bitcoin transaction ledger, known as the blockchain.
The block you have created and your solution are sent to the whole network so that other computers can validate it. Each computer that validates your solutions updates its copy of a bitcoin transaction ledger with the transaction you chose to include in the next block.
As you can imagine, since mining is based on a form of guessing for each block, a different miner will guess the number and be granted the right to update the blockchain. Of course, the miners with more computing power will succeed more often. But due to the laws of statistical probability, it is highly unlike that the same miner will do so every time.
After this stage is complete, the system generates a fixed amount of bitcoins and rewards them to you as compensation for the time and energy you spent solving the math problem. Additionally, you get paid any transaction fees attached to the transactions you inserted into the block. So, that is what bitcoin mining in a nutshell.
It’s called mining because this process helps “mine” new Bitcoins from the system. But, if you think about it, the mining part is just a by-product of the transaction verification process. So, the name is a bit misleading since the primary goal of mining is to maintain the ledger in a decentralized manner.
Satoshi Nakamoto, who invented Bitcoin, crafted the rules for mining so that the more mining power the network has, the harder it is to guess the answer to the mining math problem. So, the difficulty of the mining process is self-adjusting to the network's accumulated mining power. If more miners join, it would be harder to solve the problem. If any of them drop off, it will get easier. And this is known as the mining difficulty.
Satoshi did this because he wanted to create a steady flow of bitcoins to the system. In a sense, this was done to keep inflation in check. The mining difficulty is set so that, on average, a new block will be added every ten minutes. On average, we can have two blocks added minute after minute and then wait an hour for the next block. In the long run, this will even out to 10 minutes on average.
This self-adjusting mechanism created an arms race to get the most efficient and potent miners as soon as possible.
When bitcoin first started, there were not a lot of miners out there. Satoshi, the inventor of bitcoin, and his friend Hal Finney were some of the few people mining Bitcoin back then with their personal computers. Using your CPU, meaning your central processing unit or your computer’s brain, was enough for mining Bitcoin back in 2009 since the mining difficulty was low,
As Bitcoin started to catch on, people looked for more powerful mining solutions. Gradually people moved to GPU mining. A GPU or graphics processing unit is an individual component added to computers to carry out more complex calculations. GPUs were originally intended to allow gamers to run computer games with intense graphics requirements. Because of their architecture, they became popular in the field of cryptography. For reference, the mining power of one GPU equals around 30 CPUs.
Another revolution came later on with FPGA mining. FPGA is a piece of hardware connected to a computer to run a set of calculations. They are just like a GPU but 3 to 100 times faster. The downside is that they are harder to configure, which is why they aren’t as commonly used in mining as GPUs.
Finally, around 2013, a new breed of miner was introduced- the ASIC miner. ASIC stands for Application-Specific Integrated Circuit. And these were pieces of hardware manufactured solely for mining Bitcoins. Unlike GPUs, CPUs, and FPGAs, they wouldn’t be used to do anything else. Their function was hardcoded into the machines. ASIC miners are the current mining standard. Some early ASIC miners appeared in the form of USBs, but they became obsolete rather quickly.
After about three years of this crazy tech race, We have finally reached a technological barrier, and things have cooled down. Since 2016, the pace at which new miners are released has slowed considerably.
The idea is simple, miners group together to form a pool, combining their mining power to compete more effectively. If the pool wins the competition, the reward is spread out between the pool members, depending on how much mining power each contributed. This way, even small miners can join the mining game and have a chance of earning bitcoin, even though they get only a part of the reward. Today, there are over a dozen large pools that compete for the opportunity to mine bitcoins and update the ledger.
The profitability of Bitcoin:
Bitcoin Mining’s Profitability depends on a lot of factors. When calculating Bitcoin mining profitability, you need to take a lot of things into account. They are:
1. Hash Rate
A hash is a mathematical problem; a miner’s computer needs to solve. The Hash rate refers to your miner’s performance or how many guesses your computer can make per second. Hash Rate can be measured in Mega hash per second (MH/s), Giga Hash per second (GH/s), Terra Hash per second (TH/s), and even Peta Hash per second (PH/s).
2. Bitcoin Reward
This refers to the number of bitcoins generated when a miner finds a solution. This number started at 50 bitcoins in 2019 and halved every 210,000 blocks every four years. The current number of bitcoins awarded per block is 12.5. The last block occurred in July 2016; the next one will be in 2020.
3. Mining Difficulty
This number represents how hard it is to mine bitcoins at a particular moment according to the amount of mining power currently active in the system.
4. Electricity cost
How many dollars are you paying per kilowatt? You need to find out your electricity rate to calculate profitability. This can usually be found on your monthly electricity bill. This is important because miners consume electricity, whether for powering up the miner or cooling it down, as these machines can get hot.
5. Your Miner’s Power Consumption
Each miner consumes a different amount of energy. You’ll need to determine your miner's exact power consumption before calculating profitability. And this could be found easily with a quick search on the internet or through this list. Power consumption is measured in watts.
6. Pool fees
If you are mining through a mining pool, the pool will take a certain percentage of your earnings for rendering their service.
7. Bitcoin’s price
Since no one knows what bitcoin’s price will be in the future is hard to predict if bitcoin mining will be profitable. If you are planning to convert your mined bitcoins in the future to any other currency, this variable will have a significant impact on your profitability.
8. Difficulty increase
This is probably the most important and elusive variable of them all. The idea is that since no one can predict the rate of miners joining the network, neither can anyone predict how difficult it would be to mine in 6 weeks, six months, or six years from now. In fact, in all the time bitcoin has existed, profitability has dropped only a handful of times, even when the prices were relatively low.