This article will focus on how mining works on the Bitcoin blockchain, although the general principles apply to other PoW chains. Also, for ease of understanding, Bitcoin will refer to the blockchain or network, whereas BTC will mean the cryptocurrency.
Miners perform an essential role by validating the legitimacy of transactions and thus, ensuring the integrity of the blockchain ledger.
Mining offers a way of making money from cryptocurrencies through mining rewards and a share of transaction fees. However, it comes at a cost. Miners pay a significant up-front investment in mining equipment and bear the ongoing electricity costs of running it. Cryptocurrency mining has also become highly competitive over the years, meaning there are no guarantees of profits after all the overheads are paid.
Bitcoin was the first digital currency that successfully managed to solve the double-spend problem. This problem is unique to cryptocurrencies, stemming from the fact that they are effectively digital files. Blockchain introduces a mechanism for preventing anyone from simply copying a BTC and spending it twice, in the same way that you could copy a PDF file and give it to two people.
The entire transaction history of each BTC is recorded on the Bitcoin blockchain. When a new transaction takes place, miners compare the new transaction with the ledger to ensure it’s valid.
The general sequence of events is as follows:
Proof-of-Work (PoW) refers to the competition between miners to be the first to solve a computational problem.
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The Bitcoin protocol monitors the time it takes miners to solve the PoW problem and mine a block. If blocks are mined too quickly, the protocol will adjust the work requirements for a target hash and make it more difficult. This is known as the difficulty level, and it’s designed to ensure that no single miner can dominate the network by adding more computing power. It’s an inherent part of the Bitcoin design that’s provided security against attacks over the years.
With Bitcoin, block rewards are fixed according to the original code written by Satoshi Nakamoto. When Satoshi mined the Bitcoin genesis block in 2009, the block reward was set at 50.
However, Satoshi programmed the Bitcoin software to halve the block rewards every 210,000 blocks. The halving introduces increasing scarcity to the supply of new BTC, which Satoshi believed would drive their long-term value. So far, he (or she) has been proved right.
There have been three halvings so far. The first was in November 2012, the second in July 2016, and the third in May 2020. The next halving will take place in 2024. Most Bitcoin analysts believe that Bitcoin’s long-term price cycles are linked to the halving events, with prices peaking anywhere between 12 to 18 months post-halving.
Satoshi programmed Bitcoin so that the maximum number of BTC ever to exist will be 21 million. By around 2140, there will be no more newly minted BTC.
However, the lack of block rewards doesn’t mean there will be no incentives to mine on the Bitcoin network. Over time, transaction fees will likely increase as block rewards decrease to ensure mining remains profitable and miners continue to support the network.
In Bitcoin’s early days, Satoshi Nakamoto or another early miner would have achieved the hash rate needed to mine on the network using only a personal computer with a standard CPU. However, mining has become more popular over time, and the difficulty level has increased significantly.
Now, miners must use specialized hardware called Application-Specific Integrated Circuits (ASICs) to achieve the hash rate needed to compete for block rewards. Mining farms, vast operations that run thousands of ASICs at once, tend to dominate the market.
Ethereum may be planning a move to Proof of Stake with the Ethereum 2.0 upgrade, Bitcoin has no such plans. The Proof of Work algorithm has kept the network secure for over a decade and is a fundamental part of Satoshi’s legacy.
Far more worryingly for Bitcoin supporters, Chinese regional regulators have recently announced plans to clamp down on those involved in cryptocurrency activities, including mining. Given that China holds 65% of the global mining markets, BTC prices have been on a rollercoaster.
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Blockchains. DeFi. Cryptocurrencies. Consensus algorithms. These are terms that you may have heard of in recent months, and with the recent boom in Decentralized Finance, have piqued investors’ interests. How does this obscure piece of technology work, and how can you benefit from it?