How Does Bitcoin Mining Work? What is Crypto Mining?

Bitcoin mining is intrinsically essential for creating new digital assets and value transfer on the network. So, what is Bitcoin mining and how does it work? 

Bitcoin mining is a process where transactions are validated and then added to the blockchain network by owners of sophisticated mining devices, otherwise known as ‘miners.’ These miners compete against each other by solving complex maths problems to secure the network.

In exchange, the miners are rewarded with newly minted Bitcoins.

Bitcoin miners have to rely on powerful devices due to the difficulty of validating Bitcoin network transactions. Bitcoin uses a proof-of-work (PoW) consensus algorithm, which requires miners to compete to solve complex mathematical puzzles. 

To increase efficiency, miners usually join mining pools and utilize specialized rigs to increase their chances of validating transactions and getting the associated reward. The most popular hardware for Bitcoin miners is the application-specific integrated circuit (ASIC), although some miners use the graphics processing unit (GPU).

The Bitcoin dynamics follow a meticulous process in ensuring all transactions meet the required standard. 

The Bitcoin mining process is laid out in the Bitcoin whitepaper and follows these outlined steps:

Transactions are first sent into the ‘mempool,’ which collects all related data. Miners choose which transaction should be attended to first based on the fees attached to them, with the majority opting for higher fees when selecting a transaction to work on. 

Once the transaction is picked and added to a block, the first miner to solve the complex mathematical exercise would broadcast the new block to other miners on the network. This miner gets to earn a miner’s reward of 6.25 BTC. 

The new block is then vetted to see if all transactions are valid, i.e., if there’s no double spend in the broadcasted node. A double-spend occurs when the same Bitcoin is spent twice due to a malicious attack that alters records on the blockchain. A secondary metric will see if the new block properly references the previous one. Once these two components are in place, the new block is accepted as the ‘truth’ and added to the network.

In other words, the miners dictate the transactions that should be added to the Bitcoin network, depending on if a particular block follows the hard-core steps listed on the Bitcoin protocol.

This fastidious process has been known to ensure the security of the Bitcoin network. However, the trade-offs are transaction speed as the Bitcoin network processes about five transactions per second, and much energy is lost in the competitive process.

Crypto mining comes with its own set of challenges. For one, miners need to purchase expensive hardware gear to increase their chances of solving algorithmic puzzles. Another is the need for access to low-cost electricity due to the large amount of energy required in validating transactions. 

The first Bitcoin miner to pass the battery of tests and add the requisite block to the network gets 6.25 BTC as a reward. These rewards are cut in half every time 210,000 blocks are added to the blockchain or every four years. This event is called the Bitcoin Halving.

Although miners can use GPUs of a regular computer, ASICs have proven to be more efficient in bringing new Bitcoins into circulation and making a sizable profit. You also have to worry about other attendant costs such as costs of electricity. To increase efficiency, individual miners usually join mining pools. 

Considering the challenges involved in crypto mining, people might question if it’s worth the effort, but given the potential rewards, it can be extremely worthwhile.

If you factor in Bitcoin’s average growth rate of 82.9%, earning 6.25 Bitcoins can be a huge source of income if done at scale. 

As expected, many Bitcoin mining firms are springing up daily to profit from this opportunity, especially as the next Halving event could trim incentives from 6.25 BTC to 3.125 BTC per reward.

The legality of crypto mining varies from country to country, with different opinions expressed by world governments on the issue. 

The crypto ecosystem is currently unregulated, leaving a lot of loopholes for bad actors to exploit. However, a few world leaders are currently working on a framework, with some others – such as China – preferring to ban crypto mining and cryptocurrencies as a whole. 

However, there’s no concerted global template on crypto mining, although discussions are ongoing. A typical pro-crypto country is Latin American nation El Salvador, currently harnessing volcanic energy to mine cryptocurrencies like Bitcoin. This stands in contrast with the leanings of the U.S., which is yet to pick a side despite being one of the largest crypto markets in the world.

In essence, a country’s stance on the legality of crypto mining is largely subjective. You can check relevant government websites to learn about their stance.

Any crypto miner who wants to mine digital assets like Bitcoin needs several tools to get started. 

The first is a Bitcoin wallet to store earned coins as a Bitcoin miner. Crypto wallets are used for the secure storage of digital assets like Bitcoin. Some of the popular options available include Ledger wallets and Coinomi wallets.

The next set of tools is the Bitcoin mining hardware and the software. The hardware is a specialized computer or mining equipment that is used to mine Bitcoin, while the mining software powers its operation. 

Bitcoin mining hardware is power-hungry devices that solve complex mathematical problems in order to secure the network and create new bitcoins. 

There are various factors that should be considered when shopping for a Bitcoin mining device. They include the cost, energy efficiency, and hash rate. The hash rate is the speed at which the bitcoin equipment can verify transactions and add blocks to the blockchain. The leading Bitcoin mining hardware is the Antminer S19 Pro, given its efficiency, maximum hash rate, and power consumption.

Bitcoin mining software is also crucial in a miner’s arsenal. Mining software allows miners to link their Bitcoin hardware to the Bitcoin blockchain. It’s crucial to the mining operation as it controls how the mining equipment operates and interfaces with the blockchain. Some of the popular Bitcoin mining software includes GMiners, Shamining, and BTCMiner.

Miners are an essential component of the Bitcoin network. Think of them as regular auditors of a company’s books.

Bitcoin miners ensure that transactions posted to the network are genuine and adhere to the network’s established rules. More importantly, miners prevent the risk of a double-spend situation.

A double-spend problem occurs when a Bitcoin is spent more than once. This is due to a malicious attack known as the 51% attack. 

A 51% attack occurs when a single group or individual controls more than 50% of the Bitcoin network’s computing resources. 

This essentially rolls back blocks of transactions, allowing the entity in charge to create a duplicate of the digital asset and spend it twice while keeping the original coin. This would inadvertently undermine the blockchain’s immutability premise.

Other variants of the double-spend attack include the Race attack and the Finney attack. 

A Race attack is when two transactions are forwarded into the network with similar funds. The intention is to validate the attacker’s transaction while jettisoning the other. 

The Finney attack leans in the same direction and often involves the ‘pre-mining’ of a transaction without duly notifying the network. 

Instead, the funds in the transaction are spent and then broadcast to the network as a new one. Both attacks usually rely on the coin’s recipient accepting unconfirmed transactions for them to be successful. Since the incidence of double spending relies largely on Bitcoin miners, how likely is it to happen? 

The truth is Bitcoin miners are not incentivized to carry out this attack as it would ultimately devalue the asset.

Another critical area in which miners contribute to the continued operation of the Bitcoin network is the enforcement of block addition rules.

Before adding a new block to the previous blockchain, the new block is checked to ensure it correctly references the previous block. Once this is done, the new block of transactions is added to the previous one to form a chain. Miners are essentially the executors of the pre-programmed computing codes laid out by Bitcoin’s anonymous founder, Satoshi Nakamoto.

Bitcoin mining was an easier affair early on, as miners could mine new coins using their PCs or dedicated graphics cards. But as the years went by, the number of nodes in the network has raised the difficulty level, and this has caused miners to seek high-end gear to earn block rewards.

Many companies spend thousands and even millions of dollars to set up a large Bitcoin mining operation, but is it worth it? It just might be, based on the growth of mining companies over the last two years. Companies like Core Scientific saw their Q2 revenue rise by over 100% in 2022.

Several factors affect the profitability of bitcoin mining. They include physical attributes like the mining hardware used, network difficulty, electricity costs and many others.

However, one factor that continues to impact miners’ earnings is the Bitcoin halving event.

Bitcoin halving was created as a deflationary strategy to reduce the number of Bitcoins introduced into the market. Invariably, the price of the asset would rise if demand remains constant.

The halving event occurs when the block rewards earned by miners are cut in half.

This happens every 210,000 blocks added, which takes about four years. The first halving occurred in 2012.

Before 2012, miners received 50 BTC for solving complex mathematical puzzles and the network fees earned for verifying transactions. 

The block reward dropped by half to 25 BTC in the 2012 event. The 2016 halving event reduced this incentive to 12.5 Bitcoins.

The current Bitcoin block reward is 6.25 BTC, with the next Bitcoin halving scheduled for April 2024.

Some individuals might view the reduced block rewards as a disincentive, but is it? 

Bitcoin was worth less than $10 in 2009. So a miner who earned a miners’ reward of 50 BTC per block would receive $500 in fiat currency for their efforts (assuming there were no trade and withdrawal fees involved).

While the four halving events have decreased the mining rewards, Bitcoin’s value has grown following the massive capital inflow and the artificial shortage of its coins. 

In 2021, Bitcoin surged to an all-time high (ATH) of $69,000, and with its block reward set at 6.25 BTC, miners generated over $431,250 for every block added. This contrasts sharply with 2009’s high block reward and lower fiat value.

Bitcoin mining has evolved as the difficulty level has risen. 

In the early years, miners could verify transactions on their personal computers using their regular central processing unit (CPU). Over 2 million BTC were mined in 2010, and many miners did this using their CPUs. But this changed in mid-2010. 

Bitcoin mining moved on to dedicated graphics cards, otherwise known as GPU mining, which properly harnessed the computing resources of a PC to mine the crypto asset.

By 2012, GPU mining also became obsolete, following the rollout of application-specific integrated circuits (ASICs) miners.

This mining equipment is far more efficient than CPUs and GPUs, increasing the likelihood of a miner solving randomly generated mathematical problems.

Nonetheless, a miner can establish a Bitcoin mining farm to earn fees and block rewards consistently. However, miners do not need a mining farm to obtain block rewards.

Because ASIC miners require a large capital investment (some retail for $12,000 and above), Bitcoin miners form what is known as a mining pool. We will explain this further below.

Aside from hardware units like ASICs, BTC miners also need a software miner. The software connects the Bitcoin hardware to the blockchain.

Bitcoin software is usually free, while some could come with a subscription package of about $50 per year.

Another considerable expense is the energy cost. Bitcoin operates on a PoW consensus algorithm, which consumes a lot of energy. Since the difficulty level is adjusted every 2,016 blocks mined – or about every two weeks – mining Bitcoin can hugely increase a miner’s energy bills.

Energy consumption for Bitcoin is high, and according to the Digiconomist’s Bitcoin Energy Consumption Index (BECI), it takes about 1,549 kW/h to mine 1 BTC, which equates to about 50 days of the energy requirement of an average US household. An average cost of close to 12 cents equates to $173 cash-wise.

Furthermore, every mining operation would also require a proper ventilation system for keeping the equipment cool and a rack for placing the mining nodes. 

As previously stated, Bitcoin relies on PoW for consensus, and transactions are typically drawn out as follows:

When one party initiates a transfer to another, the transaction is temporarily stored in the mempool, otherwise known as the memory pool. Miners on the network would search through all the stored data and choose the one with the most fees. 

In summary, Bitcoin transactions are mostly chosen based on the fee the sender is willing to pay for them to be processed. 

When a transaction is selected, the miners add them to a block of other transactions. Multiple miners can add the same transaction to be included in their block. Each block contains an average of 500 transactions.

Before a transaction is included in the block, a miner has to verify if the transaction is legit and valid to be included in the block. 

The network fees included in the transaction also dictate the transactions miners prioritize in this process. To add this block to the blockchain, the Bitcoin miner must solve the mathematical function (also known as a hash output) attributed to the block. 

Each block of transactions has a unique problem that needs to be solved. Once this is solved, the miner will broadcast the result and the block to other miners. 

Other miners must verify the hash output’s legitimacy and reach a consensus before the block is added to the blockchain. The successful miner is rewarded with 6.25 Bitcoins.

This process is repeated for the next batch of transactions.

Mining pools occur when different entities partner to pool computing resources together to generate enough hash power to rival those of more sophisticated mining operations. Pool mining can be done by a third-party platform which serves as the coordinator that partners with solo Bitcoin miners.

Aside from pooling computing resources together, a mining pool allocates work units to all individual miners on its platform while also analysing and recording the contribution of each node connected to its network. Its operation also helps to concentrate the hash power of all solo miners to find new block rewards. Miners are then rewarded based on their individual contributed hash power.

In distributing rewards, mining pools employ two major methods: pay-per-share (PPS) and proportional (PROP). The PPS system lets users withdraw their earnings instantly from the accepted shares of tasks they worked on. 

On the other hand, the PROP method allows users to withdraw only after completing a mining round. The amount each miner receives largely depends on the hash power they contributed to earning the block reward.

While Bitcoin mining can be a very profitable business, some risks are involved. The first is government regulation. 

Bitcoin was designed to be a people’s currency, which means it aims to replace the current fiat currency. Given its hard-cap limit of only 21 million coins that will ever be mined, Bitcoin is a great store of value and is developing in a value-oriented manner.

However, not all nations see it positively. 

Countries such as India are currently considering prohibiting the ownership or mining of digital assets. While others pursue a dynamic regulatory framework, Asian behemoth China has outright prohibited the use and creation of Bitcoin within its borders. 

China has shut down Bitcoin mining farms in its energy-rich Inner Mongolian districts and advised its citizens not to invest in or hold the digital asset.

The reasoning is that Bitcoin mining harms its climate control initiative, but several world governments see it as a threat. As a result, regions hostile to cryptocurrency may seize mining farm equipment, causing affected miners to lose money.

Another risk of Bitcoin mining is the significant investment required. Miners spend millions of dollars setting up a warehouse, installing a ventilation system, placing racks to hold mining rigs, hiring staff, and finally purchasing the mining equipment itself to build a meaningful Bitcoin mining operation. ASIC miners are frequently updated, and the most recent models cost $5,000 or more. As a result, Bitcoin mining is a very capital-intensive business.

Following closely behind are the energy requirements and carbon footprint of Bitcoin mining. Bitcoin’s annual energy consumption is estimated to be 97.42 TW/h, according to the Cambridge Bitcoin Energy Consumption Index (CBECI). It takes approximately 1,522.95 kW/h to mine 1 BTC, which equates to a carbon footprint of 849.44 kgCO2.

This energy demand is very high, and critics have raised concerns about the environmental consequences of mining the PoW asset.