Just like mining gold, mining Bitcoin and other cryptocurrencies requires a significant investment of resources in the hope of discovering a valuable reward. The mining process refers to the mechanism for validating transactions within a blockchain, and is based on complex mathematical calculations. Discover what is crypto mining and how does it work? (Using Bitcoin as a major example)
What is crypto mining and how does it work?
CPU, GPU, ASIC – you may have encountered these terms before, but perhaps never fully understood them. These words describe a central activity in the world of cryptocurrencies: mining. Different types of mining exist, depending on the blockchain.
To make this article as digestible as possible, we will focus primarily on Bitcoin (BTC) blockchain mining. Before delving into the details of mining, let’s briefly recall what a blockchain is. It is a cryptographically secured chain of blocks that transparently and immutably records all transactions.
Mining validates transactions on blockchains operating on the Proof of Work (PoW) consensus. This is particularly true of the Bitcoin blockchain.
Miners use computer power to solve complex cryptographic puzzles and discover a new hash, or digital fingerprint, which satisfies criteria predefined by the Bitcoin protocol. The first miner to find the solution adds the new block to the blockchain and receives a reward in BTC. This financial incentive motivates miners to contribute to the security and smooth running of the blockchain.
The reward varies according to the blockchain. It can be fixed, degressive (i.e., decreasing over time), created for each transaction, or proportional to the money supply. Some blockchains adopt a “tail emission” (i.e., once the cryptocurrency in question reaches a certain lifespan, the reward granted to miners no longer decreases) to maintain an incentive mechanism.
Other blockchains base their system on transaction fees. Finally, a hybrid system is entirely possible
What machines are used for mining?
Originally, people could mine Bitcoin on a simple computer using a CPU. However, as the Bitcoin network expanded, CPUs quickly became obsolete because miners needed more computing power to remain profitable.
This requirement drove a specialization of mining hardware, leading miners to use GPUs, which proved far more efficient. NVidia and AMD are the main GPU manufacturers. This, in turn, drove the development of specialized mining structures called racks.
Then, the arrival of ASICs (or integrated circuits for specific applications) marked a new stage in terms of mining performance. ASICs, designed exclusively for mining, offer better performance and energy efficiency, but at a higher initial cost and with less flexibility, being limited to a single cryptocurrency.
ASICs can quickly become obsolete, making them difficult to resell, unlike GPUs, which people can reuse or resell, particularly in gaming.
Computing power fuels the mining industry. People measure it by the hashrate, which represents the number of hash calculations a computer performs per second.
A higher hashrate increases a computer’s ability to solve complex mathematical problems, which is crucial for maintaining and securing a blockchain network. The global hashrate of a blockchain also reflects the power that secures the blockchain.
The security of a blockchain depends largely on its hashrate: a high hashrate makes the network more resistant to attacks, notably the 51% attack, where a malicious actor could potentially take control of more than half the network’s computing power, thereby compromising the integrity of transactions.
On this graph, the blue curve shows the total hash rate of the Bitcoin blockchain, measured in terahashes per second (TH/s).The black curve represents the Bitcoin price in US dollars (USD).
How does mining work on the Bitcoin blockchain?
Bitcoin has a maximum supply limit of 21 million units. A key element of this mechanism is the concept of halving, an event programmed into Bitcoin’s code that occurs every 210,000 blocks, or approximately every 4 years.
During a halving, the reward given to miners for each new block discovered is halved. Currently, this reward is 6.25 bitcoins per block, dropping to 3.125 bitcoins at the next halving on April 24, 2024. This process is designed to progressively reduce the issuance of new bitcoins and control inflation.
Transactions on the Bitcoin blockchain are organized into data structures called Merkle trees, which enable efficient verification of transaction integrity without requiring all the individual information.
Each block contains a set of validated transactions, and only a miner can be the first to find the solution to the cryptographic puzzle.
The issue of energy consumption in Bitcoin mining is a hotly debated topic. Bitcoin’s detractors often point to its high-energy consumption and environmental impact. However, the situation is more complex. Indeed, miners, motivated by profit maximization, tend to favor less expensive energy sources, which are often renewable, especially in countries like Iceland where green energy is abundant and economical. In total, it is estimated that 37% of the energy used in the mining industry is green, a percentage that may be underestimated.
Finally, in a future where the number of bitcoins issued will be increasingly reduced, following several halvings, miners will have to rely on transaction fees as a source of revenue.
This transition raises the question of the long-term viability of mining, particularly if the Bitcoin price does not rise sufficiently to compensate for the diminishing rewards.
The last Bitcoin is expected to be mined in 2140, and the economic future of miners will then depend on the mass adoption of the Bitcoin blockchain and the evolution of its activity to generate more transaction fees.
How does the mining business model work?
The profitability of cryptocurrency mining is influenced by several crucial factors.
The cost of electricity
Since mining requires computing power throughout the day without interruption, the cost of the energy used is a crucial factor. The cheaper the energy, the more profitable it is to mine.
The initial cost of mining machines
Prices and computing power vary according to the type of machine. The more powerful the mining machine, the faster it can solve cryptographic puzzles, thus increasing the chances of receiving mining rewards.
Hardware wear and obsolescence
ASICs, while more powerful than GPUs, are not necessarily more cost-effective. As well as being more expensive, ASICs are also less flexible, as they are difficult to reuse.
The cryptocurrency concerned
A cryptocurrency whose price depreciates over time will be less attractive to mine. Consideration of the total hashrate of the network is also a central element, as it conditions the difficulty of receiving the reward for mining a block.
The influence of legislation and regulations
This varies considerably from country to country. In some less developed and politically unstable countries, changes in regulations can significantly influence the way mining operations are conducted, as well as their profitability.
Market conditions
During a bear market, miners may have an incentive to hold on to the mined crypto, as the price is relatively low. On the other hand, in a bull run, the crypto currency is highly valued, which encourages them to sell immediately.
The special case of halving
Within the Bitcoin blockchain, a significant event affecting profitability is halving, which halves the reward for validating a block. If the Bitcoin price falls below a miner’s break-even point (which varies from one miner to another), the miner may cease operations due to lack of profitability. This leads to a drop in the overall hash rate and mining difficulty. Conversely, if the Bitcoin price is above this threshold, the impact on the hash rate may lessen, despite a reduction in profitability.
Following halving, miners generally sell mining machines that are no longer sufficiently efficient, thereby compensating for the reduction in rewards as mining difficulty also decreases. This hardware upgrade can maintain or even increase the overall hash rate despite the drop in incentives.
Although past performance does not indicate future performance, rising Bitcoin prices have historically followed each halving.
As you can see, competition between miners is fierce. To cope with this, some miners have decided to pool their computing power in mining pools to increase their chances of solving a block. This stabilizes their revenues by sharing both rewards and costs.
Other alternatives, such as cloud mining, enable individuals to participate in mining without owning hardware by renting computing power. However, despite its advantages such as accessibility and simplicity, cloud mining generally offers a lower return compared to owning one’s own mining equipment.
Other cryptocurrencies that work with mining
Bitcoin is not the only Proof of Work blockchain that secures its transactions with mining. Let us take a closer look at three other blockchains that work in a similar way.
Litecoin (LTC)
Litecoin is a fork of Bitcoin that employs the Scrypt algorithm, favoring memory-intensive systems and making mining more accessible to individuals.
Similar to Bitcoin in many respects, Litecoin differs in several respects, notably in that transaction confirmation is faster, aiming for a block every 2 minutes and 30 seconds, compared with every 10 minutes for Bitcoin.
There are 84 million LTC units in circulation, 4 times more than Bitcoin (considered digital gold), earning Litecoin the nickname “digital money”.
Dogecoin (DOGE)
Dogecoin, a hard fork of Litecoin from 2014, began as a parody cryptocurrency and gained popularity, largely due to Elon Musk’s influence. Because it shares many technical features with Litecoin, its consensus gears toward a broader, informal community.
One notable difference is that the community has not halved the Dogecoin blockchain by vote since 2015.
Monero (XMR)
Monero focuses on transaction confidentiality and anonymity, using circle signatures and stealth addresses to hide transaction details. Its mining process, based on the RandomX hash function, is designed to be ASIC-resistant, favoring GPUs and CPUs. This encourages more people to take part in the mining process, enabling greater decentralization.
Conclusion on cryptocurrency mining
In conclusion, mining forms the central pillar for blockchain integrity, ensuring the validation and transparent recording of transactions within blocks.
Despite criticism of its energy footprint, mining offers unsuspected potential for the energy development of remote regions.
However, for this industry to realize its full potential, actors must overcome significant obstacles such as regulatory issues and logistical challenges.
Read also: Top 10 trading indicators every trader should know