If you’re like most of us, when your first heard about cryptocurrencies, you heard about Bitcoin (BTC). And as you waded through the morass of information trying to get a handle on what Bitcoin really was, one of the first big obstacles you ran into was that BTC comes into existence by a process called “mining.”
I thought to myself, “you mean like gold?”
If that stumped you, you’re not alone. I know it did me.
In fact, as I began my cryptocurrency journey, the process of mining became one of the most fascinating – and tricky – concepts to get my head around. I really didn’t know what to believe.
Well, no worries.
In today’s installment, I’ll give you the truth behind mining cryptocurrency. I’ll break down the basics of cryptocurrency mining, what it’s about, how it’s done, and why people do it. And if I’ve done my job, you’ll get a good understanding without a bunch of technical jargon.
Now, if you’re looking for a starter kit on crypto, I recommend taking a look at a high-level explanation of cryptocurrency and why it’s such a big deal. You don’t need those to get a good understanding of what we’ll talk about today, but they may be able to fill in some holes.
First off, some housekeeping items.
Not all cryptocurrencies are mined in the same way. There are different methods and processes for a variety of coins.
So, we’re going to tackle the basics behind mining Bitcoin. It’s the biggest cryptocurrency out there, and its mining process is similar to many other cryptocurrencies.
So, let’s put on our mining helmets and get to it!
What is Mining Bitcoin?
Blockchains work because the decentralized ledgers that record the transactions are maintained by a vast array of people and computers that make sure the transactions are correct.
In order to motivate these people to expend all this effort, they are paid in coins. When transacting business using Bitcoin, the method of payment is Bitcoin. If they do this work for another blockchain, they’ll be paid in the coin of that blockchain. (By the way, they are also paid fees for their efforts.)
Here’s where it gets a little tricky.
I used a version of this exact strategy to win the 2019 U.S. Investing Championship and have been teaching it to my students for a decade.
This process of verifying transactions and making sure the blockchain is ok is not just an audit function. When a new set of transactions is verified on the blockchain, a new “block” is considered added to the blockchain. And the person that did the verification and added the blockchain “mines” 6.25 BTC. With a recent price of $40,614, the lucky miner just pocketed a mining reward of $253,838.
Yep, that’s right. Be the first to verify a new block and add a new block to the BTC network, and you’ll take home over one quarter-million dollars.
No wonder this stuff is so popular, right?
Well, as nice as that quarter mil sounds, fact is it’s extremely difficult to verify and add that new block.
Here’s what I mean.
Miners Solve Puzzles
If you remember, a Bitcoin miner collects, organizes, and verifies the transactions on the blockchain. Since there are lots of other miners on the blockchain doing the exact same thing, who gets the reward?
The answer is simple: The first one to solve an incredibly complicated math puzzle.
Let’s unpack that a bit.
Every transaction in a new block in the blockchain has a long sequence of numbers assigned to it. This hexadecimal number is combined with other transactions in the block. While the number of transactions could theoretically be just one, the fact is they usually number in the thousands. The result is a very long and complicated series of numbers.
The miner’s job is now essentially a guessing game. Using very powerful and expensive computing equipment, miners try to guess what this series of numbers are. If you’re the first miner to guess right, you’re the winner. And you get paid the quarter mil.
But guessing this number is no easy task. The difficulty rate for BTC now stands a mind-boggling 20 trillion. That means the chance of a miner guessing the right answer to the BTC puzzle is one in 20 trillion. Not the greatest odds in the world.
Mining is Expensive
Guessing the right number to win the block isn’t just difficult; it’s extremely expensive.
In the early days of BTC, when mining difficulty was much lower than today, you could use a typical home computer to run mining software and make guesses.
But that’s no longer the case. Today miners must invest in powerful equipment that includes GPUs (graphical processing units) and ASICs (application-specific integrated circuits). These rigs are often run together and can use a tremendous amount of electricity in the process.
Now, if you add up the slim chance of guessing the puzzle on your own – and the massive cost of being a competitive miner – it’s no wonder that many miners throw in together. These groups of miners – called “mining pools” – combine their computing power and split the BTC proceeds. You can think of them as lottery pools where – if one of the members' tickets hits the right number – everybody in the pool gets their cut.
As you can see, becoming a Bitcoin miner has its appeal. But in the long run, for most of us, buying BTC is the way to go.
And remember, if you do decide to buy Bitcoin (BTC), make it a little – no more than 1% to 2% of your portfolio.
Disclosure: This contributor may own cryptocurrencies mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.