What is mining?
Cryptocurrency mining explained
Unlike traditional mining, cryptocurrency mining does not take place underground – at least not literally!
It doesn’t involve pickaxes, shovels or loaders, and it also doesn’t produce precious metals that can be made into something tangible, like traditional coins.
So what is mining in the world of cryptocurrency?
An introduction to mining
Cryptocurrency mining serves two purposes:
It adds new transactions to the blockchain. It does this by verifying the transactions and adding them to the public ledger.
It releases new currency into the circulating supply.
These two functions are related. Each new transaction that is added to the blockchain helps to keep the blockchain working and maintains its honesty. The miners are effectively acting as auditors, verifying and recording each transaction on the public ledger and, as a reward, the miners get to keep the currency they release.
Who can mine cryptocurrency?
Initially, it was only the diehard crypto enthusiasts who got involved in mining. This niche group of miners steadily opened its ranks and grew. Now, mining is a much more accessible practice, gaining popularity amongst individuals and within organisations. A group of miners can also pool their resources together to mine on a network as a collective unit - known as a ‘mining pool’ – which can be a source of more consistent rewards for their effort.
Of course, cryptocurrency mining does require some tools. The most important tools are an internet connection and a strong and steady source of computing power. Some miners also need to get their hands on customised hardware, commonly known as an Application Specific Integrated Circuit (ASIC), that has been specifically designed for mining certain cryptocurrencies, such as Bitcoin.
There are alternative methods for mining available – but ASIC-based mining is perhaps the most widely used. We will look at other mining methodologies in a later lesson.
Okay…so how does mining actually work?
The process of cryptocurrency mining is essentially about solving complex mathematical problems. Transaction data is gathered into ‘blocks’ of computational algorithms that need to be solved by miners in order for said block to be added to the blockchain.
The miners themselves don’t need to be genius mathematicians, they just need the right tools: a computer, a power source and an ASIC.
To solve one of these mathematical problems, miners set their computers to come up with a hash (a 64-digit hexadecimal number) that is less than or equal to the target hash for each block. Miners set up their computers to process a huge amount of hashes at once to give them a better chance of hitting the target hash.
The first miner to solve the algorithm gets to place the next block on the blockchain. As more blocks get added to the chain, the algorithm gets more difficult to solve. Making mining progressively more difficult is intentional - it ensures that mining is undertaken at a steady rate and regulates the amount of cryptocurrency in circulation. This is important as, for many coins, there is a finite number that can be created - Bitcoin, for example, will only have 21 million coins mined and released into circulation.
So, multiple miners might simultaneously try to solve the same problem, but only the first to do so – and provide evidence of this – will be rewarded. This is known as the proof of work (PoW) system, which validates miners’ work to prove that is correct and worthy of reward. This keeps the chain authentic.
We’ll cover PoW in more detail in a later lesson – so don’t worry if the concept has left you confused!
Rewards of mining
The reward miners earn for releasing new currency is called a ‘block reward’.
Bitcoin, for example, has its block reward halved every 210,000 blocks. For Litecoin, the reward is halved every 840,000 blocks; this is because a block is processed on the Bitcoin network roughly every 10 minutes, while it takes only 2.5 minutes on the Litecoin network.
However, the block reward only decreases if the creators of the blockchain have coded it in such a way. There may be blockchains out there which have not been designed to progressively reduce the block reward. This could mean that if those blockchains become successful, they could attract more miners.
The disadvantage of keeping the block reward constant is that the coin could then have a high rate of inflation, which could lead to reduced demand for the coin.
As you can see, mining cryptocurrency is a delicate balancing act and, indeed, a complex concept to explain. Take a look at the infographic below – it summarises the main points you need to remember.