An Introduction to Mining Cryptocurrency

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Cryptocurrency Mining

To get the most out of this article, make sure you understand the basics of how a blockchain network works.

What is Mining?

The process of mining cryptocurrency is essentially an incentive system to create robust infrastructure for Proof of Work (PoW) blockchain networks.

With Proof of Work blockchains, such as Bitcoin or Ethereum, nodes (computers) race to solve mathematical problems in order to create new blocks of transactions. The node that solves the problem first gets to create the next block in the blockchain and is then rewarded with newly created coins; throughout this entire process nodes maintain the blockchain network by processing and verifying the transactions to be included in new blocks.

Just as a gold miner must work to find a gold nugget, a node maintaining a PoW blockchain network must work to “mine” cryptocurrency.

The Incentive to Mine

Though some idealists may mine simply to support the network, for most the incentive to mine cryptocurrency is largely financial: miners receive occasional monetary rewards in the form of new coins and transaction fees whenever they win the race to create the next block. For example, the current reward for creating a block in the Bitcoin network, which happens about every ten minutes, is 12.5 bitcoins plus fees for the transactions included in that block. At current prices that’s over $100,000, and it’s easy to see why there are so many large Bitcoin mining operations around the world.

But bitcoin hasn’t always been valued so highly, and it took several years for the network to grow to where it is today. In order to encourage mining early on, blockchain networks generally begin with higher inflation rates that steadily lower as time goes by, like Bitcoin’s inflation rate, which halves approximately every four years. In 2009 the reward for creating a block was 50 bitcoins, nine years later it is 12.5 bitcoins, and it will continue to halve until 2140, when almost no new Bitcoin will be created and miners will be rewarded with transaction fees alone. In this way, early adopters receive higher rewards (in the number of coins) for helping to jumpstart the network’s infrastructure. 

Miners Play an Important Role in Securing a PoW Network

To understand the full importance of mining, we must remember that a public blockchain network such as Bitcoin lacks centralized authority and centralized infrastructure; instead, the Bitcoin network is owned and managed completely by its users. Mining provides a method for these users to work together – no matter where they are from or what their intentions are – without having to trust one another.

In order to create the next new block, a node must store a full copy of the blockchain. This enables the node to verify that any transactions to be included in the new block are valid, such as verifying that Timmy really does have 2 bitcoins to pay Sally.

As more nodes join the network and compete for rewards, more copies of the blockchain are maintained all around the world, which strengthens the network in a few key ways:

It provides an incentive for miners to stay honest: because all nodes can verify transactions, any miner trying to add a block with fraudulent transactions would have their block rejected by the other nodes. Any resources that miner spends, such as time or the cost of electricity, would be lost.

It essentially creates a fail-proof network: with nodes located all around the world, there is virtually no way to shut down a robust blockchain network without shutting down the entire internet. If one node, or even an entire country of nodes fails for whatever reason, the network will continue.

It makes the network very difficult to attack: the most feasible way to attack a PoW blockchain network is to control over 50% of the processing power. The more nodes contributing to maintaining the network, the harder and more expensive this is to attempt; the Bitcoin network has grown to a point where this type of attack is basically impossible. (This concept will be covered in more detail in a future article on 51% attacks.)

The Future of Mining

Unfortunately, mining is an electricity-intensive process, and around the world there are large warehouses full of specialized computers designed to maximize the speed at which miners can race to gain rewards. According to an estimate by digiconomist.net, the Bitcoin network alone currently uses as much power as the entire Czech Republic.

In the long term, mining on such a scale is environmentally unsustainable, and many cryptocurrencies are already using alternative methods to maintain and secure their networks, such as Proof of Stake. Other networks are changing their protocol (rules); Ethereum, for one, will be moving from Proof of Work to Proof of Stake in the near future.

Though I do expect Bitcoin to transition away from PoW at some point, mining will continue in the short term. Switching to a PoW alternative is low on the to-do list when compared to adoption-specific goals like increasing scalability and speed, or creating easy-to-use applications. Plus, Bitcoin developers may want to wait and see which alternatives fare best.

Until then, we will likely see increased mining over the next few years. Many expert investors are bullish on cryptocurrencies, meaning they expect prices to rise, especially if use and adoption rises. Rising prices will only serve to incentivize even more people to invest in mining hardware, creating further environmental strain. Still, this may be the impetus for a community-led campaign to switch from PoW to a more environmentally-friendly incentive system.