What Does Mining Cryptocurrency Do?

Mining 101

by DailyCryptoInfo 166 Views

What Does Mining Cryptocurrency Do?

Mining 101

by DailyCryptoInfo 166 Views

What is cryptocurrency mining?

Cryptocurrency mining is one of the most commonly used methods of validating transactions that have been executed over a blockchain network. Not only does blockchain work to protect transaction data through encryption, as well as store this data in a decentralized manner (i.e., on hard drives and servers all over the world) so as to keep a single entity from gaining control of a network, but also the primary goal is to ensure that the same crypto token isn't spent twice. In effect, "mining" is one means of making sure that cryptocurrency transactions are accurate and true, such that they can never be compromised in the future.


Hard drives and graphics processing units being used to mine cryptocurrency.

Image source: Getty Images.

The cryptocurrency market was absolutely on fire in 2017, delivering what might be the best year for any asset class on record. After beginning the year with an aggregate market cap of just $17.7 billion, digital currencies combined to finish the year at $613 billion, representing an increase in value of more than 3,300%.

Yet most people don't understand much about virtual currencies. Sure, more people than ever have probably heard about bitcoin, and they may have heard about some of its closest rivals by market cap, such as Ethereum and Ripple, but they don't have the faintest idea what purpose they serve or how they really work.

Back in January, we covered some of these basics by examining what cryptocurrencies are, and why they were developed, then proceeded to examine the advantages and disadvantages of the blockchain technology that underpins most digital currencies. Today, we're going to tackle another common head-scratching issue: cryptocurrency mining.

How cryptocurrency mining works

Cryptocurrency mining itself refers to a type of validation model known as "proof-of-work" (PoW). There are two common validation types, and we'll look at the other, known as proof-of-stake, in a moment.

In the PoW model -- which bitcoin, Ethereum, Bitcoin Cash, and Litecoin use, to name a few -- individuals, groups, or businesses compete with one another with high-powered computers to be the first to solve complex mathematical equations that are essentially part of the encryption mechanism. These equations correspond to a group of transactions, which is known as a block. The first individual, group, or business that solves these transactions, and in the process validates the accuracy of these transactions within a block, receives a "block reward." A block reward is paid out as digital tokens of the currency that's being validated.

As an example, the current block reward for bitcoin is 12.5 tokens. That means whoever is the first to correctly solve equations for a block is paid 12.5 tokens. With bitcoin near $9,500 per coin, that works out to a nearly $119,000 haul.

Hard drives and graphics processing units attached to a monitor.

Image source: Getty Images.

Over the past several years, cryptocurrencies like Bitcoin have been quietly growing in popularity, with an ever-larger number of people buying and selling them. Now that Bitcoin has hit the mainstream and become a worldwide phenomenon, more people than ever are looking to get into the cryptocurrency game.

However, the production of cryptocurrencies isn't anything like that of regular money. There's no central authority that issues new notes; instead, bitcoins (or litecoins, or any of the other so-called 'alt-coins') are generated through a process known as 'mining'. So what is cryptocurrency mining, and how does it work?

Cryptocurrency mining and the blockchain

Before getting to grips with the process of cryptocurrency mining, we need to explain what blockchain is and how that works. Blockchain is a technology that supports almost every cryptocurrency. It is a public ledger (decentralised register) of every transaction that has been carried out in that cryptocurrency.

These transactions are assembled into what are called "blocks". These are the verified to ensure they are legitimate by cryptocurrency miners. This checks if the same coin hasn't been expended again before the transaction has cleared, and that the input and output expenses tally. Then the next sequential transaction block is connected to it. This is how cryptocurrencies are created and how new cryptocoins are made.

Mining new blocks

As there is no central authority or central bank, there has to be a way of gathering every transaction carried out with a cryptocurrency in order to create a new block. Network nodes that carry out this task called dubbed 'miners'. Every time a slew of transactions is amassed into a block, this is appended to the blockchain. Whoever appends the block gets rewarded with some of that cryptocurrency.

To prevent the devaluation of the currency by miners building lots of blocks, the task is made harder to conduct. This is achieved by making miners solve complicated mathematical problems called proof of work'.

Calculating hashes

In order to successfully create a block, it must be accompanied by a cryptographic hash that fulfills certain requirements. The only feasible way to arrive at a hash matching the correct criteria is to simply calculate as many as possible and wait until you get a matching hash. When the right hash is found, a new block is formed and the miner that found it is awarded with units of cryptocurrency.

Think of it like one of those competitions where you have to guess the weight of the cake - only you get unlimited guesses, and the first one to submit a correct answer wins. Whoever can make guesses at the fastest rate has a higher chance of winning.

Cryptocurrency mining limits

In practice, this means that miners are competing against each other to calculate as many hashes as possible, in the hopes of getting to be the first one to hit the correct one, form a block and get their cryptocurrency payout.

However, the difficulty of calculating the hashes also scales - every new block of bitcoins becomes harder to mine. In theory, this ensures that the rate at which new blocks are created remains steady. Many cryptocurrencies also have a finite limit on the amount of units that can ever be generated. For example, there will only ever be 21 million Bitcoins in the world. After that, mining a new block will not generate any bitcoins at all.

Cryptocurrency mining requirements

Although you were once able to mine your own cryptocurrencies using a standard PC, this isn't viable any longer; the quality and quantity of hardware you need to mine effectively increases in line with the volume of people mining. That's seen requirements leap - from a reasonably-powerful processor, to a high-end GPU, to several GPUs working in conjunction, to -now - specialised chips specifically configured for cryptomining.

Nowadays you will have to spend upwards of £1,000 on the appropriate hardware to mine most modern cryptocurrencies with any success. The energy consumption, meanwhile, is substantial - and you'll need to keep an eye on these rising costs while running your machine 24/7. Most miners will spend the overwhelming majority of their income from mining on paying to maintain and run the equipment.

As the Bitcoin hype is more or less fully nestled in the wider public consciousness, organisations have invested increasingly considerable sums into it, effectively industrialising cryptocurrency mining. Large warehouses packed to the brim with floor-to-ceiling racks of expensive graphics cards, working towards the sole aim of mining new units of Bitcoin, Ether, Litecoin, and so on, have become the new normal.

The Bitcoin network - to add some context - processes 5.5 quintillion hashes per second, which means that unless you have the equipment capable of processing a massive quantity of calculations in a very short space of time, the chances of you being able to compete with the more industrial operations are miniscule. For this reason, miners often band together and pool resources to maximise their chances of profiting from the cryptocurrency mining game - creating 'mining pools' - sharing their power, as well as any returns their efforts may generate between them.

Are there disadvantages to the PoW model?

There are two major concerns attached to the PoW model. First, it's an extremely electricity-intensive practice. To mine virtual currencies, massive mining centers with graphics processing units and/or ASIC (application-specific integrated circuit) chips are set up to handle this validation and processing. The electricity costs, depending on where an operation is located, can be enormous. It could also, in theory, be a drain on local or national electric grids, depending on how large digital networks and mining farms become.

The other issue is that the PoW model has a security vulnerability, at least for smaller digital currencies. Any individual or group that can gain control of 51% of a networks computing power could essentially hold that network and digital currency hostage. Networks the size of bitcoin, Ethereum, and Litecoin have next to nothing to worry about. However, newly issued coins with fewer participants could be susceptible.

Is all PoW mining the same?

Though cryptocurrency mining might often be lumped in as one big free-for-all, there are differences in the equipment being used to validate transactions. For bitcoin, miners need to use highly specialized and expensive ASIC chips because of the difficulty in validating bitcoin transactions. Meanwhile, most other virtual currencies allow miners to use some variation of graphics processing units from the likes of NVIDIA or Advanced Micro Devices to proof transactions. However, the difficulty in this mining can still vary from one cryptocurrency to the next.

what does crypto mining do?

Image source: Getty Images.

What's the alternative?

Even though there are technically a number of proofing alternatives, the biggest competitor to the PoW model is the proof-of-stake (PoS) model. With PoS, there are no high-powered computers and mining farms sucking up electricity to validate transactions. Instead, stakeholders of a digital currency receive the randomized right to validate transactions. In plainer terms, the more of a cryptocurrency that you own, the more likely it is that you'll be chosen to validate a block of transactions. Those who are chosen don't receive a "block reward" when complete. Instead, they receive the aggregate fees from the transactions that were proofed.

The obvious advantage of this platform is that it's considerably lower cost. There's also no worry that hackers will gain control of 51% of a network's computing power with the PoS model. For hackers to gain control of a PoS-backed network, they'd need to control 51% of all outstanding virtual coins, which could get quite expensive.

Then again, it's not perfect. Arguably the biggest issue with the PoS model is that major stakeholders can have a much larger say in the future path of a digital network. Whereas PoW networks are massive and incorporate the opinions of a lot of people, PoS networks lose some of the decentralization that makes cryptocurrencies special, thusly allowing larger players to shape future technical and economic pathways for a cryptocurrency.

It's tough to say which method developers will prefer in the years to come, but at least when someone talks about "cryptocurrency mining" in the future, you'll know exactly what they mean.


Source: fool.com

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