Cryptocurrency mining verifies and validates blockchain transactions. It also refers to the process of creating new units of cryptocurrency. While the work done by miners requires intensive computing resources, it's what helps to keep a blockchain network secure.
Crypto mining ensures the security and decentralization of cryptocurrencies such as Bitcoin, which are based on a Proof of Work (PoW) consensus mechanism. It's the process by which user transactions are verified and added to the blockchain's public ledger. As such, mining is a critical element that allows Bitcoin to function without the need for a central authority.
Mining operations are also responsible for adding coins to the existing supply. However, crypto mining follows a set of hard-coded rules that govern the mining process and prevent anyone from arbitrarily creating new coins. These rules are built into the underlying cryptocurrency protocols and enforced by the entire network of thousands of nodes.
To create new cryptocurrency units, miners use their computing power to solve complex cryptographic puzzles. The first miner to solve the puzzle has the right to add a new block of transactions to the blockchain and broadcast it to the network.
As new blockchain transactions are made, they are sent to a pool called a memory pool. A miner's job is to verify the validity of these pending transactions and organize them into blocks.
You can think of a block as a page of the blockchain ledger, in which several transactions are recorded (along with other data). More specifically, a mining node is responsible for collecting unconfirmed transactions from the memory pool and assembling them into a candidate block.
The miner then attempts to convert this candidate block into a valid, confirmed block. To do this, the miner must solve a complex mathematical problem that requires a lot of computing resources. However, for each successfully mined block, the miner receives a block reward consisting of newly created cryptocurrencies plus transaction fees. Let's take a closer look at how it works.
The first step of mining a block is to take pending transactions from the memory pool and submit them, one by one, through a hash function. Each time a piece of data is run through a hash function, an output of fixed size called a hash is generated.
After each transaction is hashed, the hashes are organized into what is called a Merkle tree (also known as a hash tree). A Merkle tree is generated by organizing transaction hashes into pairs, then hashing them.
A block header acts as an identifier for each individual block, meaning each block has a unique hash. When creating a new block, miners combine the hash of the previous block with the root hash of their candidate block to generate a new block hash. They must also add an arbitrary number known as a nonce.
As we’ve now seen, miners must hash the block header repeatedly using different nonce values. They do so until they find a valid block hash, after which the miner who found it will broadcast this block to the network. All other nodes will check if the block and its hash are valid and, if so, add the new block to their copy of the blockchain.
At this point, the candidate block becomes a confirmed block and all miners move on to mine the next block. Miners who couldn’t find a valid hash on time discard their candidate block and the mining race starts all over again.
Sometimes, two miners broadcast a valid block at the same time and the network ends up with two competing blocks. The miners then start mining the next block based on the block they received first, causing the network to split into two different versions of the blockchain temporarily.
The mining difficulty is regularly adjusted by the protocol to ensure a constant rate for new block creation and in turn, steady and predictable issuance of new coins. The difficulty adjusts in proportion to the amount of computational power (hash rate) dedicated to the network.
As such, every time new miners join the network and competition grows, the hashing difficulty increases — preventing the average block time from decreasing. Conversely, if many miners leave the network, the hashing difficulty decreases, making it easier to mine a new block. These adjustments keep the block time constant, regardless of the network’s total hashing power.
Bitcoin is the most popular and well-established example of a mineable cryptocurrency; Bitcoin mining is based on the PoW consensus algorithm.
PoW is the original blockchain consensus mechanism created by Satoshi Nakamoto and was introduced in the Bitcoin whitepaper in 2008. In a nutshell, PoW determines how a blockchain network reaches consensus across all distributed participants, without third-party intermediaries. It does so by requiring significant computing power to disincentivize bad actors.
```htmlAs we’ve seen, transactions on a PoW network are verified by miners who compete to solve complex cryptographic puzzles using specialized mining hardware. The first miner to find a valid solution can broadcast their transaction block to the blockchain to receive the block reward.
The amount of crypto in a block reward varies from one blockchain to another. For example, on the Bitcoin blockchain, miners can get 6.25 BTC in block reward as of March 2023. Due to Bitcoin’s halving mechanism, the amount of BTC in a block reward decreases by half every 210,000 blocks (approximately every four years).
While it is possible to make money mining cryptocurrency, it requires careful consideration, risk management, and research. It also involves investments and risks, such as hardware costs, cryptocurrency price volatility, and cryptocurrency protocol changes. To mitigate these risks, miners often engage in risk management practices and assess the potential costs and benefits of mining before starting.
The profitability of crypto mining depends on several factors. One of them is changes in cryptocurrency prices. When cryptocurrency prices increase, the fiat value of mining rewards also increases. Conversely, profitability can decline along with decreasing prices.
The efficiency of the mining hardware is also a crucial factor in determining the profitability of mining. Mining hardware can be expensive, so miners must balance the cost of the hardware with the potential rewards it can generate. Another factor to consider is the cost of electricity; if it's too high, it could outweigh earnings and make mining unprofitable.
In addition, mining hardware may need to be upgraded relatively often, as they tend to become obsolete rather quickly. New models will outperform old ones and if miners lack the budget to upgrade their machines, they will likely struggle to remain competitive.
Last but not least, there are the changes that happen at the protocol level. For example, the halving of Bitcoin can affect mining profitability as it cuts the reward for mining a block in half. In addition, Ethereum switched completely from the PoW to the Proof of Stake (PoS) consensus mechanism in September 2022, which made mining unnecessary.
Cryptocurrency mining is a critical part of Bitcoin and other PoW blockchains as it helps keep the network secure and the issuance of new coins steady. In addition, mining can generate passive income for miners.
Mining has certain advantages and disadvantages, the most obvious of the former being the potential income from block rewards. However, this is influenced by a number of factors, including electricity costs and market prices. As such, before you jump into crypto mining, you should do your own research (DYOR) and evaluate all potential risks.