Crypto Mining

How Blockchain Works

Cryptocurrency Mining: How It Works

The uptake of blockchain technology has introduced and popularized new and arguably familiar terms and slang to the crypto ecosystem like hodling, mining, FUD, FOMO, and mooning. Mining is one of the earliest terms involving digital currencies. To understand what mining is, we must first understand how cryptocurrencies operate.

How Cryptocurrencies Work

Multiple cryptocurrency transactions occur simultaneously and, instead of verifying each transaction individually, the transactions are verified in groups known as blocks. Upon validation of the group of transactions, the block is added to a chain of blocks, hence, blockchain. The underlying technology records and secures each transaction using cryptography, making the block records immutable. Afterward, the records are distributed to users across the whole network to authenticate the transactions. This distributed ledger technology known as blockchain technology ensures that transactions remain transparent and secure without the need for a central authority.

Once a block is successfully verified, another block is created to group incoming transactions. This process of verifying transactions and creating a new block is known as mining since new coins are minted. During this process, the network users who successfully validate the blocks get rewarded with these newly minted cryptocurrencies. These users, known as miners, ensure that transactions have no irregularities and that new coins are issued.

The Purpose of Mining

Unlike fiat currencies issued and regulated by central banks, cryptocurrencies need no such oversight from any central authority. The mining process enables users to verifiably transact on a decentralized network without the need for an intermediary. This verification process is significant for cryptocurrency transactions as they have no regulatory institution overseeing the processes. What’s more, new coins are supplied to the market as mining rewards.

Mining Illustration

To understand this process better, take this example. You want to send 1.25 Bitcoins (BTC) to your friend, what happens?

1. When you initiate the transaction, the nodes or computers mining BTC are notified of your transaction and others occurring at that time.
2. Miners ensure that you have at least 1.25 BTC to send your friend by reviewing the transaction history from your public address to prevent double-spending.
3. Several miners compete to be the first to verify the block by completing the puzzle to earn the reward. Therefore, the miners run highly powerful mining nodes with Bitcoin mining software. The process to verify the block by solving a complex mathematical puzzle is known as proof-of-work (PoW).
4. The node that solves the puzzle first will notify other nodes that it has completed the task then the rest of the miners check if the task is completed correctly. When 51% of the miners agree that the puzzle is solved correctly, your 1.25 BTC is released to your friend’s wallet.
5. The node that successfully mines a valid block gets rewarded with newly minted BTC, currently 6.25BTC. All these steps have to be completed for any successful transaction.

Getting Started as a Miner

Cryptocurrencies have different methods for minting new coins or mining. Although some are pre-mined and issued gradually by a firm running the crypto project, many cryptocurrencies that aim to decentralize further will give the minting power to network users.

The two main ways that cryptocurrencies are designed to mint new coins are through the proof-of-work (PoW) and proof-of-stake (PoS) consensus algorithms. PoW method is deployed by top blockchains, including Bitcoin, Ethereum (Ethereum is currently upgrading its network to PoS in its Eth2 project). Cardano and Polkadot are top platforms that operate on PoS.

In PoW, like in the Bitcoin transaction illustration, miners must invest in specialized mining hardware known as Application Specific Integrated Circuits (ASICs). These machines have a very fast processing speed that will ensure you can compete with other miners. On the downside, they are resource-intensive since they consume a lot of power. For smaller and less popular blockchains that have equivalently low mining interests, central processing units (CPUs) and graphic processing units (GPUs) should suffice.

In the PoS consensus model, miners are often known as validators. Validators earn the right to validate the blocks depending on the number of blockchain’s native coins they hold. For instance, in the upcoming Eth2 PoS project, users had to deposit or stake 32 ETH to activate the validator software. A user who stakes more coins for a longer period will most likely win the slot for verifying a block and earning the rewards from transaction fees. PoS is a resource-conserving model compared to PoW.

Making Money Through Crypto Mining

Crypto mining is an investment like mineral mining in physical mining. Like mining minerals, crypto mining involves probability, but there are ways to up your stake to be more successful and ‘strike gold’.

There are three main ways to start mining for individuals and businesses: pool mining, cloud mining, and self-mining.

1. Pool Mining: This is the fastest method to start mining cryptocurrencies. You join a group of miners who have pooled their resources together to cut costs and enjoy economies of scale. The pool members will share the rewards from any successful validation according to their proportion to the pool. Always look out for the size of the mining pool you plan to join. Where a pool has more people, earning rewards is more likely. On the downside, more people will be sharing the rewards. Also, consider the minimum payout and the fees imposed by the pool.  
2. Cloud Mining: This method involves paying other people or firms to mine and give you the rewards. It is most effective if you don’t want to stand the risks of maintaining the mining hardware. However, you do not have much control over the mining process by your provider.
3. Self-mining: Although it theoretically looks more rewarding as you do not have to share rewards, successful self-mining requires intensive financial input. Not only is the mining equipment expensive, but running all processes and equipment maintenance requires additional money.

Summary

Mining incentivizes users to maintain a solid decentralized network of verifiable transactions. The competitiveness towards earning the rewards decentralizes the networks even further. With this feature, blockchain is disrupting the traditional financial system that is entirely centralized. Now, with crypto, users can transact directly without going through an intermediary. And miners can also earn rewards from newly-minted tokens by participating in block validation.

Top Bitcoin mining pools are Slushpool and BTC.com Pool. For Ethereum, the top mining pools are Ethermine and Nanopool.

Read more about your favorite cryptocurrencies and the latest on blockchain technology from our blog.