As you’re exploring Bitcoin (and other cryptocurrencies) you may eventually stumble upon the concept of “mining.” From an investment perspective, this is one of the more technical endeavors, but can be lucrative under certain conditions. In this guide we’ll briefly outline the main concepts.
What is Mining?
Mining is a critical function of the Bitcoin network. It is a process that validates transactions, stores information, and indirectly secures the network. It can also be viewed as a method to process and confirm payments. Without mining the Bitcoin network would cease to function.
More specifically, it is the process of using computational power to guess a key. You can loosely think of a “guess” as a single “hash.” As of this writing, the entire Bitcoin network has a hashrate over 6,000,000,000,000,000,000 H/s, that’s 6 Quintillion. This is an amazing amount of processing power.
When you participate in mining, you are contributing your computational power to the overall hashrate. You are part of the network that both validates transactions and secures the network. By contributing resources you earn block rewards and transaction fees. This is how you make money mining Bitcoin.
A Brief History on Bitcoin Mining
In the early days you could profitably mine with a simple computer, using only a CPU. As more people began to mine, the difficulty increased. More powerful and optimized Graphical Processing Units (GPUs) were employed and pooled mining was created to reduce statistical variance. By working together miners contribute computational resources and get a proportional share of the earnings.
Eventually enough opportunity was created to justify investment in Application-Specific Integrated Circuits (ASICs). ASICs are specialized circuits created for a very specific function. In this case, to mine Bitcoin. They provide the most competitive hashrates for associated power and are the dominant technology for Bitcoin mining.
To recap, computational power is required to mine. CPUs, GPUs, and ASICs can be used to mine, but for Bitcoin, ASICs are the most efficient. No matter how you mine, you should participate in a pool as the variance would be too great otherwise.
Ways to Mine Bitcoin
There are a couple different ways that you can participate in Bitcoin mining. Mining at home or mining through a hosted service or contract. Each of these methods is briefly covered.
Mining at Home
Mining at home is the most technical option requiring procurement of hardware, setup, maintenance, pool selection, monitoring, and other IT-like functions. If you are comfortable managing servers and understand the crypto-space you probably have the skillset to setup your own mining operation.
You will have the most control and be able to choose what you mine and the pools you participate in. Downsides include initial hardware investment, management time, heat generation, and noise, to name a few.
Contract or Cloud Mining
If you don’t want to deal with the intricacies of home mining you can purchase mining services including contract or hosted mining. With contracts you simply pay an upfront fee to mine a certain coin, over a period or time, at a specified hashrate. Hardware hosting services are a bit different, where you purchase the hardware, but it is hosted at a facility and you are manage it remotely. In either case you may be require to pay for rent, electricity, and other fees. In all cases do your due diligence to avoid fraud and choose a reliable service.
Bitcoin Mining Concepts
There are many terms in Bitcoin mining that may be unfamiliar. In this section we define and explain the key concepts.
As a reward for mining a block, new Bitcoin is generated and given to the miner that mined the block. In pooled mining, the reward is distributed to everyone in the pool. The block reward is a hardcoded number in the Bitcoin protocol and is halved every 210,000 blocks, or roughly every 4 years. The first block was mined in 2009 with a 50 Bitcoin block reward. As of 2017 the block reward is 12.5 Bitcoin with the next halving estimated to occur in 2020. Since the supply of Bitcoin is fixed at 21 million the block rewards cannot go on indefinitely. Instead it continues to halve for 64 iterations with the final Bitcoin mined in 2140. A key concept here is that the block reward changes over time affecting how many coins are available to miners.
The Bitcoin network targets the creation of a new block every 10 minutes. This is managed by adjusting the mining difficulty every 2,016 blocks, or roughly every 2 weeks. The protocol does this automatically. If blocks are generated faster than an average of 10 minutes the difficulty is increased. If blocks are generated slower, the difficulty is decreased. Whether the blocks are slower or faster than 10 minutes is directly tied to the total network hashrate. When difficulty increases, you get less Bitcoin for mining. When it decreases you get more Bitcoin for mining.
Hashrate, Electrical Rates, and Exchange Rates
There are three rates that go into evaluating the profitability of mining, excluding the capital cost of hardware. The two most important metrics for hardware evaluation are the hashrate (H/s) and the power consumption (Watts). The most important variables for cashflow and profitability are the cost of electricity ($/kWh) and the exchange rate ($/BTC). The optimal scenario is a high hashrate, low power draw, cheap electricity, and a high exchange rate.
When evaluating mining as an investment it’s important to understand how all of the factors interact and affect overall profitability. In a future article we will outline the methods to evaluate a mining investment and detailed steps for getting started.