Bitcoin

What exactly is bitcoin mining?

The process of minting new bitcoins is similar to that of extracting precious metals from the earth in some ways. As a result, it has become known as ‘bitcoin mining.’

According to the Bitcoin white paper:

The constant addition of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, CPU time and electricity are consumed.

The following is a simplified overview of bitcoin mining:

People compete for bitcoin rewards by putting their computing power to use in a process known as ‘Proof of Work’ (PoW). The process is named as such because only participants (miners) who have demonstrated sufficient resources (work) will be eligible for the rewards.

Rewards are distributed to a single winning’miner’ every 10 minutes.

The benefits are twofold: (1) the ‘block reward,’ which is new bitcoin. The current block reward is 6.25 bitcoins (but will be cut in half from early May 2024, then cut in half again four years later and so on). (2) the fees for all transactions in the current block. End users who want to make a transaction must include a fee as an incentive for miners to include it in the next block.

What is the purpose of bitcoin mining?

Bitcoin mining is a critical component of the network’s system for reaching agreement on the current state of the ledger. It is critical for people to be able to make Bitcoin transactions in a secure manner.

The Bitcoin network is a globally distributed public ledger that contains a massive list of timestamped transactions. One ledger entry, for example, could show that Person A sent 1 bitcoin to Person B at 10 a.m. on Monday. Every 10 minutes, the ledger is updated by adding ‘blocks’ that contain a list of new transactions. The existence of the ledger, which is voluntarily maintained by thousands of participants known as ‘nodes,’ allows anyone to view both the current state and the complete history of bitcoin ownership.

There is no centralized authority deciding which transactions should be added to new blocks by design. Instead, the ledger state (i.e. the ‘truth’) is determined collectively and through coordination by nodes in accordance with the Bitcoin protocol. This decentralization is responsible for some of Bitcoin’s most intriguing properties, such as censorship resistance and permissionlessness.

Most nodes simply validate transactions, store the ledger, and relay updates to other nodes (again, updates take the form of new blocks added to the chain). A smaller group of nodes, known as miners, compete to create new blocks. Miners are effectively updating the state of the ledger, or the ‘truth’ about who owns what when they create new blocks.

What exactly is the goal of bitcoin mining?

Bitcoin mining serves a number of purposes:

  1. It’s a method of issuing new coins.
  2. It is a component of a larger system for ensuring that only valid transactions are added to the blockchain.
  3. It is a method of prioritizing transactions in the face of limited throughput (it creates a fair market for limited block space).
  4. It provides a financial incentive for participants (miners) to dedicate resources to the network, and the resources dedicated aid in the network’s defense against attackers. It’s worth noting that the term “assailants” here primarily refers to the miners themselves. In other words, by making mining expensive, Bitcoin ensures that miners follow the rule. s

How does bitcoin mining keep the network safe?

Proof-of-Work mining contributes to the security of the Bitcoin network by requiring potential attackers to commit more resources to an attack than they could gain from the attack itself. In other words, it ensures that attacking Bitcoin is a money-losing (and very expensive) prospect, making it extremely unlikely.

What is the process of bitcoin mining?

The following is a summary of the process from the Bitcoin white paper:

  1. All nodes are notified of new transactions.
  2. Every node adds new transactions to a block.
  3. Each node is attempting to find a difficult proof-of-work for its block.
  4. When a node discovers a proof-of-work block, it broadcasts it to all nodes.
  5. Nodes will accept the block only if all of the transactions in it are valid and have not already been spent.
  6. Nodes express their acceptance of the block by constructing the next block in the chain, with the hash of the accepted block serving as the previous hash.

Let’s go over that a little more closely.

To begin, miners propose ledger updates, and only miners who have successfully completed the Proof of Work are permitted to add a new block. This is pre-programmed into the Bitcoin protocol.

Miners have complete freedom to choose valid transactions from a pool of potential transactions broadcast to the network by nodes. These transactions are accumulated in the’mempool.’ Miners who are rational and honest choose transactions from the mempool based on the fees attached to them, aiming for higher fees. This creates a fee market, which aids in ensuring that the limited block space is used fairly and efficiently.

The first miner to complete the Proof of Work broadcasts her proposed new block to the larger network of nodes, who then verify that the block follows the protocol’s rules. The key rules in this case are that (1) all transactions in the block are valid (i.e. no double spends), and (2) the new block appropriately references the previous block and is numbered as the next in the chain (ie. the new block constitutes the latest block in the longest chain). If it does, nodes forward it to other nodes, who repeat the process. As a result, the new block spreads throughout the network until it is widely accepted as the ‘truth.’

However, it is possible (and frequently occurs) that more than one miner completes the Proof of Work at nearly the same time and simultaneously broadcasts his new block to the network. Furthermore, nodes may receive new proposed blocks at slightly different times due to network delays and geographic separation.

It should be noted that one miner’s newly proposed block may differ slightly from another’s. This is because, as previously stated, miners decide which transactions to include in a block, and while they tend to optimize for profitability, location and other factors introduce variation. When two miners send out opposing new blocks, competing versions of the ‘truth’ start to spread across the network. The network eventually converges on the ‘correct’ version of the truth by choosing the chain that grows longer at the fastest rate.

Let’s dissect that last bit. Assume you have two competing chains. Assume that 75% of miners choose version A (because it was the first version they saw) and begin their Proof of Work for the next block by building on top of version A. The remaining 25% of miners choose version B (again, because it was the first version they came across) and begin the same process of building on top of that version. According to statistics, one of the miners working on version A will complete the Proof of Work first, broadcasting the new version to the network. Because nodes always choose the longest chain, version A will quickly dominate the network.

In fact, the probability that version B will grow faster diminishes exponentially with each additional block, to the point where it is statistically impossible by the time six blocks have been added. As a result, most participants consider a transaction that has been confirmed in six blocks to be final. An orphan block is one that does not end up becoming part of the longest chain (version B in our example above). Such blocks are estimated to be created between 1 and 3 times per day. Transactions contained within an orphan block are not lost. That’s because they’ll be added to the next block of the longest chain if they weren’t already in the version that ends up being the longest chain.

What is the hashing algorithm used by Bitcoin?

Secure Hash Algorithm 2 is a military-grade encryption algorithm used by Bitcoin (SHA2). Bitcoin miners are rewarded with BTC when they discover a random number that can only be generated by repeatedly running the hashing algorithm. This procedure is similar to a lottery (where buying more tickets increases your chances of winning). Miners are effectively purchasing more lottery tickets by devoting more computing power to the hashing algorithm.

What is the bitcoin mining difficulty adjustment?

The Proof of Work algorithm’s difficulty level is automatically adjusted every 2,016 blocks, or roughly every two weeks. Adjustments are made with the goal of maintaining the mining of new blocks at the current rate of 10 minutes per block.

The difficulty adjustment takes into account the total amount of computing power, or “hashpower,” applied to the hashing algorithm. The difficulty increases as computing power is added, making mining more difficult for everyone. When computing power is removed from the equation, the difficulty decreases, making mining easier.

It is worth noting that the difficult adjustment system distinguishes bitcoin mining from precious metal mining. When the price of gold, for example, rises, more miners are enticed to enter the market. More gold miners will inevitably result in more gold being produced. The market price of gold will eventually fall due to supply and demand forces. However, in the case of Bitcoin, the volume of bitcoin produced (minted) is predetermined by the Bitcoin protocol (i.e. not affected by the number and power of miners), so the volume of Bitcoin produced will not be affected regardless of how much mining power is directed towards the algorithm.

Is it legal to mine bitcoin?

Bitcoin mining is legal in the majority of countries, including the United States and Europe. The legal status of bitcoin mining in China is currently ambiguous.

Is it profitable to mine bitcoin?

Bitcoin mining is a cutthroat industry with razor-thin profit margins. Although electricity is the primary input, significant upfront investments in hardware and facilities for housing the hardware are also required. The key piece of hardware involved is known as the Application Specific Integrated Circuit (ASIC), which is a computing device that is solely dedicated to running the Bitcoin hashing algorithm. Profitability is primarily dependent on consistent access to low-cost electricity combined with the most efficient ASIC hardware.

 

Bitcoin mining is a self-balancing system. Miner margins grow as the price of bitcoin rises. This encourages more miners to enter the market. However, new entrants increase the difficulty of minting new blocks. This necessitates that all participants expend more resources, reducing overall profitability. Long-term price declines in bitcoin have historically resulted in a portion of miners quitting due to costs exceeding revenue.

What effect does bitcoin mining have on the price of bitcoin?

In most cases, miners sell their earned bitcoins to cover their mining costs. These costs, in turn, add to the net sell pressure. Miners’ attempts to maximize profits by holding or selling Bitcoin based on market momentum may affect Bitcoin’s price volatility. The argument here is that when the price of Bitcoin rises, miners may try to hold on for a longer period of time in the hopes of extracting more profit. This would result in less net sell pressure, resulting in a faster price rise. However, when the price of Bitcoin falls, miners are more likely to sell not only their reserves, but also newly acquired bitcoin. This, in turn, would contribute to downside volatility.

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