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How Does Bitcoin Mining Actually Work?

“Bitcoin Mining” is a term that has entered the public consciousness, but relatively few people can explain what this term really means. Everybody pretty much understands Bitcoin – digital money not issued by any world government – but the mechanisms by which it enters the world are mysterious to most.

In this guide, we’ll simply explain Bitcoin mining hardware/software, Bitcoin mining pools, Bitcoin Cloud mining, hashrates, and even alternative models like proof of stake. When you’re done reading, you’ll have a working knowledge to get you through a conversation at a dinner party, or even to start setting up your first Bitcoin mining rig!

Bitcoin Mining (Proof of Work)

There are nearly 18 million Bitcoin circulating in the digital world at the time of this writing. This supply is constantly increasing. New Bitcoins are added to the world supply through mining. Mining uses a combination of hardware (ASICs – more on this later) and software (Bitcoin Core – again, more on this soon.)

The Bitcoin network is what’s called a blockchain. A blockchain is a way of storing digital data. Small pieces of data (records of Bitcoin transactions) are stored in small data “blocks”. Each block is connected in a line with every other block, like a virtual string of pearls. Each block is protected with a password called a “hash”. To break into a block far down the line, a hacker would have to crack every hash code in every previous block, one by one. Because blocks are being added to the end of the chain every few minutes, this essentially makes hacking the blockchain impossible.

Miners use powerful computers to check that Bitcoin transactions are authentic, before they are stored in a block. The miners also search at random for the long hash numbers that act as codes for the blocks. If a miner finds the code, they get the honor of adding a block to the chain, and are rewarded with 12.5 Bitcoin. The “Work” the computers do secures the network, so this system is called “Proof of Work”.

(Note: There is an alternative blockchain security mechanism called “Proof of Stake” which does not use mining. Ethereum is a large blockchain currently transitioning to this model. Proof of Stake uses much less energy than Proof of Work, and is therefore considered to be better for the environment.)

Bitcoin Mining Hardware

Technically, any computer can mine Bitcoin. Practically, only very powerful computers are fast enough to compete with the thousands of BTC miners all around the world. In the old days, people could earn Bitcoin by mining with a simple desktop CPU. These days are long gone, and today’s industry is reliant upon ASICs.

“ASIC” stands for “Application-Specific Integrated Circuit”. An ASIC is a computer made to do one specific job very, very well. Bitcoin ASICs have very high hashrates, meaning that they can crunch numbers super fast when looking for the codes that secure the Bitcoin network. The higher the hashrate, the more expensive the ASIC, and the more electricity it consumes.

The world’s largest Bitcoin mining operations have physical warehouses stuffed with ASICs, all churning away with their combined hash power to earn as many Bitcoins as possible. Because of artificially low electricity costs, the largest mining operations are found in China, though successful examples are found internationally.

Bitcoin ASICs use lots of electricity. If you use machines, your electricity bill will rise sharply. ASICs also run hot, just like any other powerful computer.

An additional cost of running ASICs is paying for cooling. Even if the devices are cool enough to run safely, you may have to pay for additional air conditioning so that the temperature in your home is bearable.

When a new, more powerful Bitcoin ASIC is added to the market, it makes all previous versions obsolete. This is a danger of investing thousands in the latest device, because best machines of today will not remain competitive forever.

Of course, it’s possible to mine Bitcoin without investing in expensive hardware. We’ll cover Cloud Mining Bitcoin in the next section.

Bitcoin Mining Software

Most professional Bitcoin miners use software solutions like CGMiner to drive their computers and ASICs. Bitcoin Core, the user-facing software that runs Bitcoin all around the world, can also be used to mine Bitcoin.

There are a whole bunch of alternative Bitcoin mining software options out there as well, often geared toward people who can’t afford many thousands of dollars in ASICs, and their related upkeep. Here are some of these alternatives.

Bitcoin Mining Pools: A Bitcoin mining pool combines the hashrates of many different CPUs and ASICs. It’s an army of computer power, all working toward adding new blocks to the Bitcoin blockchain, and being rewarded with the 12.5 BTC rewards that accompany each successful block addition.

Any Bitcoins earned by the mining pool are distributed between the participants, according to the percentage of the combined hashrate each member provides. Some of Bitcoin’s most influential mining entities are

Bitcoin mining pools. Be careful in your research before joining a Bitcoin mining pool, as there are scams out there, and not all of the non-scam Bitcoin mining pools are very effective. Choose a strong pool and you stand a good chance of earning Bitcoin.

Cloud Mining Bitcoin: Cloud mining is an option for people who don’t have (and don’t want to have) the computer equipment necessary to effectively mine Bitcoin on their own. When cloud mining Bitcoin, an individual will rent access to Bitcoin mining equipment somewhere else in the world.

You’ll probably never see the equipment you rent, but it’ll work for you, and the Bitcoin earned through the operation of this equipment will be shared with you. Cloud mining Bitcoin can work well if you rent hash power from an honest provider, but fraud and mismanagement are all too common with Bitcoin cloud mining.

Be sure to do your research. On the other hand, profits gleaned through Bitcoin cloud mining can be reinvested into a higher hashrate, or into dedicated Bitcoin mining hardware which you possess and control.

Bitcoin Mining Difficulty and Profitability

Bitcoin mining has a variable difficulty. The difficulty is meant to ensure that Bitcoins aren’t added to the system too quickly or slowly. Difficulty is quantifiable, and Bitcoin miners have to use this figure, along with other criteria like electricity and cooling costs, to determine how profitable their mining operation will be over time.

Another important aspect in calculating Bitcoin mining profitability is the size of the Bitcoin reward. As we said before, each time a block is added to the Bitcoin blockchain, 12.5 Bitcoin are awarded to the Bitcoin miner who did that work. However, in 2020 this reward will be cut in half to 6.25 Bitcoin. This means that Bitcoin miners will earn Bitcoin much more slowly, and that the global Bitcoin circulating supply will also grow more slowly.

However, just because Bitcoin will become more scarce in 2020, this doesn’t mean that it will be less profitable to mine. Mining profitability in 2020 depends entirely on the price of Bitcoin. If scarcity drives the price of 1 BTC to $50,000, then 6.25 BTC will be much more valuable than 12.5 BTC are at today’s price of $10,000.

This brings us to one of the great challenges of Bitcoin mining: the highly variable price of Bitcoin. Bitcoin miners have certain fixed costs that can not be eliminated, such as the local price of electricity and rent. They pay for these costs with the Bitcoin earned in their mining operations. However, when Bitcoin prices sink for days, months, and years at a time, many once-successful miners are forced to close up shop, because they’re no longer able to pay their overhead. On the other hand, Bitcoin miners who build slowly, keeping costs well in hand, are often able to remain profitable for years.

Do You Want to Become a Bitcoin Miner?

If you want to become a Bitcoin miner, you should consider which path you want to take. Do you want to begin as a cloud miner, or do you want the control and excitement that building an ASIC collection can provide? To help you make your decision, spend some time with a Bitcoin mining profitability calculator.

There are many different examples of this free software, any of which will let you plug in factors like your electricity costs and hashrate, to give you realistic expectations about how much profit you can reasonably expect.

Bitcoin is a global network that combines software, hardware, and dedicated human users. Bitcoin can’t be controlled by any group or government body. As long as there are people using it, there will be the need for miners and mining gear. No matter what’s going on with Bitcoin prices in the news, now can be a great time to dip your toes into the Bitcoin mining waters. Choose a method that works for your skills, interests, and budget, and you could start seeing payouts in BTC soon!

Get started mining Bitcoin

You might not fully understand all the details to mining Bitcoin yet you have enough info to get started. Here is our list of of popular and recommended resources for anyone wanting to mine cryptocurrency.

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CryptoWhat was created in 2015 and has become one of the most trusted and well-respected sources of information on all things crypto. The blog's authors are dedicated to providing clear, concise, and jargon-free explanations of this complex technology, so that everyone can understand it.