Cryptocurrencies have been around for more than a decade now, and while most people are familiar with how they work, there are many who may not understand the process of mining. “Mining” is the process by which new units of a given cryptocurrency are “minted” or created. In most cases, miners are rewarded for their efforts with a small percentage of the currency they are mining. This entire process occurs in what’s known as a Proof-of-Work consensus mechanism.
In this article, we'll take a look at the basics of cryptocurrency mining and how it works. We'll also discuss the different types of miners, as well as the rewards and challenges associated with mining. Plus, what the heck is Proof-of-Work?
As the name suggests, Proof-of-Work (PoW), is proof that work has been done, which is incredibly unhelpful to anyone trying to understand. So, let’s get into specifics about the what and the why.
Let’s get one thing out of the way that can be confusing: the people who mine crypto are not doing the “work”.
Machines do the work. Namely, specialized computers and servers.
To validate cryptocurrency transactions on the blockchain.
Uh oh. Now we’ve gone and opened a whole other can of worms, right?
Here’s a quick breakdown.
The blockchain is a digital record of all transactions made with a cryptocurrency, like Bitcoin. The blockchain is immutable, meaning it cannot be stopped or changed, and it is public, meaning anyone can view it. Importantly, it’s also encrypted.
However, cryptocurrencies are decentralized, meaning there is no third party to verify if the transactions occurring are real and accurate.
In order to verify, or validate, the transactions while retaining the anonymity and encryption that makes crypto…well, crypto, there needs to be some sort of consensus as to whether the transactions are legitimate. Thus, there are consensus mechanisms such as Proof-of-Work.
There also needs to be verification that the “work” done to verify the transactions was legitimate. In other words, there needs to be “proof”. So, a computer solves a puzzle to verify the accuracy of a group of transactions (or a block). Once a block of transactions is ready to be added to the digital record, or chain (hence the name blockchain), it needs to be verified by all the other computers that are helping to host the blockchain network. Think of it as quality control on an assembly line. Once they establish proof of the work’s correctness, the block is added and the next block’s work begins.
Mining rigs need to solve complex math problems. In exchange for their efforts, miners are rewarded with a small percentage of the currency they are mining. This is an automated process built into the code itself. The math problems that miners need to solve are designed to be difficult to solve, but easy to verify.
It takes a lot of computing power to mine cryptocurrency. Small-time miners of cryptocurrency tend to have powerful computers with multiple GPUs. The biggest miners, however? They run entire warehouses of servers with the sole purpose of mining crypto. The power usage is nothing to scoff at.
Why do miners do this? Well, they get paid via the previously mentioned mining rewards. The more mining you do, the bigger the rewards.
The difficulty of the math problems that need to be solved increases as more people try to mine the currency. This is done in order to keep the rate of new currency production consistent. So, as more people start mining a given cryptocurrency, the more difficult it becomes to mine.
There are a few different ways that miners can be compensated for their work. The most common method is through a “block reward.” This is when a miner is rewarded with a certain number of units of the currency for each block of transactions that they successfully process.
Another way that miners can be compensated is through transaction fees. When someone sends a transaction, they can include a small fee which goes directly to the miner who processes their transaction.
1. Users initiate cryptocurrency transactions, which are then broadcast across the network.
2. Miners collect newly broadcast transactions in a block and race to verify them.
3. The first miner to complete a block has his work proved by the other miners on the network.
3. If the transactions in the block are valid, it is added to the blockchain.
All proof-of-work cryptocurrencies use some form of cryptocurrency mining. Here are a few examples:
Bitcoin: The original blockchain and cryptocurrency, Bitcoin uses the SHA-256 hashing algorithm. Miners compete to find a solution to a mathematical problem that allows them to add a new "block" of transactions to the Bitcoin blockchain. Since Bitcoin is the first and oldest blockchain, it has the longest and most difficult mining algorithm.
Ethereum: The second-largest blockchain by market capitalization, Ethereum uses the Ethash mining algorithm. This is a memory-hard algorithm that makes it difficult to create ASICs (Application Specific Integrated Circuits) for Ethereum mining. This allows for more decentralized mining, as ASICs are typically only manufactured by large companies with lots of money and resources. Ethereum is now transitioning to a new consensus protocol known as Proof-of-Stake. This event is known as The Merge.
Monero: A privacy-focused cryptocurrency, Monero originally used the CryptoNightR process to mine new coins. This allows individual miners to have a more equal chance of finding a solution and being rewarded, as opposed to pools of miners who can pool their resources together. Now, Monero uses RandomX.
Litecoin: Often seen as a "light" version of Bitcoin, Litecoin uses the Scrypt mining algorithm. This is a less-intensive algorithm that allows for faster mining speeds.
Dogecoin: Dogecoin began as a "joke currency" but has since grown to have a large community and market capitalization. It uses the Scrypt algorithm like Litecoin, but has tweaked it to be even faster.
Cryptocurrency mining began with Bitcoin in 2009. Satoshi Nakamoto, the pseudonymous creator of Bitcoin, designed the network such that there would only ever be 21 million bitcoins in circulation. In order to ensure that new bitcoins are released at a steady rate, Nakamoto devised a system whereby miners are rewarded with a set number of bitcoins for each block of transactions they verify. As more miners join the network and verify more blocks, the difficulty level of mining increases, resulting in a decrease in the number of miners who are able to profitably mine bitcoins.
Since 2009, various other cryptocurrencies have been created and mined in much the same way as Bitcoin. Ethereum, Litecoin, Dash, and Monero are all examples of altcoins that use similar Proof-of-Work consensus mechanisms. Ethereum was released in 2015, and its mining algorithm – Ethash – was designed to be ASIC-resistant, meaning that it cannot be efficiently mined with the specialized hardware that has been developed for Bitcoin mining.
In recent years, cryptocurrency mining has become increasingly centralized, with a few large companies controlling a majority of the hashrate. This has led to concerns about the security of the Bitcoin network, as well as the sustainability of cryptocurrency mining more generally.
Despite these centralization concerns, cryptocurrency mining continues to be popular among hobbyists and those who are interested in earning a passive income. With the right equipment and some upfront investment, anyone can start mining cryptocurrencies.
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