Guides

Bitcoin mining explained

This article is about Bitcoin mining. Why is it needed, and why there is such high energy consumption involved? We’ll also look at the alternatives. How is cryptocurrency mining done in a Proof of Stake system and what does the future of mining look like.

What is Bitcoin mining needed for?

Let’s look at Bitcoin first, since it is the best-known cryptocurrency in the market. Bitcoin mining gets also the most media attention.

Bitcoin is a cryptocurrency utilizing different technologies and algorithms. In the core, there is blockchain, which is a transaction database distributed to thousands of computers. These are called nodes.

Nodes must reach a consensus on what data will be stored on the blockchain. This is done by utilizing a consensus algorithm. It is a procedure, which all nodes must follow. The consensus algorithm for Bitcoin is called Proof of Work.

As the name suggests, this algorithm demands participants to show proof of resources being used. In Bitcoin’s case, this means computing power.

The computing tasks are performed by miners. These are specialized computers (ASIC) processing mathematical equations.

bitmain-antminers

ASIC miners manufactured by Bitmain

Powerful ASIC miners cost thousands of dollars and consume an enormous amount of energy. No one would run a computer like this for fun. This is why there is a block reward. It’s paid in bitcoins to the miners who build the blockchain.

On top of the block reward, miners get all transaction fees paid by Bitcoin users. These are typically in a range of $1 to $30 per transaction depending on the network load. The Bitcoin network can process about seven transactions per second, so this will add up to a significant amount over the years.

Miners build the blockchain by adding new transactions to each block. They are the backbone of the Bitcoin network. However, you shouldn’t forget one thing.

Even if miners do the work, it is the nodes who have the ultimate power. Full nodes to be exact. These are the nodes storing the entire Bitcoin blockchain from the first block ever produced. There are thousands of known nodes all over the world.

Nodes don’t get any rewards, so they are run voluntarily. The purpose of nodes is to enforce the consensus rules. They make sure each transaction sent to the network is valid and they double-check the new blocks. If a miner tries to include false information, nodes will reject such block.

Other Proof of Work cryptocurrencies

The Bitcoin blockchain started running in January 2009. It didn’t take long until other cryptocurrencies were built due to the open-source nature of Bitcoin’s program code. One of the earliest projects was Litecoin in 2011.

Litecoin uses also the Proof of Work consensus algorithm. However, there’s one key difference under the hood. The hashing algorithm (mining algorithm) is called scrypt. Bitcoin is using the famous SHA-256 while Ethereum has ethash.

The hashing (mining) algorithm defines what type of computation work is required. Some algorithms demand more CPU processing, while others use more GPU.

mining rig

A mining device built of graphic processors a.k.a GPU rig.

Some PoW-based cryptocurrencies use mining algorithms, which try to prevent the use of ASIC miners. Monero is one of such coins.

The reason is to keep the mining more decentralized. ASIC miners are expensive and need to be upgraded almost yearly. It’s difficult for an individual to get one. Hence, mining becomes more centralized to large mining farms.

Cryptocurrency mining alternatives to Proof of Work

Bitcoin’s Proof of Work has been criticized since the early 2010s. Its high energy consumption has been a topic of countless debates. Isn’t there a way to reach consensus without using physical miners? The solution is Proof of Stake.

Peercoin was the first cryptocurrency built on the Proof of Stake (PoS) consensus algorithm. As the name suggests, Proof of Stake uses staking instead of computation work. Network participants stake (lock) their coins as proof of their commitment.

In a PoS system, miners are called validators. They aren’t really miners either. These are entities, who have staked (locked) the most coins. This stake shows that the validator has “skin in the game” financially.

Staking gives validators an incentive to run the blockchain properly. Hostile or corrupt actions can lead to penalties where the validator could lose the staked coins. Even worse, if the value of the cryptocurrency would crash, validators would suffer the biggest losses.

Cardano is one of the Proofs of Stake platforms. The video below explains how staking is done in the Cardano ecosystem.

The advantage of a Proof of Stake system is obvious: the need for electricity is minimal. Any standard server is sufficient from the hardware point of view. Also, there are often just a handful of validators compared to hundreds of thousands of miners running the Bitcoin network.

Over the years, different PoS variations have been developed. The most popular one is Delegated Proof of Stake (DPoS). It often uses just 21 validators. All network participants can delegate their coins to one of the validators and earn part of the rewards.

There are usually no block rewards in a Proof of Stake system. Validators are rewarded through transaction fees and other incentives.

Some cryptocurrencies are using technologies, which are not even blockchains. IOTA’s DAG (Directed acyclic graph) is a good example. Such networks can reach close to real-time and zero-free transactions.

The biggest issues with the Bitcoin mining

Let’s look at the negative sides of the Proof of Work mining. It’s important to remember, that there is just a handful of popular PoW coins left, and the energy consumption is a real problem only with Bitcoin.

Some people think that all cryptocurrencies consume energy the same way as Bitcoin. This is not the case at all. There are two main concerns regarding Bitcoin mining:

  1. Energy consumption
  2. Centralization of mining

The media has its focus on the first point. It’s easy to make headlines of the energy consumption, which has reached astonishing levels. Bitcoin miners use more energy than the country of Norway. There are also other small countries, which are on the losing side of this battle.

The second point is discussed mostly inside the Bitcoin community. It can be divided further into two topics: mining pools and geographical locations.

It’s important to understand that Bitcoin mining is a very competitive business. Mining farms require tens (or hundreds) of millions of dollars of investments. Optimal locations are searched all over the world. Mining companies build massive farms including thousands of Bitcoin miners.

There is no doubt that mining operations are quite centralized due to the sheer cost of setting up a farm.

In theory, anyone can buy an ASIC miner. This doesn’t get you far unless you join a mining pool, because it could take a lifetime for your miner to actually win a block and get any rewards. The biggest pools have thousands of members and all mining revenues are shared between them.

No single mining pool is currently dominating the market. The graphic below shows you the largest mining pools. See the up-to-date information from btc.com/stats/pool.

mining-pools

When joining a pool, you guarantee yourself some profits even if your miner would never actually win the competition and mine a block. Otherwise, you’d have to compete against the whole world alone. What are the chances your machine would ever win in the mining lottery?

The second problem is geographical centralization. Most of the hashing power is currently located in China. At the end of 2019, it was estimated that 65% of Bitcoin mining took place in China. USA, Kazakhstan, Russia, and others have all less than a 10% slice of the cake.

China’s mining dominance has since fallen significantly. Still, it is by far the largest mining operator in the market. The leading ASIC manufacturer Bitmain is also Chinese. Many Bitcoin critics point this out and make the claim that the Chinese government could somehow destroy Bitcoin.

Is energy consumption a problem?

How about the energy consumption of Bitcoin mining – is it REALLY a problem? The critics would agree and shout that this is the biggest issue Bitcoin has. Many have made the argument that it’s just stupid and pointless to waste so much energy.

The first problem with such an argument is that it’s a subjective opinion. More energy is used on Christmas lights in the U.S. than some countries consume in a year. Some could argue that humans would survive just fine without Christmas lights.

christmas-lights

Christmas lights are nice, but at what cost?

People have always used massive amounts of energy to produce goods and services. Energy consumption alone isn’t an argument at all. Everything we do in our daily lives requires energy. You couldn’t even read this blog post if there wasn’t electricity available.

Some use cases are more important than others. Many would agree that electricity should be used to run hospitals, police stations, or streetlights. But how about nuclear plants or war efforts? Where do you draw the line? This is why the free market exists.

Everyone is free to develop ideas and resource use cases and bring them out to the market. If enough people agree with the idea, it gets funded. Whether we talk about Bitcoin or Christmas lights, both have clearly a demand in the free market.

If Bitcoin was a useless idea, there wouldn’t be a single mining farm in the world. Nobody would develop ASIC miners either. The industry around Bitcoin wouldn’t simply exist.

One should also compare Bitcoin’s energy consumption to more relevant operations. See the table below (Source: Dan Held).

bitcoin-energy-consumption

As you can see, gold mining requires much more energy than Bitcoin mining. It also creates enormous ecological disasters. Endless wars have been started over gold discoveries. It’s no surprise, that you can’t find a gold bug criticizing Bitcoin’s energy consumption.

How about the current fiat banking system? How about Visa, PayPal, Mastercard, and hundreds of other payment networks. Visa has alone over 20.000 employees. How much energy is needed every day for transportation and running the offices?

Bitcoin is an innovation you don’t see even once in a century. It has already improved the lives of millions of people in the poorest countries on the planet. It enables saving and prosperity to anyone regardless of religion or nationality. Bitcoin gives hope to billions of people without bank accounts.

If you don’t understand the global impact Bitcoin has, it’s impossible to see why energy consumption is needed. The biggest problem in criticizing Bitcoin is that the critics don’t understand Bitcoin.

Many would argue that Bitcoin is as important an innovation as the internet. What if this really is the case. Would you then say that the energy consumption size of Norway is too much?

Bitcoin mining is energy-efficient

There are different ways of consuming energy as well. Gold mining is an example of bad energy consumption because mines are mostly run by using fossil fuels. Bitcoin, on the other hand, is using mainly renewable energy sources.

The numbers below are from The Block article in 2019.

bitcoin-renewal-mining

The Sichuan province in China is the center of Bitcoin mining. Almost half of the world’s Bitcoin mining power was located in Sichuan in 2019. Amazingly, 90 percent of the energy was produced using renewable sources. Sichuan is known for its massive hydropower plants.

hydro

As the numbers show, 73% of all required energy was produced with renewable energy sources. This was back in 2019. Now, the number is probably 80% and growing every day. Solar and wind energy are also widely used.

Even more important is to understand how effectively this energy is consumed. Many Bitcoin mining farms are built in locations, where there is an energy surplus. In other words, the energy is produced anyway regardless of Bitcoin mining.

It’s not easy to transfer energy from one location to another. Massive amounts of electricity is lost each year because of transfers. For Bitcoin mining farms, this is not a problem. They can be built wherever there is excess energy available.

The future of Bitcoin mining

We have so far tackled the most common arguments against Bitcoin’s energy consumption. We also covered the centralization problem earlier. Are there any solutions to those issues?

Most of the mining farms are in China for a good reason. The Chinese government has given massive subsidies for the mining farms and lowered their energy costs to near zero. The leading ASIC manufacturer, Bitmain, is also Chinese.

China’s mining dominance has started to fall in the past few years. The United States is finally a significant player. There are also mining farms moving from China to other Asian countries. The political environment and the unpredictable rainy seasons are the driving factors.

Bitmain has no longer an ASIC monopoly either. There are other operators in the market building even better miners. Bitmain has also opened its own mining farms in the United States. There is a lot of good progress taking place.

Finally, you should remember what we wrote about the Bitcoin network earlier. Even if miners are doing the hard work, they cannot take over the Bitcoin network. It’s the (full) nodes, who have the highest authority. This prevents China or any other entity from taking over the Bitcoin network with miners.

See the video below for more information.

Bitcoin mining will always be dominated by mining farms. This is the natural path of development and it also optimizes resources. It would be very ineffective if miners were spread out globally to thousands of different locations.

An individual has also access to the mining market through cloud mining services or other investment instruments. There will be new products in this field, for sure. Some of the mining companies are even publicly listed.

There’s also fast development on the hardware side. ASIC miners become more and more energy-efficient over time. New renewable energy sources are implemented every day. Bitcoin mining becomes greener and more energy-efficient over time.

The future of cryptocurrency mining

Let’s look at the broader picture – how is the cryptocurrency mining sector going forward?

It’s very unlikely that there would be any significant changes in Bitcoin mining anytime soon. The Proof of Work is not going away and the hash rate keeps growing steadily. You’ll find up-to-date information on the Bitcoin hash rate at blockchain.com/charts/hash-rate.

bitcoin-hashrate-2021

All the energy consumption and the mining infrastructure make Bitcoin incredibly safe and give it value. This massive hash rate is one of the reasons why publicly listed companies like Tesla dare to invest 1.5 billion dollars in Bitcoin.

What happens in 20 or 50 years? It’s difficult to say. The last Bitcoin will be mined in 2140 and none of us are alive then. We have no clue what kind of technologies there are available even in 20 or 30 years. Maybe Elon Musk has mining farms on Mars by then?

The Proof of Stake is becoming more and more popular. Even Ethereum is switching from PoW to PoS soon in Ethereum 2.0 version. However, there are issues as well. In Proof of Stake, you can buy yourself control. This is only possible to a certain extent in Proof of Work.

In 2020, we saw how a PoS system can be abused when Justin Sun took over the Steem network through its validators.

Even if PoS has its problems, the question is this: does it really make sense for any other currency than Bitcoin to use Proof of Work? After Ethereum has moved to Proof of Stake, we have coins like Litecoin, Bitcoin Cash, and Dash left. Cheap and quick transactions can be done without PoW as well.

It might be that Proof of Work will be eventually used by a handful of special coins, like Bitcoin and Monero. The rest of the market is probably run by Proof of Stake or new technologies like DAG, which are not even blockchains.

You should also check the video below. It has an exceptionally good discussion of Bitcoin mining and topics covered in this article.

Image by Лечение Наркомании from Pixabay, Photo by Sharath G. from Pexels, Photo by Dmitry Demidko on Unsplash, Photo by Sebi Pintilie from Pexels

2229   btrz ancient egyptbtc 728x90 en

What is your reaction?

Excited
0
Happy
0
In Love
0
Not Sure
0
Silly
0

You may also like

Comments are closed.

More in:Guides