Analyses
11
Apr
bitcoin mining

This website has affiliate links. We may receive compensation if you visit partners we recommend. Read more about our advertising principles from the About Us page.

Bitcoin (cryptocurrency) mining explained

This article is a beginner’s guide to Bitcoin mining. We will go through the principles of Bitcoin mining, the criticisms of Bitcoin mining, and why mining is important for Bitcoin. The article also discusses cryptocurrency mining more broadly and compares the differences between Proof of Stake and Proof of Work.

How Bitcoin mining works

Let’s take a quick look at the principles of Bitcoin mining. Why is mining needed, and what is achieved with it?

Bitcoin mining is, in short, the maintenance work of Bitcoin’s blockchain. Like many “first generation” cryptocurrencies, Bitcoin uses a Proof of Work consensus algorithm. This algorithm refers to a method for building consensus on the information stored in the blockchain.

Miners build the Bitcoin blockchain by picking transaction data from users and adding it to new blocks. Without miners, there would be no blockchain. In addition to miners, there are nodes in the network that validate new blocks and ensure that all network rules are being followed.

Bitcoin will not be discussed in-depth in this article. For more information check out this beginner’s guide to Bitcoin.

As the term Proof of Work suggests, this algorithm requires miners to provide proofs that enough work has been done. In the case of Bitcoin, this is computational work. Miners solve mathematical equations and use a lot of energy while doing that.

Today, Bitcoin mining is done by custom-built ASICs. These are computers optimized for mining, costing thousands of dollars. Chinese Bitmain is the best-known manufacturer. The image below is from Bitmain’s online shop.

antminer

Bitcoin mining was first a small-scale hobby. It was also possible to mine profitably with a standard PC. Things changed rapidly in the early 2010s when ASICs took over the market. Today, Bitcoin mining is a huge business, dominated by mining farms worth hundreds of millions of dollars.

The mining process and the energy it requires make Bitcoin extremely secure. Attempts to modify the blockchain data (a 51% attack) would be so expensive that it would make no sense financially.

The global mining power of the Bitcoin network is described by the term hash rate. It has been rising higher every year. This tells us two things:

  • The efficiency of miners increases with the new versions.
  • New mining farms are constantly entering the market.

At the time of writing, the global Bitcoin hash rate is around 200 TH/s. Two years ago it was just over 100 TH/s and four years ago it was around 25 TH/s. You can find up-to-date information on blockchain.com.

Other Proof of Work solutions

Let’s look at other cryptocurrencies that use the Proof of Work consensus algorithm.

The popularity of Proof of Work has plummeted over the past five years. Ethereum, launched in 2015, is considered to be the latest major Proof of Work cryptocurrency launched. There are no other cryptocurrencies other than Bitcoin & Ethereum in the top 10 rankings.

Litecoin, Dogecoin, and Monero are well-known examples of Proof of Work cryptocurrencies. This is also where the mining algorithm comes into play. It is SHA-256 for Bitcoin, ethash for Ethereum, and scrypt for Litecoin.

litecoincom

The mining algorithm decides to what type of processor the mining work is optimized. For example, Monero’s mining algorithm is designed to prevent the use of ASICs. The aim is to keep mining as decentralized as possible and prevent it from being dominated by large mining farms.

Hence, it depends on the cryptocurrency whether it is optimized for CPU, GPU, or ASIC mining. For a normal user, the most profitable cryptocurrency to mine could often be a low-market-value coin. The profitability of mining is affected by the hardware used and the cost of electricity. It is also important whether the mined coins are sold immediately or held as speculative investments.

All the Proof of Work currencies mentioned above were introduced more than five years ago. Today, all major new projects use the Proof of Stake option. Ethereum will also move to the Proof of Stake consensus in 2022, abandoning traditional mining. You can read more about this in our guide called The Merge.

Proof of Stake is an alternative to mining

As mentioned above, Proof of Work was popular in the early of the industry. The first Proof of Stake coin was Peercoin, introduced in 2012. Since then, the trend has been strongly PoS-friendly. Why has it become so popular?

There are many reasons for this, but three stand out above the rest.

  1. Funding for a new project. All coins can be minted from scratch before the production-ready blockchain is even operational. The whole pot can be conveniently distributed to the development team, early-stage investors, VC firms, etc. as desired percentages.
  2. A Proof of Stake solution is easier to scale up to thousands of transactions per second with a block time of 1-2 seconds.
  3. No expensive mining equipment and no huge energy consumption.

In a PoS system, the blockchain is maintained by validators instead of miners. These entities stake the cryptocurrency which means locking tokens out of the market.

The logic behind this is simple. If you own a lot of the cryptocurrency in question, you have an incentive to do the right thing as a network validator. An attack on the network would be a direct hit to your own wallet.

There are many different variations of Proof of Stake. Some well-known ones include Delegated Proof of Stake (DPoS), Liquid Proof of Stake (LPoS), and Proof of Authority (PoA). The basic principle remains the same; the more cryptocurrency you own, the more power you have, and the more you earn in fees for the maintaining work.

The photo below is from stakingrewards.com. It lists the most popular Proof of Stake cryptocurrencies and shows their staking rewards and staking rates.

stakingrewards

Popular Proof of Stake cryptocurrencies include Luna, Solana, Polkadot, Cardano, and Avalanche. It’s typical that such projects have 45-75% of the coins in circulation being staked. The annual return for validators (stakers) ranges between 4% and 9%.

Retail investors can delegate their tokens to the validators and get access to staking rewards.

Criticism of Bitcoin mining

Let’s return to Bitcoin mining and look at the issue from the critics’ point of view. Why is Proof of Work seen as such a big problem that it has even been attacked by the EU?

The criticism is directed at the energy consumption of the mining process. There was also criticism about the centralization of mining in China, but this problem resolved itself in the summer of 2021. We will return to this subject in more detail at the end of the article.

Critics always compare Bitcoin’s energy consumption to appropriate targets, such as countries. The headline is familiar to many: “Bitcoin consumes more energy than the country of Norway”.

This is true, as Bitcoin does indeed consume more energy than many countries. Moreover, this consumption is only increasing, as the hash rate of the network is rising every year. Below is a graph of the growth of the Bitcoin hash rate over three years.

hashrate

However, the criticism misses an important point. Energy consumption offers ultimate safety and security, and you simply have to pay for it. Moreover, the scale is being overlooked. Bitcoin uses only 0.1% of all energy consumption on our planet. We are talking about a trivial “problem” on a global scale.

Bitcoin uses only a fraction of the energy used by the banking sector, for example. Bitcoin’s consumption is also much smaller than the gold mining industry, not to mention the environmental damage caused by the gold miners. No wonder why gold investors never criticize Bitcoin’s energy consumption…

Most critics see Bitcoin as a completely pointless invention. If this is the basis of their thinking, then any amount of energy consumption is too much.

Bitcoin is an unbreakable system due to its high energy consumption and it is the safest supercomputer on the planet. This is the feature that is driving billions of dollars invested in Bitcoin. Energy consumption is a factor that even makes governments and central banks rely on Bitcoin.

Solutions to Bitcoin mining problems

Almost 100 percent of the criticism of Bitcoin is directed at energy consumption. Could something be done about this problem without undermining Bitcoin’s security? Moving to a Proof of Stake solution is not an option, although this idea is being introduced often.

Reducing energy consumption is not the solution, but it can be eased from the energy production side. The more Bitcoin is mined with renewable energy sources, the better for the environment.

Bitcoin mining has been moving towards renewable energy for years. In the summer of 2021, a big step was taken when China banned Bitcoin mining. China had been doing a lot of mining with coal. After the China ban, lots of mining farms moved to the USA and began using renewable energy sources.

Bitcoin mining is a perfect partner for renewable energy. Mining farms can be set up outside cities and built next to hydropower plants, for example. In many places, mining farms are using energy that would otherwise be wasted.

hydro

For example, US energy giant ExxonMobil is diverting surplus gas to Bitcoin mining. It would be otherwise released into the atmosphere. Sweden’s state-owned energy company Vattenfall has commented that Bitcoin mining offers an excellent possibility for energy production.

Norway, on the other hand, is already mining Bitcoin with 100% renewable energy!

In 2021, the US also established a separate Bitcoin Mining Council to report on the energy use of the country’s mining farms. The latest (Q4/2021) report estimates that globally, 58.5% of the energy used in Bitcoin mining is renewable. In the US, the figure is 66%.

The future of Bitcoin mining

Let’s talk about the future of Bitcoin mining. At this stage, it is probably clear that Bitcoin’s energy consumption will not decrease. However, the hydro, solar, wind and nuclear power are increasingly being used as energy sources. It won’t be long before Bitcoin is mined entirely from renewable energy sources.

The move towards cleaner energy sources is well underway, so this criticism will be resolved by the free market. The ever-growing popularity of ESG, which stands for Environmental, Social & Governance, will give a boost. More and more investment funds are using ESG as a guiding principle for their investments.

ESG guides institutions to invest in companies that take energy consumption and the environment into account. Bitcoin mining with fossil fuels does not fit this picture. ESG is the reason why Tesla had to distance itself from Bitcoin in the summer of 2021.

Many Bitcoin mining farms are publicly traded companies. If they want to get investors’ money, mining should be done with renewable energy. ESG is therefore a good motivator.

The image below is from the Riot Blockchain homepage. It is one of the mining companies listed on Nasdaq.

riot

The Chinese mining ban in the summer of 2021 solved another big problem. Many investors were concerned about the centralization of Bitcoin mining in one country. The potential intervention of the Chinese state was one of the most popular FUD topics. Now, mining farms are more evenly spread across different countries.

China’s decision made the US by far the largest country in Bitcoin mining. Its share of the hash rate is 35.4%. Other major countries include Canada (9.5%), Russia (11.2%), Kazakhstan (18.1%), Ireland (4.7%), and Germany (4.5%). The figures are from August 2021.

Attitudes towards Bitcoin mining are slowly changing and understanding of energy use is growing. However, there is still much to be done. A good example of this is the Proof of Work ban pushed by the EU in March 2022. Fortunately, the bill did not pass. The whole idea sounds completely absurd.

We recommend Lyn Alden’s super-popular article Bitcoin’s Energy Usage Isn’t a Problem. Here’s Why. It goes through Bitcoin’s energy consumption in even more detail than this guide.

Proof of Work vs. Proof of Stake

Finally, let’s look at the popular Proof of Work vs. Proof of Stake issue. This debate popped up in 2022 when Ethereum is moving from mining to staking. Ripple founder Chris Larsen also hit the headlines when he suggested that Bitcoin should move to a Proof of Stake consensus.

One thing is 100% certain: Bitcoin will never change from PoW to PoS. That would undermine Bitcoin’s most important features and, above all, its history. Proof of Work has enabled the fair distribution of Bitcoin since its birth.

The Proof of Stake consensus always has one basic problem. You can take control of the network with money. A good example of this is Elon Musk’s investment in Twitter. The world’s richest man became the biggest shareholder in the social networking platform with a $3 billion investment.

At the same time, Musk was given a seat on the board, and he immediately started talking about changes to Twitter’s basic functionality (such as the ability to edit messages).

The world’s leading investment funds could collectively acquire a huge position in Proof of Stake Bitcoin, as the current market value of a trillion dollars is pocket money for them. The larger the position grows, the more one entity would also receive blockchain fees as a validator, further increasing its ownership.

With Proof of Work, this is impossible. Even if one entity bought 51% of all the bitcoins in the world, it would not give it power over the Bitcoin network. Buying mining power would be another prohibitively expensive and slow process, where the bottleneck would be the capacity of the equipment.

The perfectly valid question again is: what use do the old Proof of Work coins have in today’s environment? However, the energy consumption of Litecoin, Dogecoin, and similar PoW coins is so small that this is not causing much of a stir in the market. Perhaps Elon Musk will change Dogecoin to the Proof of Stake consensus next?

Bitcoin is a Proof of Work cryptocurrency, now and in the future. It may well be that in a couple of years it will be the only PoW coin in the top 100.

Photo by Sharath G. from Pexels

eToro banner
Articles written by Bitcoinsentralen are produced by our team. There are several crypto specialists working at Bitcoinsentralen. The head analyst of Bitcoinsentralen is Antti Hyppänen.