Beginner
Lesson 6
9 min

What is “Bitcoin mining” and how does mining work?

Mining is an essential activity in the Bitcoin network and is the process by which new Bitcoins are brought into circulation. It’s also a critical process for validating transactions, creating new blocks without the need for a central authority, and keeping the entire Bitcoin network safe.

• Mining is what keeps the Bitcoin network running by creating new blocks on the chain and verifying Bitcoin transactions.

• Transactions are verified by miners who use special hardware to solve mathematical puzzles. Miners are rewarded for their work with Bitcoin. They don’t have to contribute any money, only their computer’s computational power.

• Mining is an energy-intensive activity that has been criticised for its negative impact on the environment.

How does Bitcoin mining work?

Like gold miners using picks and shovels to extract gold, a Bitcoin miner needs two things: mining hardware and energy. Miners are computer owners who contribute their computing power and energy to the network of a Proof-of-Work-based cryptocurrency like Bitcoin.

Mining involves solving complex mathematical puzzles. Miners’ computers (called nodes) collect and bundle individual transactions from the past ten minutes (the fixed “block time” of Bitcoin) into blocks. The computers then compete to solve a complex cryptographic puzzle to be the first to validate the new block for the blockchain.

Here’s how it goes: Transactions trigger the opening of a block. The transaction information is entered then the block closes and creates a hash number that includes the encoded details from the transaction. Each new block contains information from the previous block to create a chain that cannot be manipulated or altered, which ensures that no one can spend the same unit of the currency twice. In Bitcoin’s Proof-of-Work (PoW) system, mining computers need to prove that they have expended energy in the mining process, which is how they prove that everything is correct.

Only one miner can be the first to find the correct solution to the mathematical puzzle. The winning solution is then broadcast to the entire network and the other nodes check to see if the solution is correct. If everything is in order, the new block is added to the blockchain. This process then starts again from the beginning.

Block rewards

As more and more units of Bitcoin are mined, the difficulty of these cryptographic puzzles increases. This means miners have to increase their computational power to continue earning the same amount of Bitcoin for solving puzzles.

The goal of every miner in the network is to solve this puzzle first. As a reward for their efforts, the first miner to find the solution gets a specific amount of newly minted Bitcoins, which is called a block reward.

Block rewards are reduced every 210,000 blocks mined, in a recurring event known as the Bitcoin Halving. The next halving is expected to take place in April 2024, and investors can keep track of this event with our Bitcoin halving countdown.

Ultimately, block rewards are important as they give everyone in the network the incentive to participate in the process and to keep it running properly. Without some form of verification and reward, blockchain technology in the way we know it wouldn’t function.

Mining and security

The puzzle-solving mechanism is necessary to protect the Bitcoin network from being compromised by attackers. For example, if anyone wanted to reverse transactions in the Bitcoin blockchain, this would take at least 51% of the whole network’s computing power, also known as a 51% attack.

However, such a heist would be quite an expensive and fruitless endeavour because it would be very difficult to modify transactions that were validated before the attack - the older a transaction, the more difficult it would be.

Mining difficulty

Mining difficulty refers to the level of complexity of the mathematical puzzle used to create new blocks. Depending on the number of miners in the network, the difficulty of mining new blocks may increase or decrease. Increased mining difficulty is needed for maintaining a network’s stipulated block creation time, which for Bitcoin is around ten minutes.

How many Bitcoins can be mined?

The Bitcoin protocol stipulates that there will never be more than 21.000.000 Bitcoins. This means that the Bitcoin supply is finite and the complete supply is fixed, potentially adding to its value as a result of scarcity. When all Bitcoins have been mined, the miners will no longer be rewarded with newly minted units but with a fraction of the transaction costs paid by others using the network.

To date (April 2023), about 19 million Bitcoins have been mined. It’s estimated that the last Bitcoin will be mined around the year 2140.

What is a pre-mined cryptocurrency?

Whereas Bitcoin releases new coins into circulation through mining, some cryptocurrencies, such as Ripple, Cardano, and Stellar, are pre-mined, meaning that a portion of the coins is created and distributed before the official launch date of the project. In most cases, a share of the pre-mined coins is distributed to ICO investors, developers and team members. In the latter case, distributing pre-mined coins to team members can serve as an incentive to employees and early adopters.

What are mining pools?

To improve their chances of earning a block reward, some crypto miners might pool their resources into what is known as a mining pool, using their combined computational resources to mine for Bitcoin or other mined cryptocurrencies. Block rewards are paid out according to how much processing power someone contributed to the pool. So the more processing power, the higher the chances of earning rewards.

DISCLAIMER

This article does not constitute investment advice, nor is it an offer or invitation to purchase any crypto assets.