What is Bitcoin Mining?
The beginner’s guide
Bitcoin mining is the process of validating new Bitcoin transactions before adding them to the Bitcoin blockchain.
With traditional government-issued currencies like the U.S. dollar or euro, users are required to place complete trust in a centralized authority – such as a central bank – to manage the creation and circulation of money.
Within such fiat systems, all information regarding user accounts and balances is privately managed by financial institutions. As such, it’s impossible for any one person to know what another is spending or how much money others have in their accounts. Only the bank has access to the complete ledger of transactions.
There are three key problems with this type of system.
- Unpredictable: Because a central bank has the sole authority to print new money into existence, the supply of a fiat currency constantly changes. This creates inflationary issues and can often result in the reduction of a currency’s purchasing power over time.
- Lack of transparency: Traditional financial ledgers are heavily guarded, creating an opaque financial system that is not open to all.
- Dependency: By design, fiat currencies create a user dependence on a country’s central bank and government – creating single points of liability or potential failure.
Launched in 2009, Bitcoin became the first globally viable, decentralized digital currency. It relies on a strict computer protocol to govern its monetary policy along with a globally distributed network of volunteers to issue, manage and secure its currency.
Being a purely digital form of money, all transactions take place electronically over the Bitcoin network and are recorded on a fully transparent ledger technology called a “blockchain.”
The Bitcoin blockchain represents a complete transactional history of every payment users have sent to each other, and is constantly being updated with new blocks containing batches of current transactions.
What’s special about public blockchains, like the one Bitcoin uses, is that anyone, anywhere in the world can view all transactions happening across the network in real-time, and review a full archive of completed transactions — including all recipient and sender addresses, as well as individual balances.
But how does this work in practice?
Bitcoin monetary policy
Unlike the powers assumed by governments and central banks to print new currency into existence whenever they choose, bitcoin’s issuance system is governed by computer code.
There are three main components to Bitcoin’s monetary policy that are baked into its protocol:
- 10-minute block times: New bitcoin enters circulation roughly every 10 minutes. This is managed autonomously via the mining difficulty algorithm.
- Fixed supply: A maximum of 21 million bitcoin will ever exist in circulation. This is Bitcoin’s hard cap supply, meaning once the number of coins released through block rewards reaches 21 million, the protocol will cease minting and distributing new coins to winning miners. As of 2022, there are over 19 million coins of the 21 million in circulation.
- Bitcoin halvings: Every 210,000 blocks (or four years) the number of newly minted bitcoin distributed to successful miners as block rewards is slashed in half. When the Bitcoin network first launched in 2009, 50 BTC were given as block rewards. Since then, block rewards have undergone three separate halving events (2012, 2016 and 2020) – with rewards currently standing at 6.25 bitcoin per block.
Rewards will continue to be halved until the last bitcoin is mined — which is expected to happen sometime around the year 2,140.
This system of halving rewards adds an additional layer of predictability to bitcoin’s monetary policy, allowing users to accurately map the circulating supply of bitcoin throughout its entire lifespan.
Due to the built-in rate of inflation, and Bitcoin’s focus on long-term stability and transparency, confidence in the protocol has remained high for developers. Furthermore, Bitcoin’s fixed monetary policy drives an increasing number of investors toward its currency as a leading store of value.
How Does Bitcoin Mining Work?
Mining is one of the key elements that allows Bitcoin to regulate the distributed network of computers that helps make its software possible.
By racing to complete cryptographic puzzles, miners propose the blocks that make up the Bitcoin blockchain and that house the history of network transactions.
When a block is discovered by a miner, they announce that block to the network where it is verified and approved by other nodes.
In exchange for this service, new Bitcoins are sent to the winning miners.
Proof of Work (PoW)
While many will use the energy consumption as a knock against Bitcoin, it is important to note that many financial-related activities consume significantly more energy than Bitcoin mining, including gold mining and cash production.
To solve the cryptographic puzzles and find valid blocks, miners must uncover the right string of pseudorandom numbers, called a hash, which must match conditions set out by the protocol. Essentially, it is a lottery system where miners' odds of finding new blocks increase depending on how much energy they expend.
Hashing is a mathematical operation that takes in any arbitrary quantity of data and produces a fixed size output. To propose blocks in the Bitcoin protocol, computers race to generate hashes until one of the hashes has a small enough value.
The winning hash is then broadcasted to other computers for them to verify whether the solution is true or not. If it is valid, the user who broadcasted the block is awarded new Bitcoin.
However, the competition for finding blocks gets increasingly difficult with every new miner that enters the network. As the difficulty increases, so too does the price of production, followed by the price of the underlying commodity, in this case, Bitcoin.
Put more technically, the probability of finding a hash is roughly equal to a miner’s total mining power on the network. This means that the more computing power a miner is able to provide, the greater his or her chances of finding the hash, and thus receiving the block reward.
Since miners with a small percentage of the mining power are unlikely to discover the next block, and thus will rarely get compensated, miners sometimes pool their efforts.
Today, most mining is done by “mining pools,” groups of cryptocurrency miners who share their processing power over a network, and share the block reward amongst themselves.
Bitcoin’s Monetary Policy
Of course, while this process benefits Bitcoin’s miners it provides a far more valuable service by enforcing Bitcoin’s monetary policy.
Miners regulate the rate at which new bitcoins are made available to users, and help trigger and enforce rules about the Bitcoin money supply set forth by the software itself.
For example, the number of Bitcoin (BTC) released in each block is cut in half after 210,000 blocks are produced to keep the total supply finite. This event, called the “halving,” ensures Bitcoins continue to get more scarce over time.
In fact, according to the software rules, there will only ever be 21 million BTC introduced to the network’s economy. Satoshi put a lot of importance on Bitcoin having a fixed supply in order for Bitcoin to become more valuable over time in an effort to hedge against cash.
As of 2020, more than 18.5 million BTC has been made available to users. The last block is projected to be mined in the year 2140.
Due to the built-in rate of inflation, and thus Bitcoin’s focus on long-term stability and transparency, confidence in the protocol has remained high for developers. Furthermore, the fixed monetary policy is also the reason why the number of investors has been steadily increasing.
Kraken's Crypto Guides
- What is Bitcoin? (BTC)
- What is Ethereum? (ETH)
- What is Ripple? (XRP)
- What is Bitcoin Cash? (BCH)
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