How does Bitcoin mining work?
How does Bitcoin mining work?
Bitcoin mining involves verifying transactions before adding them to the blockchain. Because Bitcoin is decentralized and transactions are not managed by third parties such as banks, miners verify transactions to prevent fraud.
However, Bitcoin mining is a complex process that requires special equipment to solve cryptographic puzzles. Miners are rewarded with freshly mined new Bitcoin based on their contribution of computing power, time, and energy in verifying transactions.
Let’s decode and better understand the comprehensive Bitcoin mining process.
1. Setting up mining hardware
The first thing you need to mine Bitcoin is special mining equipment. Bitcoin mining requires excessive energy, making it nearly impossible to mine Bitcoin with a regular computer.
Application-specific integrated circuits (ASICs) are advanced mining machines with superior hash speed, energy efficiency, and computing power, allowing them to solve puzzles faster and mine blocks faster.
These ASICs are highly sophisticated machines that are precisely programmed for specific mining algorithms. For example, Bitcoin ASIC miners are programmed for the Bitcoin mining algorithm SHA-256. Therefore, miners can efficiently mine their intended cryptocurrency despite network difficulties.
The setup process for all ASICs is simple. So, for all ASIC miners, whether Bitcoin miners, Zcash miners or Kaspa miners, the setup process is pretty much the same.
ASICs require more power and do not support Wi-Fi, so they only require a dedicated power infrastructure and a wired network connection. To better understand the ASIC setup process, read our setup blog.
2. Install mining software and cryptocurrency wallet
After completing your mining hardware and building a suitable power infrastructure for that hardware, the next step is choosing the right mining software. Multiminer, XMR Miner, and CG Miner are some of the most popular Bitcoin mining software used by Bitcoin miners.
Almost all Bitcoin mining software is available online and can be downloaded for free. Now that you have your mining hardware, software, and power setup, you are ready to mine Bitcoin. But where do you store the Bitcoin reward? To store and transfer Bitcoin, you need a dedicated Bitcoin wallet.
3. Join a Bitcoin mining pool
Now that you have your dedicated Bitcoin mining setup, why join a Bitcoin mining pool rather than just mine alone? In addition to mining infrastructure, Bitcoin mining also requires technical expertise.
Mining pools facilitate this by allowing miners to share their computing resources and knowledge with fellow miners on the network, increasing their chances of solving blocks and successfully mining new Bitcoins. And of course, more miners means a more stable and secure network.
4. Start Bitcoin Mining
Bitcoin mining is a technical process that requires miners to solve complex algorithms. Let’s take a closer look at the process. The Bitcoin mining algorithm, SHA-256, generates a random hash and adds another number called a nonce to it.
A nonce (a number used only once) is a randomly generated 4-byte number. Miners use this nonce to find a hexadecimal number called a hash that is less than or equal to the network’s target.
Nonce always starts with 0 when a miner starts the mining process. With each attempt it changes to 1, 2, 3 and so on until the miner finds the hash. The generated hash and nonce must be less than or equal to the target hash. Otherwise the attempt will fail. The miner who solves the puzzle first receives a reward, and a new block is created.
5. Proof of Work (PoW)
Bitcoin mining follows a proof-of-work (PoW) consensus mechanism that requires large amounts of energy and computational power to solve puzzles and achieve a hexadecimal number equal to the target hash. The task performed here is to verify the transaction. That’s why it’s called Proof of Work.
6. Confirm
Block confirmation is once again an extensive process. Each block contains the hash of the previous block, so changes to a block also affect the hashes of other blocks. This feature strengthens blockchain security.
Confirmation of block resolution is now done until approximately 5 blocks have been reached. You can change block information until you reach 6 verifications, but because the network is decentralized, it is highly unlikely that you will change the information after that.
7. Compensation
Miners who successfully verify a block are rewarded with newly mined Bitcoin. Bitcoin halving occurs every four years, i.e. after 210,000 blocks have been mined, so the reward is not fixed and constantly changes.
For example, miners received 50 bitcoins for mining one block in 2009. Block rewards were halved and received 25 Bitcoin in 2012. In successive half events the rewards were reduced to 12.5 and 6.25. In the upcoming Bitcoin halving event, the reward will be reduced to 3.125.
In addition to rewards, miners will also receive transaction fees. Bitcoin is expected to reach its maximum limit of 21 million around 2140. Miners are paid for processing transactions, and network users pay to keep the Bitcoin network running.
Costs Associated with Bitcoin Mining
Bitcoin mining is a technical process that requires specialized mining infrastructure and power setup. Additionally, Bitcoin mining is energy-intensive, so your electricity bills can be high.
So, if you are considering mining Bitcoin, you may need to prepare for the following costs:
1. ASIC Miner
Cryptocurrency mining requires special devices called ASICs that are optimized for specific cryptocurrency mining algorithms. Bitcoin miners are fine-tuned for the high hash rate SHA-256 algorithm, allowing miners to mine Bitcoin successfully.
These advanced Bitcoin miners can be expensive, so you should consider this before starting professional Bitcoin mining.
2. Electricity bill
Most ASIC miners that help in cryptocurrency mining require high power. Therefore, it is natural that power consumption increases rapidly. So, before purchasing a Bitcoin mining machine, consider the electricity rates in your area.
3. Cooling costs
Bitcoin miners emit a lot of heat, so you may need to invest in additional cooling systems such as air conditioners, fans, etc., especially if you live in a tropical area.
4. Internet and networking costs
Connecting your miner to the Bitcoin network requires a stable, high-speed internet connection. Consider the cost of your internet and any additional network devices you may need.
5. Mining pool fees
Bitcoin mining pools charge a portion of the rewards as mining pool fees. Before partnering with a mining pool, inquire about their service fees.
6. Tax
Depending on your country’s laws, mining profits may be taxed. Therefore, before getting into Bitcoin mining, it is important to understand the tax implications in your country.
Incentives for Bitcoin Miners
Bitcoin mining requires miners to use advanced ASICs with high computational power to solve complex algorithms to verify transactions and mine new Bitcoins. So what do miners get in return for all their effort, time and money? – incentive.
So how are incentives calculated? Miners receive newly minted bitcoins as rewards and transaction fees as incentives.
Simply put,
Bitcoin Miner Incentive = Block Reward + Transaction Fee
As discussed earlier in the blog, Bitcoin halving will have a major impact on the profitability of Bitcoin miners in the future. But miners will have to wait.
Factors that determine Bitcoin mining profitability
Bitcoin mining profitability depends on a variety of factors, some of which you can control, some of which you do not. Below is a list of factors that affect Bitcoin mining profitability.
1. Bitcoin price
2. Hashrate
3. Mining difficulty
4. Number of network participants
5. Electricity bill
6. Mining Hardware Efficiency
7. Mining pool fee
8. Market trends
9. Regulatory affairs and taxes in your country
The list is endless. Therefore, miners must pay attention and do their best to understand the market. This will help you take calculated risks while increasing your profits and minimizing your losses.
