What is crypto mining?

The mining process, in the context of cryptocurrency, is how transactions are validated and new blocks are added to the blockchain. As a reminder of what we touched on in Lesson 4, we explained that a blockchain is a peer-to-peer network of computers using open-source software to check and validate the accuracy of all transactions stored on the blockchain.

With this in mind, we can understand that the miners are those individuals, or groups of people, who solve complex mathematical problems, thereby enabling new blocks to be added to the chain. The blocks verify and store the transactions. Once this process is complete, the miners are rewarded with newly minted cryptocurrency coins.

To understand how cryptocurrency is mined, we need to introduce two key concepts; proof-of-work (PoW) and proof-of-stake (PoS).

PoW

Bitcoin is a key example of a PoW consensus mechanism. This means that when miners attempt to solve the complex mathematical problems to earn rewards, the first miner to successfully solve it earns the right to add the new block and, in turn, earns the bitcoin reward.

PoS

Ethereum is an example of a PoS consensus mechanism. Unlike PoW, this mechanism doesn’t rely on miners solving complex mathematical problems. Instead, the way the rights are determined to add the new block is based on the miners existing ownership or ‘stake’ in the cryptocurrency.

With this understanding, if we take the example of PoW, mining requires a huge amount of computing power, electricity and equipment.

There are two key purposes when it comes to mining cryptocurrency. The first, is the process helps secure the network, solving the ‘double-spend’ problem.

The double-spend problem refers to the potential for an individual to attempt to spend the same amount of currency more than once. Let’s say Alice wants to send Bob £10, but then attempts to spend that same £10 she sent Bob when she goes shopping. If users can send the currency more than once, this reduces trust in the system and creates potential for fraud. 

When physical currency, or cash, is used in an exchange the double spend problem isn’t an issue as you physically part with the cash in question. This is why miners play a key role, their collection and verification of transactions ensures that the spender has enough currency and has not attempted to spend those funds more than once.

Equally, the decentralized and trustless nature of a PoW consensus mechanism in particular, is that no single entity or third party has any control over the network. Meaning, an attempt for an individual to double-spend is near impossible from a control, computational and resource perspective.

The second key purpose is the issuing of the reward to miners with newly minted coins, acting as a form of payment for their efforts. Given that we understand how costly, from a computing hardware and energy consumption perspective, the process of mining is, it’s reasonable that miners should earn a reward and are incentivized to contribute their time and resources to keep the network secure.

Let’s put all of the information above into a contextualized example. If a miner chooses to mine bitcoin, they’ll need to be the first miner to successfully solve the complex set of math problems in order to earn the right to add the new block. 

If successful, the miner (as of April 2024) will earn 3.125 BTC. To give an idea as to how energy intensive the mining process for one new block is, it’s estimated that creating one bitcoin consumes more than 147 terawatt-hours each year. According to the Cambridge Bitcoin Electricity Consumption Index, that’s more energy than is used by the entirety of the Netherlands. 

An important fact to note is that the rewards for bitcoin mining halve approximately every four years, also known as the bitcoin halving cycle. So, if we look back to the first bitcoin mined in 2009, the block reward was 50 BTC. In 2012 the reward halved to 25 BTC, in 2016 halved again to 12.5 BTC and in 2020 halved once again to 6.25. Meaning, the halving cycle in 2024 reduced the reward to 3.125 BTC.

The reason as to why the block reward halves is outlined in the Bitcoin protocol. To delve into more detail see our lesson here, but we have outlined a summary of the key points specific to the halving below. 

As we’ve outlined, the process to mine bitcoin requires not only time, but has a high cost in terms of both computing power and equipment. If the block reward halves, miners would need to adapt accordingly in order to remain profitable from the mining process. Thus, competition increases and miners who are less efficient and productive are driven out. 

The Bitcoin Protocol itself is designed in such a way as to control the supply of new bitcoin entering into circulation, which is why it outlines that by fixing the bitcoin supply leads to increased scarcity over time. This increased scarcity adds to bitcoin’s value as a deflationary asset. When we also consider that halving the block rewards also serves to limit excessive levels of inflation when it comes to new bitcoin entering the market, the restricted approach aims to keep price stability and maintain the assets value in the long run.