Bitcoin is a digital currency. As with all currencies, they need checks and balances, validation and verification. Normally central governments and banks perform these tasks, making their currencies difficult to forge while also keeping track of them. In paper currency you will always find a serial number on your dollar bills… in Bitcoin digital currency, this “serial number” is a long number that is unique to that particular Bitcoin.
The big difference between paper currency and Bitcoin is that it is decentralized. In other words, there is central government regulating it. This begs the question, how do we then know that the transactions are accurate?
How do we know that person A has sent 1 bitcoin to person B?
How do we stop person A from also sending that bitcoin to person C?
The answer is mining.
What is Bitcoin Mining? A good way to think of Bitcoin Mining is to think of Gold Mining, with a Twist…
Just like Gold, there is only a limited amount (there will only ever be 21 million Bitcoin). The more you mine from the ground, the more scarce it becomes, and the more difficult it becomes to mine it, or, even find the next gold “mine.” While Bitcoin is “mined” in the sense mentioned above, the entire process is actually quite different… and it is ingenious… once you begin to understand it, and its implications. Bitcoin mining is not actually mining for actual Bitcoins… it is instead solving mathematical computations, that produce, as a reward, Bitcoins that are awarded to the successful “miner” who first solved the mathematical computation. What the miners are actually doing is validating transactions, and therefore, receiving, as a reward, a certain amount of Bitcoins. In other words, miners are validating that person A sent 1 Bitcoin to person B, therefore, he “spent” his Bitcoin…. and cannot send the same Bitcoin to person C. So how do they do it?
Bitcoin mining requires a computer and a special program. Miners will use this program and a lot of computer resources to compete with other miners in solving complicated mathematical problems. About every ten minutes, they will try to solve a block that has the latest transaction data in it, using cryptographic hash functions.
What are Hash Functions?
A cryptographic hash function is an essentially one-way encryption without a key. It takes an input and returns a seemingly random, but fixed length hash value.
For example, if you use Movable Type’s SHA-256 Cryptographic Hash Algorithm:
Message: How does mining work?
Hash Value: 46550fef 26f87ddd 5e15407f 45a0b8d2 9513291c 4e0f0acc 24a974de 907a1569
If you change even one letter of the original input, a completely different hash value will be returned. This randomness makes it impossible to predict what the output will be.
How Are Hash Functions Useful For Bitcoin?
Because it is practically impossible to predict the outcome of input, hash functions can be used for proof of work and validation. Bitcoin miners will compete to find an input that gives a specific hash value (a number with multiple zeros at the start). The difficulty of these puzzles is measurable. However, it is impossible to cheat. This is because there is no way to perform better than by “guessing” blindly.
The aim of mining is to use your computer to “guess” until it comes up with a hash value that is less than whatever the target may be. If you are the first to do this, then you have mined the block (normally this takes millions and billions of computer generated guesses from around the world). Whoever wins the block will get a reward of 12.5 bitcoins (as long as it becomes part of the longest blockchain). The winner doesn’t technically make the bitcoin, but the coding of the blockchain algorithmis set up to reward the person for doing the mining and thus helping to verify the blockchain.
Each block is created in sequence, including the hash of the previous block. Because each block contains the hash of a prior block, it proves that it came afterward. Sometimes, two competing blocks are formed by different miners. They may contain different transactions of Bitcoin spent in different places. The block with the largest total proof of work embedded within it is chosen for the blockchain.
This works to validate transactions because it makes it incredibly difficult for someone to create an alternative block or chain of blocks. They would have to convince everyone on the network that theirs is the correct one, the one that contains sufficient proof of work. Because everyone else is also working on the ‘true’ chain, it would take a tremendous amount of CPU power to beat them.
Who Are Bitcoin Miners?
Initially, Bitcoin miners were just cryptography enthusiasts… curious and random people who were interested in the project and used their spare computer power to validate the blockchain so that they could be rewarded with Bitcoin. As the value of Bitcoin has increased, more people have seen mining as a potential business, investing in warehouses and hardware to mine as many Bitcoin as possible. To date there are hundreds of Bitcoin mining warehouses spread across the globe, all competing to be the first to solve the mathematical puzzle, and be awarded Bitcoin.
Bitcoin requires many sophisticated computers, working together, to successfully solve the mathematical puzzles. The computers must be operational 24/7/365. This requires A LOT of electrical power. For that reason, most Bitcoin mining warehouses are found in areas around the world that offer low electricity prices, to further reduce their costs, such as Iceland and parts of China. While it is still technically possible for an enthusiast to mine for Bitcoin from a personal computer at home, from a practical perspective, and economies of scale, it is no longer a viable proposition.
If all this has still left you unsure of what this is all about, you are not alone. As mentioned earlier, it is all about solving complex mathematical computations, and being awarded Bitcoin to the successful “miner” who solved the puzzle.
What is important to take from this is that you do not need to know precisely how something works, to profit from it, or to begin using it as a form of financial transactions. Millions have been made so far from people that have invested in this new currency, and many more millions will be made because the last Bitcoin to be mined will not occur until the year 2140! The first Bitcoin was mined in 2009, with virtually a Zero value. As of this writing, Bitcoin is trading at $2220.84 USD. Many predict it will someday, in the next decade or so, be trading at upwards of $1 million USD per Bitcoin. As countries begin to adopt the currency as a valid form of payment, and businesses continue to add and accept Bitcoin for payment, its value continues to rise.
Dislaimer: This is not investing advice, this website is for educational purposes only.