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Bitcoin mining is crucial to maintaining the blockchain underpinning the cryptocurrency. But miners are facing fewer rewards and higher costs, while competition continues to heighten. We have a look at what bitcoin mining is, how it works, and how profitable it is.
Mining has historically been a term usually reserved for those digging for gold and other metals deep underground, but today there is a new type of miner searching for very different treasure in a very different way.
Bitcoin miners, equipped with high tech computers rather than a spade, are crucial to the bitcoin ecosystem: dedicating the crucial computing power needed to maintain the blockchain and verify the thousands of transactions occurring every day while also providing the network’s immunity to hackers, ability to track trade and (the only) way to create new bitcoins.
Read more about bitcoin and how it works
The art of bitcoin mining is not even ten years old but the rewards on offer has already seen it evolve from a hobby-like operation that anyone could do at home into an industrialised, energy-intensive market.
Decentralisation is at the heart of bitcoin and, while the importance of the blockchain is well understood, how this public ledger operates is often overlooked considering it isn’t controlled by a single person or entity. So, what is bitcoin mining and how does it work?
Bitcoin mining is the process that ensures that bitcoin functions as intended and is the only way of adding new supply into the market. Miners are individuals or companies that contribute computing power to help maintain and operate the blockchain network that underpins bitcoin as a digital currency. These computers are responsible for verifying all bitcoin transactions and in return they get the opportunity to ‘mine’ for bitcoin that has been newly created.
Although the Internet created a fast and universal communication channel around the world, the development of a truly decentralised system capable of operating on a global scale was still being held back by three big questions. Firstly, with no one in control, who will keep a record of (and incur the costs of recording) all the transactions? Secondly, who would hold these record keepers to account? And thirdly, how do you incentivise people to become record keepers in the first place?
Satoshi Nakamoto, the founder of bitcoin, came with up an answer for all three. People – known as miners - would use their own computers to power and maintain the blockchain, helping organise other people’s transactions. The computers of other miners would then check the work to ensure it is correct to provide a public consensus on which transactions to confirm – if the information from the original miner doesn’t match what everyone else has then it is clear something is amiss. In return for doing this, the miners are paid transaction fees and, so long as there is still new bitcoin to be made, an opportunity to win the new bitcoin that the protocol releases every ten minutes or so.
Using bitcoin miners to operate the blockchain addressed many of the problems that brought down previous systems. It is decentralised: the ledger is not under a single point of control and anyone can access and verify the transactions that have been recorded. It is incentivised: people have a reason to use their hardware and pay for the electricity needed to run the blockchain as they are rewarded with new bitcoins. Together, this makes it immune to hackers: the fact it is powered by a vast array of computers around the world rather than a single source means it is extremely unlikely (although not impossible) anyone could gain control of over 50% of the network to take control.
Today, bitcoin mining is predominantly done using powerful, purpose-built computer systems known as rigs that run bespoke software day and night. All the rigs have been set up for the same reason: to mine for new bitcoin. But to mine for this bitcoin they must assist in updating the public ledger and help validate the work done by other miners maintaining the blockchain. Every single bitcoin in existence has been created through mining, meaning every bitcoin is owned by a miner until (or if) they decide to sell it.
Every bitcoin transaction initially enters the network as ‘pending’, or ‘unconfirmed’, so there is a constant stream that need to be verified by the miners, in order for the transaction to be confirmed. This is the same principle as a bank clearing a payment using your debit card. These transactions contain all the important information needed for the transaction such as the wallet addresses of each party and the date, as well as other optional data such as transaction codes, reference numbers or messages.
Miners (also referred to as mining nodes) then automatically begin to organise this data. Firstly, they reduce all the information within the transaction into a hash: an alphanumeric string of 64 characters. This not only condenses large amounts of information into a smaller file but also encrypts the information that the hash now represents. Once the hash has been created the underlying information it represents cannot be changed without messing up the hash, which would then alert the rest of the miners operating the blockchain.
Importantly, the blockchain is organised in chronological order and mining software automatically starts gathering the most recent transactions before moving on to the second most recent transaction, then the third and so on. Once one transaction has been hashed, it is combined with the information of another transaction to make a new hash. Transactions keep being added together and combined under a single hash until they form a block. It is these blocks that are added to grow the chain of transactions (hence the name blockchain).
During this process miners are racing with one another to be the one to seal off the block so that it is ready to be inserted into the chain, as the miner to do this is the only one that is rewarded with new bitcoin. Sealing off complete blocks, however, is a guessing game rather than one based on skill. Miners compete to find the random block hash that the bitcoin protocol is looking for by rapidly submitting numerous guesses (known as nonces) in the hope of striking a match.
The random nature of this process means miners can’t find patterns to follow or gain a better insight into what next hash will be needed to seal off a block and earn new bitcoin: it all comes down to luck. They can, however, maximise their chances – the more computing power a miner has the more guesses it can make. It is the same principle as playing the lottery: you can purchase more tickets to increase your chances of winning but there is no guarantee of a prize regardless of how many you buy.
Once a miner seals off a new block it creates a block number that sequentially follows the last block that was added to the chain, mathematically tying the new block to the other blocks of transactions in the chain that have already been confirmed and verified by the consensus-based network.
Once the new block has been added to the blockchain it needs to be confirmed by other miners. The miner that has sealed off the block has to have their proof-of-work (PoW) checked by other miners to make sure all the information is correct. This is done by multiple other miners checking that the hash of the block matches that of the underlying information it represents, reaching a consensus as to whether the new block is legitimate or not. This consensus-based model is what prevents fraudsters from tampering with previous or new transactions and stops people from ‘double spending’ (when someone spends bitcoin they have already spent and no longer have), as the blockchain will recognise if any new transactions involve bitcoin that has already been spent.
In this capacity, miners are essentially acting as auditors of one another’s work to ensure everyone is playing by the rules.
The miner that completes the PoW to add a new block to the blockchain – having helped verify a group of transactions over a certain timeframe - is rewarded twofold: they are given the new bitcoin that the protocol releases, and they are awarded the transaction fees attached. This is a way of acquiring bitcoin without having to purchase them.
The bitcoin protocol dictates the speed and volume at which new bitcoin supply is added to the market. New bitcoins are released to successful miners every ten minutes, but the algorithm controlling this is not technically dictated by time. Instead, it is designed to adjust how difficult it is for the miners to seal off a new block, to keep the flow of new supply steady at that speed. This means the rate at which bitcoin is released is unaffected when the number of miners in operation increases or more computing power is applied. The rewards on offer remain the same regardless how many miners are competing for it, and the new bitcoin on offer stays the same no matter how much computing power is thrown behind it. The only thing that does change is the odds of each miner winning the rewards on offer.
While new bitcoin will continue to be released over ten minute windows the volume of new bitcoins issued to successful miners does change, halving roughly every four years (technically, every 210,000 blocks). When bitcoin was first mined by Satoshi in 2009 the reward was 50 bitcoin before dropping to 12.5 bitcoin in 2012, and then down to the current level in 2016. The next cut, down to 6.25 bitcoin, is expected to happen in 2020, when miners will be hoping lower volumes will be offset by higher prices.
There will only ever be 21 million bitcoins in existence and the vast majority have already been mined - the 17 millionth bitcoin was released in April 2018. The constant rate of release of gradually smaller volumes of new bitcoin means the last bitcoin won’t be mined until sometime around 2140.
Miners are also paid transaction fees in addition to the new bitcoin that is released. The huge sums that payment processors and banks cream off the billions of transactions we all conduct each day is often cited as one of the reasons why bitcoin and other cryptocurrencies are necessary. But it is often misunderstood that using bitcoin is not free, albeit cheaper than what the traditional financial system currently offers. Miners do not have to charge transaction fees and not too long ago they often only applied them to certain types of transactions, such as particularly large or small ones, but income from transaction fees has rocketed and their reliance on this income stream is only set to grow.
In short, it is impossible to define whether bitcoin mining as a practice is profitable in general. There are too many variables: the cost of hardware and the energy needed to power it differs wildly across the globe and the return that each miner delivers depends on how able it is to compete with an increasing number of competitors all vying for the same prize.
In the same way a gold miner’s chances of finding a nugget would reduce as more people started digging in the same territory, a bitcoin miner’s chances of winning the new bitcoin and transaction fees declines the more competition there is in the market. There aren’t any other bitcoin deposits to dig up and bitcoin miners must compete for the same treasure or not at all.
While it is not known for sure whether bitcoin mining is profitable right now, we do know some things for sure. One, most bitcoin miners were making profit in the initial years. Two, some miners must be reaping rewards as otherwise there would be no incentive for them to continue mining. And three, while some could still be making money mining bitcoin it is certainly less profitable than it used to be and harder to compete than ever before.
That third point is demonstrated by how difficult it has become to seal off a new block and win the reward. According to blockchain.com, the difficulty level to find a new block (measured by the hashing power deployed by all miners) has risen exponentially in 2018, demonstrating the rise in competition.
Additional data shows the hash rate – the amount of hashes being submitted by miners per second – has risen 12-fold since late 2017.
The most important variable determining the profitability of mining is obviously the price of bitcoin. At the dizzying highs of $19,000 late last year the 12.5 bitcoin reward would be worth close to $240,000. Today, at bitcoin’s current price of $6270 those same 12.5 bitcoin are worth around $78,400. The sums on offer now, although low relative to less than one year ago, are nothing to be sniffed at, but the costs of acquiring ever-more powerful computers and burning through more electricity, twinned with heightened competition, means rigs can struggle even at higher prices.
Read more about how mining affects the value of cryptocurrencies
As the amount of new bitcoin being released declines the incentive for miners to continue to do their job and maintain the blockchain will gradually swing to the transaction fees on offer rather than mining new bitcoin.
The volume of daily bitcoin transactions peaked at around 490,000 when the price was at its heights late last year, but the most recent statistics show daily volumes currently vary between 200,000 and 260,000. It is not uncommon for volumes to experience the severe volatility that the bitcoin price has become known for – a drop of 25% in a single day happens often.
The amount of transactions being conducted is obviously important in terms of how much miners can earn in transaction fees. Their fees have fallen in correlation with decline in volumes. When prices were high bitcoin miners were earning as much as 1500 bitcoin between them each day but that is now considerably lower. Miners have charged less than 30 bitcoin per day in transaction fees since the end of June 2018:
Bitcoin mining was originally done using simple home computers (CPUs) and although anyone can still download the software and begin mining these small players have largely been pushed out of the industry by those packing more serious computing power.
The first upgrade, so to say, came after miners began to realise they could use the graphics cards (GPUs) in their computers. GPUs were being dedicated to mining and offered more power than CPUs, and therefore better chances of sealing off new blocks and earning the rewards. Once one miner made this discovery it didn’t take long for others to follow, sparking what is being dubbed as a ‘hash rate war’ that continues to rage on today as miners continue to upgrade to better equipment in order to maximise their chances in an increasingly competitive market.
This race has moved bitcoin mining from a household hobby into an industrial-scale operation. GPUs have been replaced by bespoke hardware that has been designed to carry out nothing but mining operations. These application-specific circuit chips (ASICs) started to gain traction as hardware manufacturers, originally in Asia, began to introduce new equipment specifically designed for miners before becoming virtually impossible to competitively mine without using ASICs.
As the technology becomes more sophisticated so do the people using them. This high tech equipment is becoming more expensive and therefore the role is being increasingly taken up by businesses that have the financial firepower needed to buy enough to pack out warehouse-sized data centres. The amount of bitcoins that each miner earns is broadly proportionate to the level of computing power they contribute to the overall network and although crypto-enthusiasts and bitcoin lovers may have been the ones to originally mine the cryptocurrency (making the so-called 'Bitcoin Billionaires' that act as brand ambassadors), today they have been pushed out by huge energy-intensive operations.
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The technology is still developing and there are some ASICs in the market that are already classed as outdated. The rapidly evolving technology pushes the costs of mining higher as there is a constant need to upgrade to stay competitive, and the larger and more powerful these operations become (often referred to as ‘mining farms’) the more electricity they need to operate.
In the days of GPUs the big hardware manufacturers like NVIDIA and Advanced Micro Devices (AMD) dominated, with the former accounting for over 70% of the market. But the move to ASICs has left both firms in the dust as neither have any ASICs on offer.
The company to have emerged as an early dominating force in the mining hardware industry is Chinese firm Bitmain. This behemoth applied for a multi-billion dollar initial public offering (IPO) in Hong Kong earlier this year, publishing a prospectus that revealed it made over $2.5 billion in revenue in 2017 compared to just $277.6 million the year before. The profits are equally astounding, rising (on a pre-tax level) from just $137.8 million in 2016 to $897.4 million in 2017.
That rapid progress has continued in the first half of 2018, with revenue of $2.85 billion and pre-tax profit of $907.8 million both outstripping the annual figures reported last year. Bitmain sold over 2.5 million rigs in the first six months of 2018, more than it has sold over the prior three years combined, and it is the largest bitcoin mining hardware manufacturer in the world, followed by another Chinese firm, Canaan, in second place. Canaan, which makes ASICs under the brand name Avalon, also filed for an IPO in Hong Kong earlier this year.
Not everyone may be able to afford the sophisticated equipment needed for modern-day bitcoin mining but this has opened up new markets and models for bitcoin miners to follow.
As individuals have seen their ability to compete dwindle, many have decided to team up to create a big enough mining system to take on the big players. These mining pools combine the computing power of many individual rigs to increase the chances of earning the rewards on offer, although this also means the rewards must be shared out among more people. These mining pools also charge fees to join, further reducing profitability. Mining pools are an effective way to mine for those that would otherwise have little chance of success, albeit at a price.
The other new model is cloud mining. Individuals or companies, rather than purchasing the capital-intensive and energy-hungry mining hardware, can rent time on someone else’s rig and reap any rewards that the rig earns during that period. The companies renting out these rigs have numerous ways of making money. Some charge monthly fees, others charge based on the hash rate (the amount of processing power used), and some add on other charges like maintenance fees. Cloud mining can be complex and expensive but it does take out the hassle and costs of setting up and running your own rig.
There are other ways to gain exposure to bitcoin apart from mining. The most obvious is buying bitcoin through the number of cryptocurrency exchanges that make money by acting as the middlemen to facilitate transactions. However, these exchanges bring trading back under centralised control and expose traders to hacks, theft and other problems that bitcoin and other cryptocurrencies were designed to avoid.
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Interestingly, there are more ways to get your hands on cryptocurrencies (other than purchasing or mining them) than you might think. For example, one of the largest cryptocurrency exchanges, Coinbase, in 2018 bought Earn.com, a ‘paid email’ service that allows users to ‘earn’ cryptocurrencies by replying to emails and completing specific tasks. This is being used by companies to get people to take surveys or review their products in return for cryptocurrencies.
Read more about Coinbase, the $8 billion crypto-exchange
Some initial coin offerings (ICOs) – when new cryptocurrencies are offered to the public in the same way a company offers new shares under an initial public offering (IPO), although you are only purchasing the cryptocurrency, not investing in the company conducting the ICO – offer free coins to those willing to refer a friend to the offering.
Some services offer cryptocurrencies in return for watching videos, and one new concept is even trying to reward users based on the amount of time they use a new ad-supported social media platform. The blockchain will continue to find new innovative applications and uses as it develops. Ethereum for the use of smart contracts is one example of how different cryptocurrencies solve different problems.
You can also speculate on the price of bitcoin and another ten cryptocurrencies with IG, much in the same way you can with traditional fiat currencies.
‘For now, the release of those rewards is what ensures that bitcoin’s public ledger, its blockchain, is updated, maintained, and preserved. Over time, as the generation of new bitcoins slows, the reward system will shift to one in which miners are compensated with modest transaction fees imposed on anyone making payments,’ – ‘Cryptocurrency: The Future of Money?’ by Paul Vigna and Michael J Casey.
New bitcoin will continue to be released until well into the next century, but its contribution to the overall reward will decline as time goes on, placing more importance on the transaction fees that miners earn. There is a heated debate about what this all means for the future of bitcoin mining - a crucial topic considering the blockchain that gives bitcoin its meaning is nothing without the miners that power and operate it.
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One belief is that the decline in new bitcoin being released will lower the appeal and lead to fewer miners maintaining the system, potentially to an inadequate level to keep bitcoin going.
Another is that transactions fees will have to rise to ensure the miners are paid enough to keep the public ledger going, potentially to levels that make it more expensive than the traditional system used today.
Some think the emergence of huge mining farms and data centres specifically designed to mine bitcoin and maintain the ledger will eventually centralise the network as more computing power falls into fewer hands. Others think that the increased scarcity of bitcoin (as the amount of new bitcoin entering the market decreases) will lead to higher prices that can offset the lower volumes being released.
One last theory worth mentioning rewinds all the way back to the beginning of bitcoin. Satoshi’s own wallet, left largely untouched since the very earliest days of the cryptocurrency, holds around one million bitcoin that some believe is being left in reserve as a way of injecting serious amounts of new supply into the market should it be necessary in the short or long-term future. Satoshi may have more influence than anyone in the market: selling off one million bitcoin in one go could easily crash the market. But many would say this pioneer of decentralisation would never look to act in the way a central bank does in issuing new currency to try to steer value.
The future of bitcoin mining is as uncertain and exciting as bitcoin itself. Miners can try to maximise their chances by packing the best computing power they can, but they all have to ultimately rely on a sizeable bit of luck and, as the hardware and running costs rise, the rewards on offer fall, and the competition for this more limited supply of rewards increases, they might need quite a lot of it.
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