Cryptocurrency is one of the best-performing investments of the last decade. Despite its increasing popularity and profitability, it is a mysterious topic.
You may have heard of cryptocurrency mining or bitcoin mining. It may leave you wondering, how does crypto mining work? How can you “mine” a digital currency?
These are important questions to ask. Before investing in cryptocurrency, knowledge of the technical background behind the crypto universe is important.
So, how does crypto mining work? Keep reading to understand the intricacies of cryptocurrencies and how to start crypto mining.
What is Cryptocurrency?
Before explaining how crypto mining works, it is important to get a sense of what cryptocurrency is.
As of August 2021, there are over 5,840 different cryptocurrencies. Cryptocurrencies are digital coins that are tracked and recorded using decentralized digital ledgers called blockchains. The blockchain is like a bank statement that tracks all of the transactions for that specific cryptocurrency.
Since the blockchain is decentralized, no one specific entity (i.e., bank) keeps track of these transactions. Rather, the enter system or community shares a permanent, transparent record and cannot be inappropriately changed.
Unlike fiat currencies like the US dollar to the Japanese yen, most cryptocurrencies have a circulation limit. For example, the circulation of Bitcoin is limited to 21 million coins.
Cryptocurrencies are holders of value and vehicles for payment. More companies and financial institutions are accepting cryptocurrencies as a form of payment.
Crypto mining is an essential part of cryptocurrency. Mining creates cryptocurrency coins as well as tracks, validates, and records cryptocurrency transactions.
What is Crypto Mining?
Some people think that crypto mining is just the process of creating new coins. The creation of new coins is only part of crypto mining. It also involves validating cryptocurrency transactions and recording these transactions. Additionally, crypto mining prevents fraudulent charges or transactions from occurring.
There are over 5,000 different cryptocurrencies, and each currency is mined. This process occurs for each currency separately and independently.
All cryptocurrency transactions are recorded. When an individual spends cryptocurrency, a record must be kept. With physical currency, this takes the form of cash exchange hands or a charge being placed on a debit or credit card.
The digital nature of cryptocurrencies creates a unique challenge. Digital platforms can be manipulated, so keeping an accurate record of cryptocurrencies is essential. Fundamentally, crypto mining is the process of keeping a record of transactions on the blockchain to ensure that transactions on that specific cryptocurrency are accurate.
The miners who secure a crypto currency’s blockchain are rewarded with new coins. Therefore, the mining process is crucial for validating transactions and preventing fraud.
In order to prevent illegitimate crypto miners from mining and validating transactions, each cryptocurrency has a proof-of-work (PoW) protocol. In addition to verifying cryptocurrency mining and validating transactions, PoW protocols protect the crypto currency’s network from external attacks.
How does crypto mining work? Proof-of-Work is an essential part of understanding this question. A good way to understand this concept is with an allegory.
Crypto mining is named because of its similarities to the mining of precious metals. When a miner discovers silver or gold, the precious metal is processed and then purchased. Similarly, crypto mining releases new coins into circulation.
“Crypto mining” refers to solving cryptographic equations known as cryptographic hashes. A hash is a digital signature that represents a larger piece of data or block. They are used to validate and secure the exchange of cryptocurrencies on the blockchain.
Hashes are 64-digit hexadecimal numbers. Each block of transactions has a specific number associated with it. The number is always 64 digits, no matter how big the block of data is.
Any change to a transaction or block of data will change the hash. Unique hashes make recorded transactions fraud-proof.
If a hacker attempts to change the information in a data block, all future connected blocks will have different hashes. If the hashes of a block do not match up with the blockchain (public record), it will not be accepted.
For example, if someone had one Bitcoin and attempted to change the blocks to indicate that it was 10 Bitcoin instead of 1, all the subsequent hashes for that block would change. The blockchain would have a record of what the correct hash is. If the hacker tries to send his “10” Bitcoin as payment, the blockchain rejects the transactions because the hash doesn’t match the rest of the blockchain.
A cryptocurrency miner uses their computers to try and identify the hash value of a transaction. The first miner that correctly identifies the hash adds the transaction to the ledger and receives a reward.
Each hash connects to the previous block and transactions that came before it. The connection creates a chain of data known as the blockchain. The blockchain allows users on a cryptocurrency network to identify if a coin is valid or not, preventing fraudulent transactions from occurring.
Methods of Mining Crypto Currencies
To understand how crypto mining works, one must understand the different mining methods.
There are a variety of different methods for mining cryptocurrencies. Each method requires a different procedure and takes a different amount of time.
The most popular form of crypto mining was central processing unit (CPU) mining when cryptocurrencies were first introduced. However, as cryptocurrencies continued to grow and the hashes became more complex, CPU mining became less common.
Today, many crypto miners find CPU mining to be too slow and impractical. Due to the slower speeds and high electrical and cooling costs, it is difficult to turn a profit from CPU mining.
Graphic processing unit (GPU) mining is a more popular form of cryptocurrency mining. This form of mining is more popular and profitable because a single computer can use multiple GPUs.
GPUs process graphics and display them on a monitor for video games. However, they are also used to mine cryptocurrencies. GPU mining is cheaper than CPU mining and requires a motherboard and cooling system.
Another form of cryptocurrency mining is application-specific integrated circuit (ASIC) mining. ASICs mine cryptocurrencies and do not have another purpose (i.e., GPUs). As a result, they are more efficient than CPU and GPU miners and produce more cryptocurrency coins.
However, ASIC mining is expensive, and the circuits can quickly become obsolete.
One of the newest forms of cryptocurrency mining is cloud mining. Cloud miners leverage cloud computing to mine cryptocurrency instead of building a CPU, GPU, or ASIC mining rig. This form of mining is relatively hands-free.
Traditionally, cryptocurrency miners have competed against one another to find the hash codes as fast as possible. A new trend is emerging where miners pool their resources to increase their chances of finding and mining blocks on a specific blockchain.
This type of collective mining is called mining pools. If a mining pool successfully finds and mines a coin, the miners share the reward based on their contribution to the total computational power of the pool.
Many crypto mining applications include a mining pool, but miners can join or create mining pools. You can change mining pools whenever you want.
Is Crypto Mining Worth It?
Now that you have answered the question “How does crypto mining work?” the next question is: “is it profitable?
Before you start mining cryptocurrencies, it is important to evaluate several different factors. Whether CPU, GPU, ASIC, or cloud mining, the most important considerations are the mining rig’s hash rate, power consumption, and maintenance costs.
Crypto mining rigs are expensive. The hardware needed is in short supply. Currently, there is a global CPU and GPU shortage. Additionally, mining rigs consume large amounts of electricity.
For example, on average, it takes 1,544 kilowatt-hours to mine a single Bitcoin.1,544 kilowatt-hours is the equivalent of around 53 days of power for the average US home.
Therefore, cryptocurrency miners must carefully evaluate electricity consumption, electrical costs, and cooling costs.
Additionally, the miner must consider the difficulty of mining. Different cryptocurrencies have different levels of mining difficulty.
The rewards for mining crypto changed based on the coin. For example, if you are mining Bitcoin, when your computer successfully creates the correct hash, the miner gets 6.25 Bitcoin – about $354,000 as of November 22, 2021.
6.25 Bitcoin may seem like a huge reward, but it is important to remember that many miners compete to create a hash correctly. So a miner’s rig might use a lot of electricity but fail to generate the right hash.
Additionally, it is important to consider halving. Over time, the rewards from creating the right hash undergo halving.
For example, the last Bitcoin halving was on May 11, 2020. On that date, the rewards fell from 12.5 Bitcoin per hash to the current 6.25. Bitcoin halving happens once every four years.
Different cryptocurrencies have different halving timelines, so it is important to know the specific currency you are interested in mining. Generally speaking, miners must consider the fact that the reward they will earn will decrease over time.
Before starting to mine cryptocurrency, you need to evaluate these variables to identify profitable operations.
Is Crypto Mining Legal?
Your location and the way you mined the currency determine the answer to these questions. But the answer, in general, is yes.
Various governments around the world view cryptocurrency mining differently. The United States has recently passed legislation regulating cryptocurrencies as property. As a result, the United States taxes cryptocurrencies the same way as real estate. Some countries label cryptocurrency mining profits as taxable, while other countries consider it non-taxable income.
For example, Israel treats crypto mining as a business, and the cryptocurrency rewards are subject to corporate income tax. Meanwhile, Germany considers mining to fulfill a service, so it is not taxed the same way as Israel.
Although there is increasing legislation on mining and the sale of cryptocurrencies, few countries have outlawed or banned mining. China is one of the few exceptions.
How you mine the cryptocurrency also affects its legality. If a crypto-miner uses a GPU rig or similar technology, absent any specific legislation, this is legal. However, if the mining is through malware or similar technology that controls an unaffiliated third party, this is considered cryptojacking and is illegal.
Before starting to mine cryptocurrencies, you must know and understand the letter of the local law. Additionally, the lack of current laws does not guarantee the implementation of future legislation.
How to Start Crypto Mining
If you have evaluated the variables and decided to start cryptocurrency mining, there are some important steps before mining your first coin.
Your first step is buying the appropriate computer hardware. You will have to decide if you want a CPU, GPU, or ASIC rig. Alternatively, you could invest in cloud mining.
Your next step is setting up a cooling system. Mining cryptocurrency generates a lot of heat. If you do not properly cool your mining rig, it could crash and become damaged. The most common form of cooling is fans. However, some more advanced rigs use liquid cooling.
After you have your rig set up, your next step is creating a cryptocurrency wallet. There is a wide range of wallets to choose from. The right wallet may depend on the type of crypto you are mining.
Once your wallet is ready, you will need to download mining software. There is a wide variety of these programs available for different types of cryptocurrencies. After you have selected the right software, you will install it on your mining rig. Be careful; there are many illegitimate types of mining software on the internet.
Once your hardware and software are ready, you can start mining. You can mine on your own or consider joining a mining pool.
Cryptocurrency mining is complex and requires technical skills. It is also an unpredictable market. You must understand the variables before spending your hard-earned money.
Many people are making a great deal of money through crypto mining. With the right information and resources, you can also achieve success.