What Is Crypto Mining?

Crypto mining is a critical aspect of cryptocurrency operations as it generates new coins, verifies transactions, and adds new blocks to the blockchain ledger through a network of decentralized nodes or validators using a consensus algorithm. These networks of nodes confirm and record transactions waiting to be included in the blockchain database.

Due to the increasing difficulty in mining blocks (that’s for Proof of Work, PoW) and the huge demand for computing power beyond the capability of the individual; companies and groups are pulling resources together creating “mining pools” to squarely tackle the ever-growing sophistication of crypto mining. Though, this is not the case with Proof of Work, (PoS) which requires coin owners to stake their coins to become validators. However, crypto mining essentially has two functions; generating new coins and validating/adding new blocks of transaction in the blockchain.

To a large extent, the security of a blockchain depends on mining activities. So, miners in PoW deploy highly specialized computers with a steady supply of electricity, and validators in PoS stake a certain amount of cryptocurrency to confirm transactions and maintain the security of the blockchain and its decentralized nature.

In this article, the concept of crypto mining will be discussed with a special focus on the two most popular consensus algorithms — Proof of Work (PoW) and Proof of Stake (PoS).

A Study of Crypto Mining: Special Focus on Bitcoin Mining

In the early stages, Bitcoin mining was done by individuals using personal computers to process and validate transactions on the blockchain but over the years the cost and sophistication of the entire exercise grew, thus, requiring companies and mining pools to carry on with the operation.

These specialized companies or pools try to solve the complex mathematical calculations required to validate crypto transactions and add blocks to the blockchain database. And as a reward for the work done, these computers receive a predetermined amount of the newly minted coin. This reward has been programmed to halve once every four years of the life cycle of proof of work (PoW) blockchain, such as Bitcoin and Litecoin. Let’s briefly talk about block rewards halving, using Bitcoin as an example.

Bitcoin Halving

Bitcoin halving is a systematic reduction in the total cost of mining one Bitcoin block once every four years of the life cycle of the blockchain. In other words, it is half the reward miners receive for verifying transactions and for generating a Bitcoin block.

For example, Bitcoin (BTC) and Litecoin (LTC) undergo blockchain halving once every four years. Bitcoin witnessed its first halving event on November 28, 2012, at a block height of 210,000, with miners’ rewards dropping to 25 BTC from 50 BTC. After the second halving event, on July 9, 2016, at a block height of 420,000, the block reward fell to 12.5 BTC from 25 BTC as mining difficulty increased, as well as an increase in the number of miners.

The third and most recent Bitcoin halving was on May 11, 2020, at a block height of 630,000 which results in a drop in block reward at 6.25 BTC. The next expected Bitcoin halving is in 2024 and the countdown has already begun.

The primary reason for Bitcoin’s halving is to increase its stability in the market, fight inflation and strengthen its market value as a deflationary currency. Inflation has always been a huge problem when it comes to the financial industry and Bitcoin’s goal is to squarely address the negative events of 2008 (that’s the global recession). Most proofs of work (PoW) consensus mechanisms carry out block reward halving, just like Bitcoin. Let’s quickly look at Litecoin Halving.

Litecoin Halving

Litecoin is among the leading cryptocurrency in the industry and it was launched in 2011 to provide a suitable alternative to Bitcoin. Litecoin has experienced two-block reward halving. The first was on August 25, 2015, at a block height of 840,000, with the block reward dropping to 25 LTC from 50 LTC. The second occurred on August 5, 2019, at a block height of 1,680,000, with a current block reward at 12.5 LTC which will decrease to 6.25 LTC by the next Litecoin halving, scheduled for August 3, 2023. This halving event has on two occasions reduced the total miners’ rewards.

Litecoin halving reduces inflation by half the initial rate, thus, increasing the value and purchasing power of the coin. The Litecoin inflation rate per annum is at 3.72% after the 2019 halving event. It is expected to drop to 1.80% per annum at the next block halving event. The price of the coin is expected to rise at the next halving if demand for the coin increases.

Consensus Algorithms: Proof of Work (PoW) and Proof of Stake (PoS)

Blockchain technology is a decentralized system and uses consensus algorithms to generate coins, validate transactions and enable the addition of blocks of transactions to the blockchain.

The consensus algorithm is very important to the maintenance and security of the blockchain as it prevents incidences of double spending and validating illegal transactions. Each verified block of transactions is time-stamped with a cryptographic hash upon addition to the blockchain.

Thus, in simple terms, a consensus algorithm is a process in which a decentralized network of computers or nodes reaches an agreement on a data value or network state. Usually, they require at least 51% of nodes to accept a data value. Hence, it enables the agreement between decentralized computers on a distributed peer-to-peer network, ensuring the maintenance and security of the system as well as data records. Basically, consensus algorithms replace the need for a centralized entity or third party.

Further, consensus algorithms are widely used in blockchain technology and also across several sectors such as supply chain management, smart power grids, control of unmanned aerial vehicles like drones, etc. In this section, we will be looking at the leading consensus mechanism in blockchain technology, that’s Proof of Work (PoW), and Proof of Stake (PoS) algorithms.

Proof of Work (PoW)

The Proof of Work consensus algorithm is the first system of agreement between nodes used in the blockchain, and it is synonymous with the Bitcoin blockchain — though other blockchains use PoW, such as Litecoin.

The PoW consensus algorithm involves a decentralized network of computers and nodes that compete to solve a puzzle or a complex mathematical equation by finding a cryptographic hash of a particular block. The participating node tries to solve the puzzle by randomly guessing different nonce values that match the difficulty. The node that successfully solves the puzzle is rewarded, usually in cryptocurrency.

Further, the transaction data and the nonce value are input for a hash function while the corresponding solution or hash output (cryptographic hash) needs to match the difficulty. So, the network of nodes utilizes very high computational power to solve the problem, thereby producing a cryptographic hash that matches the difficulty, hence the reason for the term “work”.

Bitcoin uses the hash function SHA - 256 to solve cryptographic puzzles.

The PoW algorithm is considered “inefficient” and very expensive to operate because it consumes a large amount of electricity in computational power and takes a lot of time (10 minutes) to successfully mine one Bitcoin or add a transaction block to the blockchain. This is seen by many as a great setback and environmentalists have frequently criticized Bitcoin mining over the adverse environmental impact and the global climate. This has led to an outright ban on Bitcoin mining in some countries, such as China, Bolivia, Bangladesh, Qatar, and Morocco.

However, recent technological innovation — and in following the first law of thermodynamics, that energy can neither be created nor destroyed but can be converted from one form to another — sees a growing number of companies producing devices that can convert the huge mining energy to heat our homes and buildings during winter.

Proof of Stake (PoS)

The high computational power of PoW needed to solve complex mathematical puzzles, and the length of time spent to discover the cryptographic hash gave rise to a close alternative Proof of Stake (PoS). The PoS consensus algorithm doesn’t require computational resources (specialized equipment and electricity) to mine blocks. Rather, owners of the cryptocurrency can stake their coin to participate in synchronizing data, validating transactions, and adding blocks to the blockchain. Also, staking pools enable small coin holders to stake/lock their coins in a pool for an opportunity to earn from the transaction fee.

Basically, coin owners lock up a percentage of their crypto in a wallet and then set up a unique validator node. The cryptocurrency protocol will randomly select a validator to confirm transactions and validate blocks. Choosing a validator node depends on the number of coins staked and the duration of the staked coin. Blocks are validated by more than one validator and are rewarded with a transaction fee. The validators must confirm and add accurate blocks to the blockchain to avoid losing a portion of their stake or even the entire stake.

The PoS consumes less amount of electricity (energy), thus, it’s environmentally friendly and cheaper to operate, compared to PoW. The major drawback is it is believed that PoS offer less security than PoW as the validator with the highest coins staked invariably controls which transaction is approved and added to the blockchain. This negates the blockchain’s feature of decentralization.

Ethereum initially used the PoW algorithm to validate transactions but recently moved to PoS in a view to cut down on too much electricity consumption and time required to mine a block. Thus, under the PoS algorithm, Ethereum 2.0 requires coin owners to stake 32 ETH to be selected as a validator.

How Does Mining Work: A Special Focus on the Bitcoin Proof of Work Algorithm

During Bitcoin mining, miners validate transactions by solving or hashing a set of mathematical equations or transaction-related algorithms by using complex computers and large amounts of electricity. These transactions are recorded in a block, with each block having a unique hash linked to the next block via a cryptographic technique. Alteration of the hash of a particular block inadvertently alters the hash of subsequent blocks thus, rendering the entire blockchain network void.

NB: Block Hash is an alphanumeric string of alphabets and numbers that conceals transaction data and user identity, generated using a hash function — Bitcoin uses SHA - 256.

The growing difficulty in mining crypto is a result of the challenging process of hashing a block which means a large amount of computing resources is required to solve these mathematical cryptography calculations and to discover a transaction or block hash.

Equipment needed to mine Bitcoin includes:

• Specialized Hardware Device: These are devices specifically built for mining cryptocurrencies, such as Graphics Processing Unit (GPU), SSD for crypto mining, Application-Specific Integrated Circuits, (ASICs), and the recently launched Field Programmable Gate Array (FPGA) chips.

  These equipment perform specific types of computational operations required for mining. This is a departure from the use of ordinary home computers and consumer-grade graphics processing cards.

It is pertinent to note, that these hardware are not suitable for the domestic environment because they consume a large amount of electricity. They are very noisy and release a huge volume of energy into the environment.

• Software Applications: These are specialized software apps that run on computers and are fast in carrying out mining activities. They verify and record transactions in a block which are sent to the network of nodes/miners for confirmation before being added to the blockchain. The software needed to be used is ECOS, BeMine, Kryptex Miner Awesome Miner, Easy Miner, and Pionex. Also, this software calculates the mining reward and transfers the same to your wallet address.
• Supply of Electricity: Crypto mining requires a steady supply of electricity to power the computers involved. Thus, to beat energy costs, miners usually site mining farms close to power plants, etc.

Nevertheless, technical knowledge is very important to install various equipment and check their optimal performance.

Factors Affecting Crypto Mining

• Cost of Electricity: This is a major problem in crypto mining. The high cost of electricity needed to power hardware mostly drives down miners’ profits. Mining cryptocurrency requires huge amounts of electricity.
• High cost of Hardware: Most mining devices, such as ASICs, are very expensive, discouraging retail miners from taking up crypto mining.
• Increasing difficulty in mining: As blockchain technology witnesses greater abduction, so too does the demand for cryptocurrency and other digital assets. At the moment, cryptocurrency is gaining widespread popularity, with an increase in demand for digital currency. With this surge, miners compete to mine more cryptocurrency, hence an increased mining difficulty.
• Decrease in miners’ rewards: With increased mining competition and block difficulty comes to a systematic reduction in miners’ rewards.

Risks associated With Crypto Mining

A common challenge most face is an operational expenditure, particularly the cost of providing steady electricity. This alone has greatly discouraged retail miners. The cost in some countries are very expensive, thus, Crypto miners are at risk of not making profits as their operational cost is far above the returns on investment.

A possible way out is to cite mining farms close to power plants or within an industrial settlement, and tap into their huge power source.

Also, the cost of acquiring modern equipment (ASICs) is huge and further limits the class of people going into Bitcoin mining. This doesn’t mean you can’t mine Bitcoin with your PC, but to have a competitive advantage of earning a block reward you need to have an ASIC, a device specifically made for crypto mining.

With the creation of mining pools and mining farms, retail miners can provide a percentage of their computing power or mining equipment and earn a proportion from the mining pool’s block reward.

Also, most of these mining devices cause serious environmental pollution such as noise and emit large amounts of heat into the environment leading to global warming. A way out is to channel this useful heat energy into heating homes, offices, and buildings during winter.

Conclusion

Crypto mining is a worthwhile venture as it greatly contributes to the maintenance and security of the blockchain, and also verifies and records transactions in the blockchain ledger. Miners earn block rewards in PoW while validators charge transaction fees in PoS.

It is expedient to understand the pros and cons of the operation of crypto mining and the return on investment. To maximize profits in PoW, miners need superior equipment, a cheap electricity supply, and technical knowledge while in PoS, validators need to stake huge sums of coins to have a competitive advantage of becoming a validator.