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Bitcoin Mining Explained

  • Bitcoin mining is the process of creating new Bitcoins while verifying and securing existing Bitcoin transactions
  • Bitcoin mining works by using high-powered computers to “guess” a 64-digit hexadecimal number, known as a “hash,” that’s less than or equal to the network’s proposed target hash
  • Bitcoin and Ethereum mining are most profitable using mining rigs, or high-powered computers specifically designed to mine coins; however, some coins can be mined at home relatively cheaply
  • If you don’t want to put in the time and effort to design a mining rig, you can also make money with Bitcoin by buying cryptocurrency, working for companies that pay in cryptocurrency, or investing in Bitcoin mining stocks

Bitcoin is all the rage these days – and it’s no wonder, with a chart that looks like this:

But if you’re like most of us, you may not know much about bitcoin mining beyond how to make money with Bitcoin in the cryptocurrency market. (And if you know that much, we’re pretty impressed already!)

Cryptocurrency Refresher: What is Bitcoin?

Bitcoin is a cryptocurrency – literally, an encrypted currency – that uses a blockchain network to create new coins and confirm Bitcoin transactions. Because the responsibility of monitoring and legitimizing transactions is not in the hands of one person or government, Bitcoin is considered “decentralized” money that does not rely on a central authority for regulation.

What is Bitcoin Mining?

Bitcoin mining is the process of creating new bitcoins for circulation by using sophisticated computers to solve complex math problems, or cryptographic equations. In addition to “minting” Bitcoins, mining helps maintain, develop, and secure the ongoing blockchain ledger (transaction history), thereby serving as a crucial component of this cryptocurrency’s continuity and legitimacy.

Another purpose of Bitcoin mining is to ensure that transactions are accurate and do not duplicate coins. This unique quirk of digital currencies, known as “double-spending,” occurs when spenders make a copy of their Bitcoin and to complete a transaction while keeping the original – in other words, the digital version of counterfeiting.

Another way to look at Bitcoin miners is that they’re unofficial auditors of Bitcoin transactions. They do the work of verifying the legitimacy of Bitcoin as it circulates through users’ wallets. Once they’ve validated one block of Bitcoin transactions and added it to the chain, they’re eligible to receive Bitcoins in return. (One block is equal to 1 megabyte of information.)

However, eligibility is not a guarantee. To earn your Bitcoins, you need to meet two conditions of the blockchain:

  • You have to verify one megabyte worth of Bitcoin transactions
  • You have to be the first miner to solve a numeric puzzle, known as “proof of work”

Bitcoin and “Proof of Work” Computations

When we talk about mining Bitcoin, the most common way to explain it is “solving complex math problems,” just as we did above. But that’s not entirely accurate.

What Bitcoin miners actually do is guessing a 64-digit hexadecimal number, known as a hash, that is less than or equal to a specified target hash. In other words, your computer is guessing for the right answer. The first miner to reach the answer “wins.”

This seems simple enough – computers are designed to solve problems, right?

But that’s not the whole story, either. Each problem your computer solves has trillions of answers, which means that your computer needs a lot of processing power (or a lot of time) to reach the right answer. And with thousands of other computers online searching for the same answer, you’re not only guessing blindly, but you’re racing against the clock.

Thus, to mine successfully, you need to have a high “hash rate,” which is the number of hashes your computer can complete in a specified amount of time. The higher your hash rate, the more likely you are to correctly reach the target hash before other miners – and score your Bitcoin reward.

Why Do Bitcoin Mining?

Many miners mine Bitcoin for the sheer thrill that comes with designing their own mining rigs or being part of “the future of money.” Some mine coins to earn “voting” power when changes to the Bitcoin network protocol are proposed, such as when it comes time to fork in a new coin.

And still others, particularly mining operations, mine Bitcoin to turn a profit and ensure that more Bitcoins enter circulation.

But the future of Bitcoin is limited – or at least, the number of Bitcoins is. By design, the Bitcoin Protocol, as it’s known, will limit the number of mined Bitcoins to 21 million. After that point, miners will be paid a small fee to verify transactions and maintain the network’s integrity without the thrill of minting their own currency.

But if you’re worried about jumping in too late, never fear! Because the rate of mined Bitcoin is reduced over time, the final Bitcoin won’t be minted until around the year 2140.

Bitcoin Mining 101: How to Mine Bitcoins

Cryptocurrency mining is one way to make money with Bitcoin…sort of. While it’s been oft-touted as a way to generate passive income, it’s painstaking, energy-expensive, and only occasionally rewarding if you go it alone.

But that hasn’t stopped hundreds of Bitcoin miners from seeking out their capital-B Bitcoin reward for mining Bitcoin (or Ethereum if they mine Ethereum, or Dogecoin if they mine Dogecoin…you get the idea).

Unfortunately, gone are the days of profitably mining Bitcoin on your personal laptop. One of the main reasons for this is the increasing difficulty of Bitcoin problems – an intentional quirk in the network’s algorithm.

Essentially, in order to ensure that the blockchain functions smoothly and accurately, the Bitcoin algorithm evaluates and adjusts the difficulty of mining every 2,016 blocks – roughly every two weeks – to maintain a rate of one block produced every 10 minutes. The more mining rigs that come online, the more difficult the mining process becomes.

This means that, no matter the number of mining rigs competing to solve the hash problem, you won’t be able to outpace the rest of the network (and thus cheat the system) for very long.

That leads to the second reason for Bitcoin mining’s increasingly expensive overhead: the advent of the Application Specific Integrated Circuit, or ASIC, hardware designed specifically to mine Bitcoin. These mining rigs, as they’re known, are designed to reach Bitcoin’s target hash as quickly as possible, all the while verifying transactions in the background. But the speed of ASICs comes at a hefty price, sometimes to the tune of thousands of dollars per rig.

For that reason, many Bitcoin miners often turn to mining pools. These groups are comprised of individual miners who put their computational heads together to increase their success. While this vastly improves your chances of guessing the right hash, you’ll have to split any proceeds among other members of the group.

But the longer you mine Bitcoin, the less money you stand to make (assuming a constant USD-to-Bitcoin price). Another quirk of the Bitcoin algorithm is that the rewards for mining Bitcoin are halved every four years. When Bitcoin was introduced in 2009, miners could earn 50 BTC per block added to the chain. As of May 11, 2020, one block only nets you 6.25 BTC.

Mining Other Cryptocurrencies at Home

That said, some cryptocurrencies can still be mined at home with comparative ease. But the mining process tends to vary from coin to coin, based on the network design.

For instance, all you’ll need to mine Ethereum is a handful of GPUs, or graphics processing units, with sufficiently powerful graphics cards. You’ll also need a computer capable of downloading the blockchain from the cryptocurrency’s official website.

Once you have your hardware set up, you’ll need to install the proper mining software. Some software, such as MultiMiner, work for a range of mining algorithms to let you produce several cryptocurrencies, such as Bitcoin, Ethereum, Monero, and Zcash. Others are more suited to a particular coin.

Alternatively, you can opt to buy or build an Ethereum mining rig, which is a powerful (and expensive) system designed to mine Ethereum with greater efficiency.

Dogecoin is another home-mineable coin with a substantial user base. To mine DOGE, you’ll first need a wallet to store your coin. Then, you’ll need a mining software such as CPU miner, as well as a handful of graphics cards to speed up the process. Note that if you decide to mine with GPUs, you’ll need to switch your mining software.

In other words, if you want to mine cryptocurrency, you’ll need to read up on each one’s particularities. You can usually find coin-specific mining instruction on the crypto’s website.

Keep in mind, however, that cryptocurrency mining is an energy- and heat-intensive process. As such, you should expect your energy bill to go up (and you should invest in a fan or three to keep your devices cool).

How to Make Money with Bitcoin

But you have other options to make money with Bitcoin and other cryptocurrencies if turning a profit is your primary desire.

For instance, you can buy cryptocurrencies using “real,” or fiat, currencies on a cryptocurrency exchange such as Coinbase. Once you have your cryptos in hand, you wait until the price rises and then sell your coins, just like you would stock shares on a roll.

Of course, that’s assuming that the price of your selected crypto will go up, of which there’s no guarantee. And because over 7,000 cryptocurrencies populate the market currently, knowing which ones to buy and which to avoid can be tricky.

You can also buy into Bitcoin – or many other cryptos – by exchanging one for another. For instance, if you want to invest in Bitcoin, but all you have is Ethereum, dozens of exchanges will facilitate your cryptocurrency trades. (Potentially at a price.)

If you don’t want to exchange your cryptos, but you’re not certain of their future either, you can park your cryptos in an interest-bearing crypto account using a crypto exchange. These work just like a typical interest-bearing savings account, with the notable exception that they usually bear interest in the form of more cryptocurrency.

You can also complete tasks or work in exchange for cryptocurrencies, thereby making money with bitcoin the old-fashioned way. For example, some websites pay their blog writers in cryptocurrency as opposed to traditional currency.

Bitcoin Mining Stocks

Another way to make money with Bitcoin is by investing in various Bitcoin mining stocks.

Some of these stocks, such as Hive Blockchain Technologies, Riot Blockchain, and Marathon Patent Group, are directly involved in the Bitcoin mining business. These companies purchase equipment, set up software, and mine cryptocurrencies day and night to secure the blockchain and generate coins.

A number of other companies have their hands in the technical portion of the pie instead – specifically, manufacturing equipment that facilitates Bitcoin mining. One such company is Canaan, a China-based ASIC maker that sells equipment to mining firms.

You can also look into investing in semiconductor companies that make the GPUs underlying many individual miners’ success. Nvidia in particular designed a GPU just for cryptocurrency miners known as the CMP HX (while at the same time reducing the hash rate of newer cards to ensure they’re less desirable for miners and more desirable for their intended audience: gamers).

But what if you want to profit off of Bitcoin mining without investing in Bitcoin mining stocks? You might be interested in energy stocks that provide the crucial backbone for cryptocurrency to function: electricity. Without electricity, there is no way to mine Bitcoin, transact on a traditional cryptocurrency exchange, or brag about your good fortune on your favorite social media.


Disclosures

Q.ai offers advisory services through Quantalytics Investment Advisors, LLC ("QIA"), a Registered Investment Adviser. This is solely for informational purposes. Advisory services are only offered to clients or prospective clients of QIA . Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. Comments by viewers or third-party rankings and recognitions are no guarantee of future investment outcomes and do not ensure that a client or prospective client will experience a higher level of performance or results. Adviser has reasonable belief that the content posted by a Third Party does not contain untrue statements of material fact or misleading information regarding its advisory services.

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