Cryptocurrency mining in plain English
6 MINUTE READ
The value of cryptocurrencies such as Bitcoin and Ethereum have skyrocketed over the past few months. In January 2017, a single Bitcoin was roughly equivalent to $800. At the time of writing, the value of a Bitcoin now stands at $13,575 – a staggering 1597% increase.
Unsurprisingly, the topic of cryptocurrency mining is now beginning to grab the attention of many in the tech world. Many businesses and investors are considering whether they should make the leap into the mining business.
But others new to the topic are likely wondering – how does cryptocurrency mining actually work?
The way cryptocurrencies work is fairly complex. To help get you up to speed, in this article we’ll aim to cover the fundamentals of cryptocurrencies and cryptocurrency mining in a way that is easy to understand.
Bear in mind that the point here is to give a general understanding, so some of the more complex details have been simplified for the sake of clarity. While this guide specifically references Bitcoin as an example, the same points apply to other cryptocurrencies as well.
What is a cryptocurrency?
A cryptocurrency is a currency which can’t easily be tracked and has no regulating agency such as a bank or government. Users can send and receive payments with complete anonymity.
The lack of a regulating agency means there are practically no fees or charges for using it. This makes cryptocurrency a very attractive prospect for many people. Other more widely-used payment services like PayPal charge hefty fees for sending and receiving money. While the market-leading cryptocurrency is Bitcoin, there are a whole host of others available which operate in a similar way including Litecoin, Ethereum, Ripple, DASH, and many others.
The most noteworthy thing about cryptocurrencies is that no one can control them. With regular currencies, governments and other agencies can step in to slightly alter the value, or regulate production in other ways. This is not the case for Bitcoins as they are based on a mathematical code that doesn’t change. The code itself determines how many Bitcoins are created and how they are distributed.
How do Bitcoins work?
Individuals who want to use Bitcoin first have to set up an online “wallet”. This wallet can be thought of as functioning like a bank account. The wallet stores Bitcoins and each user has a unique “wallet ID” which is similar to an account number. People can send money by requesting a transaction from their own bitcoin wallet, and then entering the ‘wallet ID’ of the recipient.
The transaction sends what is called a ‘block’ which is a essentially a complex math problem. This block is sent through a string of different computers around the world which have Bitcoin software installed on them. The computers then work solve the math problem (the block) as quickly as possible.
These computers are owned by a multitude of different private companies and cryptocurrency enthusiasts rather than one particular bank or organisation. The computers run continuously and are dedicated solely to sending and receiving blocks.
When you send money through a bank, the bank processes the transaction and sends the money to the other person:
Sender> Bank (e.g. HSBC)> Receiver
With Bitcoin the flow of money is the same but rather than a bank, the middle link is a series of random computers which sort through transactions or ‘blocks’ and route the money to the correct person. The computers through which the block passes through are said to be “mining”.
What is Bitcoin mining?
Mining is the term given to computers which run the software enabling them to act as a bank. The computers automatically sort through hundreds of these blocks and send them on the right path. In doing so, the computer ‘mines’ a few bitcoins as part of the process. It’s a tiny fraction of the transaction, sort of like a bank charging you to use them.
The faster the computer that is mining, the more blocks it can solve and therefore the more Bitcoins it earns. Due to the demand for high-performance hardware, setting up a profitable Bitcoin mining operation tends to be quite expensive.
A complete mining kit consists of graphics cards, a processor, power supply, memory, cabling and a fan, and costs between $2,400 and $3,800 on according to Bloomberg. Dedicated Bitcoin mining companies have entire warehouses filled with thousands of these kits running 24/7.
Those who are engaged in mining are essentially offering computing power in return for a reward in Bitcoins. Their computers helps the network of people using Bitcoin, and therefore the system rewards them with a few parts of a Bitcoin.
How is the value of a Bitcoin determined?
The mining process is set up in such a way to ensure the value of existing units does not depreciate. If currencies could be mined without an monitoring system built into the underpinning code it would simply cause inflation, rendering the process unprofitable.
The value of a cryptocurrency, like almost every other product and service, depends on demand and supply. If more people demand a specific cryptocurrency and it is short in supply, its value increases. More units are then mined to meet the demand.
But many cryptocurrencies have restrictions on the total number that can be mined. For instance, the number of Bitcoins that can exist is currently capped at a maximum of 21 million. This limited supply coupled with a significant uptick in demand is responsible for the recent spike in the value of Bitcoin.
The Future of Bitcoin
Writing for Forbes about the future of Bitcoin, Harold Stark suggests that the future looks bright.
“Several colleges have even begun to accept Bitcoin as a means of payment, a move which will clearly help bring this alternative currency to the mainstream. The acceptance of Bitcoin, in general, has already led to a few companies considering genuine investment opportunities in the currency, further fueling its journey to mainstream.
“Will cryptocurrencies be the new norm after 2017? Perhaps it is too soon to tell. But if there is one thing we know for sure, it is that the currency seems to have a wide appeal with a particular section of technologically-savvy individuals, a point that is sure to soon work in its favor,” he said.
However others remain skeptical. Speaking to CNBC, Paul Donovan, global chief economist at UBS, called Bitcoin a ‘speculative bubble’ that could be destructive in the long term if people keep pumping money into the cryptocurrency.
But at the end of the day these are just informed opinions and predictions. It is impossible to tell what the future will hold. However, it will certainly be interesting to watch how the Bitcoin market evolves in 2018.
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