Ever wondered how bitcoins are actually made?
Over the past several years, cryptocurrencies like Bitcoin have been quietly growing in popularity, with an ever-larger number of people buying and selling them. Now that Bitcoin has hit the mainstream and become a worldwide phenomenon, more people than ever are looking to get into the cryptocurrency game.
However, the production of cryptocurrencies isn't anything like that of regular money. There's no central authority that issues new notes; instead, bitcoins (or litecoins, or any of the other so-called 'alt-coins') are generated through a process known as 'mining'. So what is cryptocurrency mining, and how does it work?
Cryptocurrency mining and the blockchain
To understand how cryptocurrency mining works, you have to first understand the concept of the blockchain. The blockchain is the technology that underpins virtually every cryptocurrency, and it basically operates as a decentralised record - or public ledger - of all the transactions that have been conducted with a given cryptocurrency.
Mining new blocks
Without a central authority, someone needs to collect all the transactions conducted with a cryptocurrency in order to form a new block. The network nodes that do this are referred to as 'miners'. Each time a bundle of transactions are collected into a block, it is added to the blockchain, and whoever assembled the block is rewarded with units of the currency.
However, in order to prevent the currency being devalued by miners creating large volumes of new blocks, the task of creating a block is made artificially harder. This is done by requiring miners to solve a complex mathematical problem called a 'proof of work'.
In order to successfully create a block, it must be accompanied by a cryptographic hash that fulfills certain requirements. The only feasible way to arrive at a hash matching the correct criteria is to simply calculate as many as possible and wait until you get a matching hash. When the right hash is found, a new block is formed and the miner that found it is awarded with units of cryptocurrency.
Think of it like one of those competitions where you have to guess the weight of the cake - only you get unlimited guesses, and the first one to submit a correct answer wins. Whoever can make guesses at the fastest rate has a higher chance of winning.
Cryptocurrency mining limits
In practice, this means that miners are competing against each other to calculate as many hashes as possible, in the hopes of getting to be the first one to hit the correct one, form a block and get their cryptocurrency payout.
However, the difficulty of calculating the hashes also scales - every new block of bitcoins becomes harder to mine. In theory, this ensures that the rate at which new blocks are created remains steady. Many cryptocurrencies also have a finite limit on the amount of units that can ever be generated. For example, there will only ever be 21 million Bitcoins in the world. After that, mining a new block will not generate any bitcoins at all.
Cryptocurrency mining requirements
While it used to be possible to mine your own cryptocurrencies using a regular PC, for the most part that is no longer the case. As more people start mining, the hardware necessary to mine effectively increases; from a moderately-powerful processor, to a high-end GPU, to several GPUs working together, to specialised chips designed specifically for mining.
In order to successfully mine most modern cryptocurrencies, you'll need to spend well over a grand on hardware, as well as footing the substantial electricity bill that having it running 24/7 will generate. In fact, most miners spend the vast majority of their mining income on covering the costs of running their equipment.
Now that the Bitcoin boom is thoroughly underway, certain companies and groups have started putting serious money behind it, with large warehouses full of floor-to-ceiling racks of expensive graphics cards, doing nothing but trying to mine new units of Bitcoin, Litecoin, Ether and the like.
For context, the Bitcoin network processes 5.5 quintillion hashes per second. Unless you have equipment that can process a vast number of calculations in a very short space of time, your odds of competing with large mining operations are infinitesimally small. This is why many miners join forces, banding together to create 'mining pools', sharing their compute power and any returns generated from their efforts.