What is cryptocurrency mining and how does it work?

Summary

Cryptocurrency mining verifies blockchain transactions and is the process of creating new units of cryptocurrency.

Miners require substantial computational resources, which also ensures the security of the blockchain network.

What is cryptocurrency mining?

Cryptocurrency mining is based on the proof-of-work(PoW) consensus mechanism, ensuring the security and decentralization of cryptocurrencies like Bitcoin. Mining is the process of validating user transactions and adding them to the public blockchain ledger. Therefore, mining is a key element that allows Bitcoin to operate independently of central authorities.

Mining operations also introduce new coins into the existing circulating supply. However, cryptocurrency mining follows a set of hardcoded rules that govern the mining process and prevent anyone from arbitrarily creating new coins. These rules are embedded in the underlying protocol of the cryptocurrency and enforced by the entire network of thousands of nodes.

To create new units of cryptocurrency, miners use their computational power to solve complex cryptographic puzzles. The first miner to successfully solve the puzzle has the right to add the new transaction block to the blockchain and broadcast it to the network.

How does Ethereum mining work?

Once new blockchain transactions are confirmed, they are sent to a pool called the “mempool.” Miners’ responsibilities are to verify the validity of these pending transactions and assemble them into blocks.

A block can be viewed as a page in the blockchain ledger, recording several transactions and other data. Specifically, mining nodes collect unconfirmed transactions from the mempool and assemble them into a candidate block.

Then, miners attempt to convert this candidate block into a valid, confirmed block. To do this, miners must solve a complex mathematical problem, which requires significant computational resources. However, each time a block is successfully mined, the miner receives a block reward, which includes newly created cryptocurrency and transaction fees. Further details on how mining operates are provided below.

Step 1: Hashing transactions

The first step in block mining is to select pending transactions from the mempool and submit them through a hash function one by one. Each run through the hash function produces a fixed-size output called a “hash value.”

During mining, each transaction’s hash value is composed of a string of numbers and letters used as an identifier. The transaction hash represents all the information contained within that transaction.

In addition to hashing and listing each transaction, miners also add custom transactions to send block rewards to themselves. This transaction is called a “coinbase transaction,” which creates new coins. Usually, this transaction is recorded as the first transaction in the new block, followed by all other pending transactions awaiting validation.

Step 2: Creating a Merkle tree

After hashing each transaction, these hash values are combined into a “Merkle tree” (also known as a “hash tree”). Transaction hashes are paired and then hashed again, generating the Merkle tree.

The new hash outputs are combined into pairs and hashed again, and this process repeats until a single hash is created. The final hash is called the “root hash” (or “Merkle root”), which essentially represents all the hashes used to generate it.

The Merkle tree combines transaction hashes into pairs and hashes them.

Step 3: Finding a valid block header (block hash)

The block header serves as an identifier for each individual block, representing a unique hash value for that block. When creating a new block, miners combine the previous block’s hash with the root hash of the candidate block to generate a new block hash. Miners also need to add a random number called a “nonce.”

Therefore, when validating the candidate block, miners must combine the root hash, the previous block’s hash, and the nonce, then process them through the hash function. This process is repeated to create a valid hash.

Since the root hash and the previous block’s hash cannot be changed, miners must repeatedly modify the nonce until they find a valid hash. The output (block hash) must be less than a target value specified by the protocol to be considered valid. In Bitcoin mining, the block hash must start with multiple zeros, which is known as “mining difficulty.”

Step 4: Publishing the mined block

As we see, miners must repeatedly hash the block header with different nonce values until they find a valid block hash. The miner who finds this hash can then broadcast the block to the network. All other nodes will verify whether the block and its hash are valid. If valid, the new block is added to the blockchain copy.

At this point, the candidate block becomes an confirmed block, and all miners will continue mining the next block. Miners who fail to find a valid hash in time will discard their candidate block and re-enter the competition.

What if two blocks are mined simultaneously?

Sometimes, two miners will publish a valid block at the same time, resulting in two competing blocks in the network. Miners will then start mining the next block based on the first received block, causing the network to temporarily split into two different versions of the blockchain.

The competition between blocks continues until a new block is mined on top of one of the competing blocks. The first to mine the new block is considered the winner. The discarded block is called an “orphan block” or “stale block,” and all miners who chose this block will switch to the chain containing the winning block and continue mining.

What is mining difficulty?

Mining difficulty is periodically adjusted by the protocol to ensure that new blocks are created at a consistent rate, maintaining the planned issuance of new coins. The difficulty adjusts proportionally to the total hash power (hash rate) contributed to the network.

Thus, whenever new miners join the network, competition intensifies, and the hash calculation difficulty increases, preventing the average block time from shortening. Conversely, if most miners leave the network, the difficulty decreases, making it easier to mine new blocks. After difficulty adjustment, the block time remains unaffected by the overall network hash rate, staying constant.

Types of cryptocurrency mining

Cryptocurrency mining methods are diverse. With new hardware and consensus algorithms emerging constantly, equipment and processes are continuously optimized. Miners typically use specialized computing devices to solve complex cryptographic equations. Here are some of the most common mining methods.

Central Processing Unit(CPU) Mining

Central Processing Unit(CPU) mining refers to using a computer’s CPU to perform the hash functions required by the proof-of-work model. In Bitcoin’s early days, mining costs and entry barriers were low, and ordinary CPUs could handle the difficulty, allowing anyone to attempt mining Bitcoin and other cryptocurrencies.

However, as more people started mining Bitcoin, the network’s hash rate increased, making mining less profitable. Additionally, more powerful specialized mining hardware gradually emerged, rendering CPU mining nearly obsolete. Today, all miners use dedicated hardware, and CPU mining is no longer feasible.

Graphics Processing Unit(GPU) Mining

Graphics Processing Units(GPU) are designed for parallel processing of various applications, commonly used in video games or graphics rendering, but also suitable for mining.

Compared to specialized integrated circuits(ASIC) mining hardware, GPUs are relatively inexpensive and more flexible. While users can still mine certain altcoins with GPUs, mining efficiency depends on the difficulty and the algorithm.

ASIC Mining

Application-Specific Integrated Circuit(ASIC) are hardware designed for a single specific purpose. In the cryptocurrency field, they refer to hardware developed specifically for mining. ASIC mining is known for high efficiency but comes at a high cost. ASIC miners use cutting-edge mining technology, with equipment costs far exceeding those of CPUs or GPUs.

Moreover, ASIC technology advances rapidly, making older models unprofitable, requiring miners to upgrade regularly. Even without considering electricity costs, ASIC mining remains one of the most expensive mining methods.

Mining Pools

Since block rewards are awarded to the first successful miner, the probability of finding the correct hash is extremely low. If a miner’s capacity is weak, it’s difficult to find the next block independently. Mining pools solve this problem.

A mining pool is a group of miners who combine their resources (hash power) to increase the chances of earning block rewards. When the pool successfully finds a block, the rewards are shared among miners according to their contribution.

Individual miners participating in pools benefit from hardware and electricity cost advantages, but if pools dominate the network, there are concerns about potential 51% attacks.

What is Bitcoin mining and how does it work?

Bitcoin is the most popular and well-developed example of mineable cryptocurrency, based on a proof-of-work consensus algorithm.

Proof-of-work is a blockchain consensus mechanism first created by Satoshi Nakamoto and introduced in the Bitcoin white paper in 2018. In short, proof-of-work determines how the blockchain network reaches consensus among all distributed participants without third-party intermediaries. This mechanism requires significant computational power to prevent malicious behavior.

As we see, in proof-of-work networks, transactions are validated by miners. They compete to solve complex cryptographic puzzles using specialized mining hardware. The first miner to find a valid solution can broadcast the transaction block to the blockchain and earn a block reward.

Different blockchains have varying amounts of cryptocurrency awarded as block rewards. For example, as of March 2023, miners on the Bitcoin blockchain earn a block reward of 6.25 bitcoins. According to Bitcoin’s halving mechanism, the number of bitcoins awarded per block halves every 210,000 blocks (roughly every four years).

Will cryptocurrency mining still be profitable in 2026?

Cryptocurrency mining can still be profitable, but it requires careful planning, risk management, and thorough research. Mining involves investments and risks, such as hardware costs, cryptocurrency price volatility, and protocol changes. To mitigate these risks, miners often implement risk management strategies and evaluate potential costs and rewards before starting.

The profitability of mining depends on multiple factors, including the price movement of cryptocurrencies. When cryptocurrency prices rise, the fiat value of mining rewards increases. Conversely, falling prices reduce profitability.

Mining hardware efficiency is also a key factor in profitability. Mining hardware can be expensive, so miners must balance hardware costs against expected rewards. Another critical factor is electricity costs; if electricity prices are too high, exceeding the rewards, mining becomes unprofitable.

Additionally, mining hardware can become obsolete quickly, requiring frequent upgrades. Newer models outperform older ones, and if miners cannot afford to upgrade, maintaining competitiveness becomes difficult.

Finally, protocol changes can impact profitability. For example, Bitcoin’s halving reduces block rewards by half, affecting mining income. Also, Ethereum transitioned from proof-of-work to proof-of-stake(PoS) consensus mechanism in September 2022, making mining obsolete.

Conclusion

Cryptocurrency mining is a vital component of Bitcoin and other proof-of-work blockchains, helping to maintain network security and ensure the stable issuance of new coins. Additionally, mining can generate passive income for miners. For detailed step-by-step explanations of the above topics, please read our article “Cryptocurrency Mining Guide.”

Mining has both pros and cons. The most significant benefit is the potential profit from block rewards. However, this depends on factors like electricity costs and market prices. Before engaging in cryptocurrency mining, be sure to conduct thorough research(DYOR) and carefully assess potential risks. $ICP $CPOOL