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What Is Bitcoin Mining and How Does It Work?

May 10, 2022
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Bitcoin mining is the process of using computer power to mint unique digital tokens that can be transmitted across the internet and used as currency to buy goods.

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When governments mint money, they do so under highly controlled conditions. The U.S. Mint, for instance, is the sole entity authorized to print dollars, and anyone who tries to do it on their own will face lengthy prison terms for counterfeiting. At the same time, the U.S. Federal Reserve is the only institution permitted to distribute fresh cash to the banking system. That’s one of the reasons the Fed exerts such a powerful influence on the economy.

The cryptocurrency Bitcoin is the opposite. Because of its open source software programming, anyone with a computer, special microchips, and an internet connection can try to create the digital tokens. There’s no authorization needed. Moreover, those who do introduce new Bitcoin can record their handiwork on a publically available ledger called the blockchain. The upshot: Bitcoin creators have raked in billions of dollars in profits.

What is Bitcoin mining?

Bitcoin mining is the process of using computer power to mint unique digital tokens that can be transmitted across the internet and used as currency to buy goods and services. Bitcoin mining also adds to—and manages—the digital ledger, or blockchain, which records all Bitcoin transactions.

Mining takes a lot of labor, albeit mostly done by computers. Reflecting this idea, the mechanics of producing Bitcoin and similar cryptocurrencies are called proof of work. Mining Bitcoin is an essential part of the cryptocurrency’s operation, and has been mimicked by thousands of other digital asset networks.

Bitcoin mining is predicated on the concept of decentralization. By joining the minting and recording processes into one function, mining takes place on autopilot. In other words, Bitcoin doesn’t need a central authority directing how new money must be made, how much should be made, or how it should be distributed. That’s very different from money that’s created and circulated by fiat or government decree.

Bitcoin is controlled by the original software program written by the pseudonymous person or group Satoshi Nakamoto. The program sets up a regimen that establishes what miners must do to mint Bitcoin.

How does Bitcoin mining work?

Nakamoto designed the minting of digital tokens to be a contest, or more precisely, a mathematics contest. Anyone can play, if you have the right equipment. But speed is of the essence.

The Bitcoin program requires would-be miners to be the first to solve super-complex mathematical problems. There was a time when miners with home personal computers could take a crack at winning the race.

Nowadays, these problems can only be solved by deploying networks of advanced computers. Miners backed by tens of millions of dollars in investment have constructed vast server farms near power sources like dams to compete in the Bitcoin race. It’s an industry.

The key to mining Bitcoin is a programming function called a hash rate. These features convert mathematical values in coding. Miners on the Bitcoin network receive hashes in their raw form and race to produce a “target hash” that is less than—or equal to—the original ones.

Those miners that solve the problems first earn the right to add a “block” of data to the “chain” of transactions in the Bitcoin network. In return, they are rewarded with newly minted Bitcoin.

How much do miners get paid?

Miners get paid 6.25 Bitcoin per mined block. With Bitcoin hovering at about $40,000 per token as of late April 2022, that amounts to a payday of around $244,000. Yet, that rate won’t last.

Every time 210,000 blocks are added to the blockchain, Bitcoin’s programming automatically halves the rate of new tokens awarded to miners. The number of Bitcoins is capped at 21 million tokens, the program is designed to slow the minting process.

The next Bitcoin halving cuts the rate to 3.125 new Bitcoin. Halving the supply of new Bitcoin does tend to raise its value, so even though the number of newly minted Bitcoin is fewer, their value may be considerably higher. Bitcoin, after all, was worth only $9,000 in June 2020.

Miners also must cover the expenses associated with this activity. Miners must shell out capital for computers, a facility to house them, maintenance, and the electricity to keep them going.

What kind of hardware and software do Bitcoin miners use?

Most Bitcoin miners utilize computers equipped with special microprocessors called application-specific integrated circuits, or ASICs. Designed to handle complex computations at high speeds, they are targeted specifically for cryptocurrency miners.

Some miners opt for subscribing to cloud computing providers to handle the processing chores for them. Still others join forces with like-minded miners and form pools that harness computing power across a network in a bid to outpace competitors in the race to hash new blocks.

By using Bitcoin mining pools, miners can expand or contract their number to maximize the economics of their operations in different market conditions: When Bitcoin is soaring, the pool may increase the number of ASIC-powered computers to gain an advantage, and when the market is down, it can shrink its footprint to be more efficient.

Is Bitcoin mining legal?

Bitcoin mining is legal in most nations. The U.S., the U.K., the European Union, and most countries in Asia, Africa, and Latin America have not outlawed the industry.

However, there have been crackdowns. In June 2021, China banned cryptocurrency mining largely to curtail the vast amounts of electricity outfits were consuming as they processed Bitcoin and other cryptocurrencies. Beijing prohibited all cryptocurrency activities in September 2021. Some other nations followed suit including Egypt, Algeria, and Qatar.

Russia has also threatened to clamp down on crypto, and it is unlawful to use digital assets to pay for goods and services there. Many crypto experts expect Moscow to impose a more comprehensive ban in the future.

What are the risks and disadvantages of Bitcoin mining?

Minting new tokens and tending the blockchain has been profitable for many but the rewards are getting harder to earn. Some of the potential drawbacks to Bitcoin mining include:

  • Climate change. Bitcoin mining has driven a surge in the consumption of electricity, which is often produced by burning fossil fuels. Bitcoin mining uses almost as much energy annually as Poland, according to the University of Cambridge. As a result, environmental authorities and advocates say Bitcoin mining is worsening global warming. 
  • Volatile economics. It isn’t easy to make money in any industry subject to rapid price changes when you need expensive fixed assets like computers, large plants, and loads of power. If a miner makes major capital expenditures and Bitcoin loses 40% of its value—as it did between November 2021 and April 2022—an operation could plunge into the red.
  • Arms race syndrome. In an industry awash in capital and ambitious entrepreneurs, new mining outfits with more firepower may come online and force smaller miners to ramp up if they want to keep pace.
  • Proof of stake. This new form of processing transactions and minting tokens doesn’t have the same power consumption problem as proof of work. Proof of stake has been embraced by Ethereum, the second most valuable cryptocurrency network, and this could challenge the long-term value of Bitcoin and Bitcoin mining. 

The bottom line

Bitcoin mining was the breakthrough that spawned the cryptocurrency revolution. By fusing the minting of unique digital tokens with a transparent digital ledger, the Bitcoin system showed that an automated and decentralized form of money was possible, and durable. As a result, Bitcoin mining has become an industry with $15 billion in revenue in 2021, according to The Block Research.

Yet, mounting concerns about Bitcoin mining’s carbon emissions could drive cryptocurrency investors to favor alternatives such as Ethereum, which is poised to shift to the much greener proof-of-take processing approach. Bitcoin mining’s pollution could also prompt regulators to crack down on the industry, further eroding its fortunes. Ultimately, Bitcoin mining will depend on a key ratio: whether the value of Bitcoin justifies all the capital investments in computers and microchips and power.

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