What is Cryptocurrency Mining and How Does it Work?

What is Cryptocurrency Mining and How Does it Work?

9 minutes to read | 04.02.2022
TL;DR Cryptocurrency mining is one of the steps in the blockchain process. Every blockchain needs to securely come to a consensus (an agreement that the transactions on the blockchain are valid). Cryptocurrency mining makes sure this happens. Miners validate the blockchain's transactions and are incentivized to do so by being rewarded with the blockchains's cryptocurrency for successfully mining a block. People want to mine cryptocurrency in order to receive rewards, introduce coins to increase the circulating supply, and very importantly, safely keep the blockchain's network running. There are a few different methods of consensus like proof of work, where miners compete to solve a complex math problem in order to prove they used energy to mine a block. Then there is proof of stake, where validators (miners) lock up crypto as a "stake" in the network. Then validators are selected almost randomly to validate a block and receive rewards. Finally, there is a method called proof of burn, where you are only able to validate blocks after sacrificing your own cryptocurrency. Each method has its own advantages and disadvantages like speed and energy efficiency.
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The blockchain process can be quite confusing. One of the steps during the blockchain process is to mine a block. Mining a block is also what generates new cryptocurrency which is added to the supply in circulation, but most importantly it helps keep the network secure. You may have heard of people getting rich by mining Bitcoin, the most popular crypto, or heard that mining is terrible for the environment, or just want to learn what cryptocurrency mining is. Today, you will learn what crypto mining is, why people want to mine crypto, and different ways to mine crypto along with their advantages and disadvantages. Time to jump right in.

What is Cryptocurrency Mining?

Mining is a way for the blockchain to come to a consensus by confirming new transactions and rewarding miners for doing so. A consensus means that all the computers on the network agree on the blockchain's transactions. To mine computers check the list of transactions to make sure it is accurate, then generate an extremely complex code to securely connect a new block (the newest list of transactions) to the previous block, and finally receive a reward in the form of the blockchain’s currency. The code the computers generate is called a “hash”, and is what keeps two blocks connected to each other and can also tell you what's inside the block. A block will contain its own hash and the previous block’s hash. The blocks are connected by containing and matching the previous block’s hash. So, computers are listening for incoming transactions and writing them down on a block (every computer on the blockchain's network is doing this.) When the block is full of transactions, every computer on the network races to guess the hash. When the first computer has solved for the hash, the block will be mined, the reward will be given, and the blockchain process will start all over again. Here’s the thing. There are hundreds or even thousands of computers trying to mine a block at the same time, yet only one computer can be the first one to solve the code. That means only one computer will receive an award each time a block is mined. Getting an award is almost like winning a lottery.

Why Would Anyone Mine Cryptocurrency?

There are three main reasons why anyone would mine cryptocurrency. It's mostly just one main reason, but we will look at the others too.

To Get Rewards

The attraction to mining is because you receive rewards for being the one who mines the block. For example, if your computer solves the code first for Bitcoin, you would receive 6.25 Bitcoin, which is worth $250,000. So, right there you can see what’s attractive about mining. Not all cryptocurrencies are worth that much, but people will try to mine them anyways, especially if it’s a crypto they believe will be worth a lot in the future.

To Keep the Network Running and Secure

People mine for the rewards, but the reward is an incentive for the main reason of mining, which is to keep the blockchain’s network running and to check if all transactions are valid. Making things simple, the miner does a little check to make sure that all the transactions are valid from things like double spending. If people were able to double spend their crypto, it wouldn’t have much legitimacy or use. Keeping the network running means that miners are adding new blocks to the blockchain. Since everyone has a copy of the blockchain, the most valid version of the blockchain is held by whoever mined that block. This is called reaching a consensus.

To Generate New Currency

When you receive your reward for successfully mining a block, the crypto that you have received has not been in use before. Using Bitcoin as an example, the 6.25 Bitcoins that you just got are brand new and shiny, and have been taken from the non circulating supply and put into the circulating supply to be used… or HODLed because of these diamond hands! But it’s mostly to get those sweet rewards.
Types of crypto mining

Types of Crypto Mining

There are a few different mining methods that blockchain's can use to come to a consensus. They include:

Proof of Work

Proof of work is what most people think of when they think of mining. This is the main way of mining cryptocurrency. This was kind of explained above, but to reiterate: In order to add the next block to the blockchain, computers must solve a code, called the hash. To solve this code it takes an extreme amount of computing power. That's because the computer is making random guesses at a predetermined answer. The hard part about this is that it is a really long code and there are so many possibilities it's unfathomable. So it takes a really long time to guess and a lot of power to do so. And yours isn't the only computer that's doing so. For Bitcoin, there are over a million computers guessing at this code at the same time. With this many computers guessing, it takes about 10 minutes for someone to guess the hash and mine the block. When a computer solves for the hash, it tells the network that the computer put in a certain amount of work in order to mine the block, thus making it a valid block to be added to the blockchain. The reward is then given to the miner and the blockchain process starts all over again with computers on the network listening for transactions. The block cannot be mined without this proof that a specific amount of effort, or work, has been used. The consensus is then that the most up-to-date blockchain is the one with the most amount of work. Now the blockchain with the block added by the miner who solved the code is the new version of the blockchain because that is now the version of the blockchain with the most amount of work. This is then shared with everyone on the network, and they will update their own version of the blockchain as such. One huge negative of proof of work is because it takes so much computing power it uses a lot of energy. Many people associate this with negative environmental impact since a lot of electricity is being used. However, more and more cryptocurrencies are being mined using green energy methods. A few popular proof of work cryptocurrencies are Bitcoin, Dogecoin, Ethereum 1.0, and Litecoin.

Proof of Stake

Staking isn’t technically mining, but it serves a similar purpose. Proof of Stake still grants rewards, verifies transactions, and updates the blockchain, but it does so in a different process. Instead of using energy to prove an amount of work in order to mine a block, proof of stake achieves consensus by (mostly) randomly selecting a validator on the network. A validator is basically a miner. They keep the network running by holding a copy of the blockchain. How do you become a validator? By voluntarily locking up your cryptocurrency on the network, creating your stake. The more crypto that you stake, the better your chances are for getting randomly selected. If your node is randomly selected then you will receive the rewards. Instead of new cryptocurrency being given to the validator, it will instead receive the fee of the transaction. Besides getting rewards, the incentive to help keep the network secure is because you will have your own cryptocurrency at stake if the network goes down. If any node tries to validate a fraudulent transaction, it will be penalized, and may lose some of its staked crypto. This form of consensus is less energy intensive since it doesn’t require tons of computers computing at the same time. That’s good news for the environment! This is one of the reasons that some cryptocurrency projects like Ethereum are making the change from proof of work to proof of stake. The downside to proof of stake is because the more crypto you have staked, the better your chances are for getting selected, which means that over the course of time it’s the already rich that get richer. The most popular proof of stake cryptocurrencies are Cardano, Ethereum 2.0, Solana, and Algorand. We will cover Proof of Stake in more detail in the future.

Proof of Burn

Another less known way to achieve consensus is called Proof of Burn. This is where miners would burn their coins to mine/validate blocks instead of using energy. It was created to combat the energy consumption of proof of work. Burning cryptocurrency means permanently removing the crypto from the circulating supply by sending it to a wallet where it will never be able to be accessed. The way proof of burn works is that when miners burn their coins they are granted the power to mine blocks. The more crypto they burn, the bigger the chance to mine the block and receive rewards of their own. Depending on the blockchain, miners are able to burn the blockchain’s currency or an alternate currency like Bitcoin. The advantage of proof of burn is increased security, due to the investment made. Basically you must pay crypto to make crypto. The security is great in proof of burn because only those who are able to prove that they have gotten rid of a certain amount of their coins are trusted enough to be chosen as the block validator, or miner. If you cannot prove that you have destroyed a certain amount of coins you are not eligible to mine. These miners are trustworthy because they have risked losing their crypto in order to keep the blockchain's network alive. Another advantage of proof of burn is that it requires a lot less power than something like proof of work, which again, is really great for the environment and energy consumption. Since the only effort that is made is when the coins are burned, this method uses minimal energy and doesn't require powerful hardware like a mining rig. A disadvantage of proof of burn is that you will lose your crypto even if you are not chosen to validate any blocks. Where in proof of stake, if you choose to stop validating blocks you will receive your crypto back. While proof of burn is quite new and not very popular, there are a few coins that use this method of consensus like Slimcoin. Summary Mining is a method of consensus for the blockchain to confirm new transactions and make sure the transactions are accurate and valid. Miners are rewarded for doing so. A consensus means that everyone on the network agrees with the list of transactions on the blockchain. There are many reasons that people would want to mine for cryptocurrency including to get rewards, introduce new coins into the supply, and most importantly, to keep the blockchain's network running and secure. The few types of crypto mining are: proof of work, which requires proof that you used a certain amount of energy; proof of stake, which requires that you lock up your crypto in order to be randomly selected to validate (mine) the next block; and proof of burn, a less known method consensus, which works by having miners prove they burned a certain amount of coins in order to participate in mining blocks. Now that you can answer the question, “what is cryptocurrency mining?”, you can learn how to easily stake crypto called Cardano.
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