crypto
Technology

Cryptocurrency mining: The ins and outs to understand the trade

Cryptocurrency mining is an activity that often pops-up as an advertisement. Participate in shared mining pools and you will get all the fortune with only minimal investments. These schemes are often too good to be true. This does not mean that cryptocurrency mining is not a lucrative trade nor should it be ignored. Mining is what keeps the blockchain space alive, at least for a majority of the coins out there. In this article we will dive into the ins and outs of mining.

Why does blockchain have mining?

That is a very good question to begin with. Like the word suggests, a blockchain is a chain of blocks. These blocks include transactions, often with a cap of a certain amount (e.g. 1000 transactions). To determine ones balance on a blockchain, a calculation is made that looks at all the previous blocks. Summing up the all the transactions and then showing the balance. A new block that is added changes the balances as a result of new transactions. 

Adding a block to the chain

However, we do not want dozens of people adding blocks to a blockchain automatically. This will result in one big mess. Therefore, the creator(s) of Bitcoin, the first blockchain solution, came up with the concept of mining. In essence, cryptocurrency mining is the process of solving a very difficult computation. Transactions are gathered throughout the network and combined with a random number, known as the nonce. These are then ‘hashed’ (a cryptographic process) and the result should come close to the solution. 

The closeness refers to the difficulty of the problem. When there are a lot of users (i.e. miners) that try to solve the problem, the difficulty of the computation increases. This means you will need even more computation power to find the solution first. Once a user finds an outcome that comes close to the solution, its hash is being shared with other users. The other users can then validate the outcome and indeed see it is close, automatically accepting it. Once the majority of the network accepts it, the new block is added.

Do you want to learn more about hashing? The SHA-256 algorithm (link: https://en.wikipedia.org/wiki/SHA-2) is a famous hash that is being used in cryptocurrencies and computer science in general.

Rewards

In return, the miner who found the solution first is rewarded. This makes sense, since the process of hashing requires a lot of computation and thus electricity. The reward is paid in cryptocurrency and is the result of newly minted coins. Yes, you read that correctly. With every new block validated, a transaction is made to the user that found the solution with a reward. This incentives the users to work to find the solution and validate a new block of transactions, maintaining the network.

It’s all about the network

As becomes evident from the process of cryptocurrency mining, the miners keep the network alive. Without the validation of new transactions in a fair way, there is no cryptocurrency that can survive. By incentivizing its users, the cryptocurrency hopes that the majority (more than 51% of the users) behaves in the interest of the cryptocurrency. Having a large network thus increases the chance of showing the desired behavior. 

With smaller groups, they could decide to overthrow the network, known as a 51% attack (link: https://en.wikipedia.org/wiki/Cryptocurrency). This means that the majority will not accept any new transaction or worse, they will neglect transactions of particular users or groups and take over the network. Incentives are therefore an important cornerstone of the cryptocurrency space.

Types of transaction validations

Now that we talked about cryptocurrency mining, let’s take one step back. Mining refers to the process of hashing to validate a new block of transactions. This type of transaction validation that is also being used by Bitcoin is known as Proof of Work (PoW). Where work refers to the computations that need to be conducted. But, are there also other ways to validate a new block? Yes! In fact, there are many different ways.

Proof of Stake

In a Proof of Stake (PoS) setting, currency owners are validating a new block of transactions together. They do so by approving the transactions based on their stake in the network. For example, with a new block of one thousands transactions, several users with a stake are randomly selected. Together they need to provide their consent. The reasoning is that people who have a stake tend to serve in the interest of the network as it will benefit their stake as well. 

There are more complex algorithms for selection and validation present in the cryptocurrency space. A good example is the shift from Ethereum from PoS towards PoW (link: https://ethereum.org/en/eth2/#proof-of-stake). Why make the shift? PoW requires a lot of computation and thus energy. This is bad for the environment and also unnecessary to begin with. PoS offers the same protection, but with less energy consumption and thus a more efficient blockchain environment.

Making money with cryptocurrency mining

You can start making money with cryptocurrency mining yourself. By downloading the software of your favourite cryptocurrency on your laptop, you automatically become a node in the network. Based on the validation mechanism (e.g. PoW or PoS), the need for a stake is determined. In the case of PoS, you do not need to have any stake to start hashing and look for solutions. 

Difficult to win from mining farms

Do note that you need to be fast to find the solution. With a regular computer it can be very hard to find a solution faster than any other node. There are special computers created for solving hashing problems, which are stacked in huge centers known as mining farms. With the computational power of a farm, it can be hard for a regular user to find the solution. When you do not find the solution, your computations will be for nothing. There is only a reward for the first user to come close to the solution. 

Why beat it if you can join it?

And no, we do not refer to joining the dark side. There are multiple ways you can become part of a network.

Join a cryptocurrency mining pool

Your computer can become part of a mining pool, which is often a separate piece of software. With this, you share your computational power with a network that is looking for the solution. Once a solution is found and the currency is being rewarded, it is shared among the participants of the pool. 

Invest in a mining farm

Another way to participate is by investing in mining farms. The money will be used to by equipment and the rewards are then being shared among the investors. Do note that you need to be careful with these schemes. Several have been found to be a scam, with no return being given to the investors. Always stay cautious and follow the simple rule: if it seems to good to be true, it often is…

Leave a Reply

Your email address will not be published. Required fields are marked *