Although many individuals investing in cryptocurrencies simply purchase them on a crypto exchange, this is not the only way to acquire coins such as Bitcoin or Ethereum.
The other way that individuals acquire units of cryptocurrency is through a process known as ‘mining’ – which is how some of the biggest cryptocurrency fortunes have been amassed.
Cryptocurrency mining has frequently appeared in the headlines for the significant energy expenditure it requires. After all, the real-world, tangible cost of generating electricity in order to mine new cryptocurrencies is part of what makes them so valuable.
It should also be stated that mining is an essential part of the cryptocurrency ecosystem. This is because mining generates new coins that are put into circulation and that are then bought, sold or used to make various types of transactions.
But what exactly is cryptocurrency mining, and how does it work?
What is ‘mining’?
A simple way to think about cryptocurrency mining is that it is a way of creating new digital coins or units of cryptocurrency.
To create these coins, computers solve incredibly complicated cryptographical puzzles and validate transactions on a blockchain network so that they can be added to the open, distributed ledger. Typically, only verified miners can update transactions on the blockchain, which helps to prevent double-spending and reduce the risk of fraudulent transactions.
As decentralized digital currencies lack a central authority, mining is an essential part of validating transactions on the blockchain. Mining therefore acts as a way of incentivizing participation in these validation processes by offering miners newly minted coins as a reward. This also helps to increase the security and integrity of the blockchain network as a whole.
How does mining work?
Typically, crypto miners will use their computers to solve complex mathematical equations. Once these are solved, transactions are authorized. This process of authorization involves adding the data about that transaction to the public ledger – i.e., the blockchain – which is secured by these encryptions.
In return for this, the miner will earn a unit of cryptocurrency. This acts as a way of both incentivizing participation in this process and also helping to cover the energy costs that the miner incurred in doing it. Solving these cryptographical puzzles can be quite energy intensive as it requires a significant amount of computer power.
What cryptocurrencies can you mine?
As the first cryptocurrency, Bitcoin was the first currency to have a mining system in place. Many of the earliest miners of Bitcoin were able to generate vast sums of currency when Bitcoin was in more plentiful supply.
However, the basic ‘mining’ system underpinning Bitcoin has been largely replicated by many of the major cryptocurrencies. This includes the likes of Ethereum, Litecoin, Tether and Monero, all of which have a similar system in place.
Bitcoin and Ethereum are the most popularly mined cryptocurrencies, largely due to the fact that their total market cap is the highest. Bitcoin and Ethereum are also the highest-value cryptocurrencies, which helps to incentivize mining on their respective networks.
Proof of Work vs Proof of Stake mining
Cryptocurrency mining can broadly be split into two distinct types: Proof of Work and Proof of Stake.
Proof of Work mining is one way of publishing the latest block (which includes transaction data) on the blockchain. The work is undertaken by miners whose computers perform complex computations and solve equations to change a particular input into a required output. The first miner to produce the output will share it with the network, which then double-checks and verifies to see if it’s functioning properly. If it is, the miner is rewarded.
Proof of Stake mining is slightly different. This allows would-be miners to put up existing units of their cryptocurrency as collateral for the opportunity to validate a block. Multiple validators will be needed to verify a block and they will be selected from a pool of candidates who have put up crypto as collateral. Validators will be rewarded with coins for their efforts.
Major currencies such as Ethereum are due to shift to a Proof of Stake mining system, which will make the process both more efficient and less energy intensive. This will help to increase the transaction speed and lower any associated transaction fees.
Advantages and disadvantages of crypto mining
The most obvious benefit of mining cryptocurrency is that it provides a revenue stream for miners. When cryptocurrencies such as Bitcoin were more plentiful, this could be quite substantial. However, as more coins have gone into circulation through mining, the volumes you can generate diminish.
It has also become a lot more expensive to mine cryptocurrencies. This is because you need much more powerful hardware to do it these days, and also because the energy costs have increased. As such, it can be very difficult to get started mining these days, with the majority of mining done through server farms rather than by individuals.
Mining cryptocurrency also has a significant environmental impact, both due to the hardware requirements and the electricity cost.
However, it is believed that once the major cryptocurrencies switch to Proof of Stake mining, this will significantly decrease the energy requirements in the long term.