An Introduction to Bitcoin for The Rest of Us
Cryptocurrency
A digital money system made up of "coins" or "tokens" that are controlled by a decentralized electronic database ledger. Everything is electronic. Unlike “traditional” forms of money, there are no metal coins minted or paper money printed. Many casual observers may not realize there are different applications for cryptocurrency. Investors often look at Bitcoin as a hedge against inflation. The second largest crypto, Ethereum, is used for non-fungible token (NFT) transactions that are increasingly popular in the art and collectibles world.
Bitcoin
Perhaps the best known “cryptocurrency.” Bitcoin was created
in 2009 by an unknown person using the alias Satoshi Nakamoto. Unlike
traditional currencies such as the US Dollar, Bitcoin isn't controlled by a
bank or government. Bitcoin is by far the most valuable and popular
cryptocurrency in use today.
Blockchain
The technology behind cryptocurrencies. Essentially a
“digital ledger” a blockchain can be used to store many types of information, similar
to a database, but its most common use is in recording cryptocurrency
transactions. Once a transaction is made, it's entered in this public ledger,
which is managed by a global peer-to-peer network of millions of computers. Blockchain
is fundamental to Bitcoin's appeal: As a decentralized database, it can't be
controlled by any one person or group. Unlike a fiat currency such as the US Dollar,
which is managed by a central bank.
Mining
The process by which new Bitcoins are entered into
circulation. Mining is not for amateur enthusiasts: It requires high-powered
computing to solve complex mathematical puzzles in order to create a new
"block" on the blockchain through cryptography and hash algorithms. The
mining process requires a great deal of computing power and electricity, leading
to concerns about Bitcoin's environmental impact.
Wallet
Just like the old leather wallet you carry your cash and credit
cards around in, a “digital wallet” in the crypto world is a place to store
digital currency. The main thing you need to remember about wallets is that you
must never, ever lose or forget your password.
How are Bitcoins Created?
Bitcoin Mining is the process by which new Bitcoins are
entered into circulation, but it is also a critical component of the
maintenance and development of the digital blockchain ledger. Cryptocurrency mining
is painstaking, costly, and only occasionally financially rewarding.
Nonetheless, mining has an appeal for
many investors because of the fact that successful miners may be rewarded for
their work with crypto tokens.
Mining rewards are paid to the first one to discover a
solution to a complex hashing puzzle. You will need either a GPU (graphics
processing unit) or an application-specific integrated circuit (ASIC) in order
to set up a mining rig. The primary attraction is the potential for being
rewarded with Bitcoin. The Bitcoin reward that miners receive is an incentive
that motivates them to assist in the primary purpose of mining: to legitimize Bitcoin
transactions, ensuring their validity. Because these responsibilities are
spread among many users all over the world, Bitcoin is a
"decentralized" cryptocurrency, or one that does not rely on any
central authority like a central bank or government to oversee its regulation.
Miners are essentially getting paid for their work as
auditors. They are doing the work of verifying the legitimacy of Bitcoin
transactions. This convention is meant to keep Bitcoin users honest and was
conceived by Bitcoin's founder. By verifying transactions, miners are helping
to prevent the "double-spending problem." Double spending is a
scenario in which a Bitcoin owner illicitly spends the same Bitcoin twice. With
physical currency, this isn't an issue: once you hand someone a $20 bill to buy
a bottle of vodka, you no longer have it, so there's no danger you could use
that same $20 bill to buy lotto tickets next door. While there is the
possibility of counterfeit cash being made, it is not exactly the same as
literally spending the same dollar twice. With digital currency however, there
is potentially a risk that the holder could make a copy of the digital token
and send it to a merchant while keeping the original.
Once miners have set up operations and verified 1 MB worth
of Bitcoin transactions, known as a "block," those miners are
eligible to be rewarded with a quantity of Bitcoin. The 1 MB limit was originally
set by Satoshi Nakamoto. Simply verifying 1 MB worth of transactions only makes
a miner eligible to earn Bitcoin however. Not everyone who verifies
transactions will get paid. To earn Bitcoins, you need to meet two conditions:
1) You have to verify 1MB worth of transactions. This is the
easiest part.
2) You also have to be the first miner to arrive at the
right answer, or closest answer, to a numeric problem. This process is also
known as “proof of work.“ Contrary to what you may have read, no advanced math
or computation is involved. What they're actually doing is trying to be the FIRST
miner to come up with a 64-digit hexadecimal number (called a "hash")
that is less than or equal to the target. A 64 bit number looks something like
this:
0000000000000000057fcc708cf0130d95e27c5819203e9f967ac56e4df598ee
If you had lots of time, you could obtain the same result by
rolling a 16-sided die 64 times to arrive at random numbers. The total number
of possible guesses for each of these problems is in the trillions. To be the
one to solve the hash problem first, miners need a LOT of computing power. To
mine successfully, you need to have a high "hash rate," which is
measured in terms of megahashes per second (MH/s), gigahashes per second
(GH/s), and terahashes per second (TH/s). It's literally a numbers game.
Currently, the chance of producing a hash below the target is one in 17.59
trillion. Lousy odds if you're working on your own, even with a tremendously
powerful mining rig.
Mining and Bitcoin Circulation
In addition to rewarding successful miners and putting additional
Bitcoins into circulation, mining serves another purpose: It is the only way to
release new cryptocurrency. In other words, miners are basically
"minting" currency. In November 2020, there were around 18.5 million Bitcoins
in circulation. The rewards for Bitcoin mining are reduced by half every four
years. When Bitcoin was first mined in 2009, mining one block would earn you 50
BTC. In 2012, this was halved to 25 BTC. By 2016, this was halved again to 12.5
BTC. On May 11, 2020, the reward halved again to 6.25 BTC. In November of 2020,
the price of Bitcoin was about $17,900 per Bitcoin, which means you'd earn
$111,875 (6.25 x 17,900) for completing a block. Not a bad incentive to solve
that 64 bit hash problem. If you are interested in seeing how many blocks have
been mined thus far, as well as the current price of Bitcoin, there are several
sites, such as https://www.blockchain.com
that will provide that information in “real-time.”
What Do I Need To Mine Bitcoins?
Although in the early days of Bitcoin, individuals were able
to compete for blocks with a regular home computer, this is no longer the case.
The reason for this is that the difficulty of mining Bitcoin changes over time.
In order to ensure the smooth functioning of the blockchain and its ability to
process and verify transactions, the Bitcoin network aims to have one block
produced every 10 minutes or so. However, if there are one million mining rigs
competing to solve the hash problem, they'll likely reach a solution faster
than a scenario in which 10 mining rigs are working on the same problem. For
that reason, Bitcoin is designed to evaluate and adjust the difficulty of
mining every 2,016 blocks, or roughly every two weeks. When there is more
computing power collectively working to mine for Bitcoin, the difficulty level
of mining increases in order to keep block production at a stable rate. Less
computing power means the difficulty level decreases. To get a sense of just
how much computing power is involved, when Bitcoin launched in 2009 the initial
difficulty level was one. As of Nov. 2019, it is more than 13 trillion.
In order to mine successfully, miners must now invest in
powerful computer equipment like a GPU (graphics processing unit) or, more
realistically, an application-specific integrated circuit (ASIC). These can run
anywhere from $500 to the tens of thousands. Some miners buy individual
graphics cards (GPUs) as a low-cost way to put together a mining operation.
The legality of Bitcoin mining depends totally on your
location. The very concept of “cryptocurrency” threatens the predominance of “fiat”
currencies and government control over financial markets. For this reason, Bitcoin
is illegal in certain places around the world. Some examples of places where it
is illegal at the moment are Algeria, Egypt, Morocco, Bolivia, Ecuador, Nepal,
and Pakistan. In general, however, Bitcoin investing and mining are legal
across much of the globe.
The risks of mining are mostly financial and environmental. Bitcoin
mining clearly carries a significant financial risk. Assuming you have
purchased the necessary mining equipment (which could be many thousands of
dollars) you may still show no return on investment despite your best efforts. There
is also the potential environmental risk from the rapid growth of Bitcoin
mining due to the increased energy demands required by the computers running
the “hash” algorithms. While the efficiency of microchips has increased
dramatically, the growth of the Bitcoin network itself is outpacing
technological progress. As a result, there are concerns about the environmental
impact and carbon footprint of Bitcoin mining. There are ongoing efforts to
mitigate this effect by seeking green energy sources for mining operations
(such as geo-thermal or solar power) as well as utilizing carbon offset
credits.
Sources:
https://www.cnn.com/2021/04/26/investing/crypto-definitions/index.html
https://www.investopedia.com/tech/how-does-Bitcoin-mining-work
https://www.cnn.com/2021/05/24/investing/elon-musk-bitcoin-dogecoin-tesla/index.html
