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Bitcoin Mining

With real world currencies, governments print cash and distribute it. But with bitcoin there is no central controlling organisation. Instead, new bitcoins are created by people mining for them.

This doesn’t involve digging with picks and shovels – the mining is done by powerful computers running special software to solve complex maths problems. These calculations are used to verify transactions and to create new blocks which are added to the blockchain. This function is called hashing.

Here’s how it works. New transactions (ie people transferring bitcoins from one address to another) are collected together into blocks. Miners take a new block and apply a mathematical formula to the information in the block. This turns it into a random sequence of letters and numbers called a hash. The hash is stored along with the block, at the end of the blockchain at that point in time.

The properties of the hash mean it becomes like a digital wax seal. It verifies that the information in the block hasn’t been tampered with. Anyone can check that the hash matches the block. If anyone does try to change the block then it won’t match, so everyone would know that it was a fake.

Also, since each block’s hash is produced by using the hash that belongs to the block that comes before it in the chain, checking a hash verifies that all the blocks that come after it are legitimate too.

Yes, it’s complicated – you do need a degree of proficiency with computers to set up a mining kit to do these calculations.

In return for this work, the computer’s owner is paid with new bitcoins.

Sounds like money for nothing, but it’s not. The computing power needed requires specialised kit which is expensive, and is in short supply right now because of the huge demand from bitcoin miners.

The machines run very hot, so you have to think about cooling as well. Unless you live in a very cold country this is going to add to your costs.

Then there’s the power requirements: the electricity costs in running the computers and the cooling can all but wipe out any profit you make.

There are several websites that will let you calculate your mining profitability. You input the details of your hardware and your electricity costs and you will see how long it will take you to pay back your investment at the current value of bitcoin.

Mining gets progressively harder as time goes on. The cryptographic puzzles that the software has to solve get harder as the blockchain grows bigger and more bitcoins enter circulation. The puzzles require the computers to go through a lot of extra steps to create a hash, just to make sure new bitcoins can’t be produced too fast.

Also, the rewards miners receive in return get cut in half regularly, so there’s a gradual slow-down of new bitcoins being generated.

If you do want to mine bitcoins, you’re going to be competing with vast farms of servers, each worth millions of pounds, all churning out the calculations. The first miner to solve the puzzle associated with a block gets the reward – there are no prizes for second place. If your kit is working on a block that someone else solves, all that work is wasted.

Mining Pools

To help get over this wasted effort, miners can band together into a mining pool. This forms a network of computers that work together to solve a block, and then share out the reward. You get less per block than you would if you mined on your own, but being in a pool means you’ll find and solve more blocks in the same time.

It is almost impossible for an individual to compete against a mining pool or a large mining operation, so if you do want to get involved in mining you need to join a pool.

The first mining pool was called Slush, and it currently mines about 3% of all blocks. The biggest is a China-based pool called Antpool, which mines about 25% of all blocks. In fact, most of the biggest pools are based in China. Before decided which pool to join, do some research to make sure it’s a legit operation.