September 11, 2017

What is bitcoin mining and how does it work?

Most people that have heard of Bitcoin mining see it as a way to get free Bitcoins, bordering on theft. You set up a server program, and every now and then it presents you with some bitcoins. Sounds simple doesn’t it and a bit like money for nothing?  In fact, Bitcoin mining is one of the fundamentals of the Bitcoin network and without it the network would be in danger of collapse.

We have said before that the main difference between Bitcoin and traditional currency is that Bitcoin doesn’t have centralised control, like a central bank would for traditional currency for instance and that Bitcoin is protected and run by blockchain technology. This means that every single transaction in Bitcoin is recorded in the blockchain and time stamped. This is effectively a public ledger, which is updated all the time and held on many thousands of computers across the world. The role of the miners is to secure this chain, and they do this by solving immensely difficult computations which chains together blocks of data, which is what keeps the network safe.

If the Bitcoin network was ever attacked it would need 51% of miners to be dishonest and to create blocks with false transactions but mining is a costly process that takes lots of hardware, software and a lot of electricity. If someone wanted to try and dishonestly mine that amount of the network it would cost many millions, maybe even billions and only a seriously large corporation or government could achieve it. So, all the good miners are pivotal to the success of bitcoin and for this good work they are rewarded with Bitcoins.

The amount of bitcoins that miners are rewarded with will change over time and effectively half every 210,000 that are created, which should equate to around 4 years. If the value of bitcoin keeps increasing, this should keep it profitable for the miners.

Due to the high cost of mining, much of the mining is done by pools of people i.e. people have banded together to form conglomerates that together mine for bitcoin. Half of these are located in China, so there are some that worry that the 50% safety rule might be broken. But, if that were to happen the credibility of bitcoin would fall dramatically along with the price, so the value of carrying out that attack would be pointless.

There are many discussions on the legality of bitcoin mining and also the tax implications but they are a little complex to discuss here and do rather depend on where in the world you are based and the status of bitcoin there.

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Comments (18)

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