How Does Bitcoin Mining Work?

Bitcoin Mining Explained

Redhead checking her GPU mining rig
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Bitcoin is a sovereign system of digital money. It has no direct correlation to any real-world currency, nor is it controlled by any government or centralized entity, but people can (and do) use it to purchase real-world items at major retailers such as Overstock.com and Expedia.

To process these transactions securely, entities called "miners" compete to solve mathematically complex problems. The miner who is successful in solving the problem adds a "block" to Bitcoin’s blockchain and receives a reward of 6.25 bitcoins. In July 2021, a single bitcoin was worth more than $33,000—meaning that every new block found was worth more than $205,000.

Not only is this a reward for the miner’s efforts, but the process of mining is how new bitcoins are generated and introduced into circulation.

Key Takeaways

  • A blockchain is an online decentralized ledger that records approved transactions (blocks) that are tied together (chains) throughout a network.
  • Bitcoin miners add individual blocks to the blockchain by solving complex mathematical problems, with the winner receiving a set number of bitcoins.
  • The mining difficulty of bitcoin is extremely high, requiring expensive hardware, large amounts of electricity, and specific software.
  • Whether bitcoin mining is profitable depends on the cost of electricity, though it is most profitable when miners work in pools to combine resources.
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Bitcoin Mining Explained

How Bitcoin Mining Works

All mining starts with the blockchain. This is an online decentralized ledger that records transactions throughout a network. A group of approved transactions is called a “block.” These blocks are tied together to create a "chain"—hence, the term "blockchain."

In the Bitcoin network, a miner’s goal is to add individual blocks to the blockchain by solving sophisticated mathematical problems. This pursuit requires enormous computational and electrical power. While many miners compete to add each block, the miner who solves the problem will actually add the block—along with its approved transactions—to the blockchain. This miner receives a reward of 6.25 bitcoins (the block reward is cut in half roughly every four years).

The reward rate is cut in half every 210,000 blocks, which means roughly every four years. This process, called “halving,” is algorithmically enforced, ensuring a predictable, unalterable rate of introducing new bitcoins into the existing supply—eliminating concerns of inflation.

Due to the inherent difficulty in mining bitcoins, there are a number of requirements when it comes to the actual mining process.

Mining as Verifying Transactions

In order for bitcoin miners to actually earn bitcoin from verifying transactions, two things have to occur. First, they must verify one megabyte (MB) worth of transactions, which can theoretically be as small as one transaction but are more often several thousand, depending on how much data each transaction stores.

Second, in order to add a block of transactions to the blockchain, miners must solve a complex computational math problem, also called a "proof of work." What they're actually doing is trying to come up with a 64-digit hexadecimal number, called a "hash," that is less than or equal to the target hash. Basically, a miner's computer spits out hashes at different rates—megahashes per second (MH/s), gigahashes per second (GH/s), or terahashes per second (TH/s)—depending on the unit, guessing all possible 64-digit numbers until they arrive at a solution. In other words, it's a gamble.

The difficulty level of the most recent block as of August 2020 is more than 16 trillion. That is, the chance of a computer producing a hash below the target is 1 in 16 trillion. To put that in perspective, you are about 44,500 times more likely to win the Powerball jackpot with a single lottery ticket than you are to pick the correct hash on a single try. Fortunately, mining computer systems spit out many hash possibilities. Nonetheless, mining for bitcoin requires massive amounts of energy and sophisticated computing operations.

The difficulty level is adjusted every 2016 blocks, or roughly every 2 weeks, with the goal of keeping rates of mining constant. That is, the more miners there are competing for a solution, the more difficult the problem will become—and the more expensive it becomes to generate a new block of bitcoins. The opposite is also true: if computational power is taken off of the network, the difficulty adjusts downward to make mining easier.

What Do I Need to Mine Bitcoin?

Bitcoin is designed to adjust the difficulty required to mine one block every 14 days (or every 2,016 blocks mined). The overarching goal is to maintain the time required to mine one bitcoin to 10 minutes. Since Bitcoin has been around since 2009, its mining difficulty is currently extremely high, which is why resource-intensive, powerful hardware is necessary to mine it.

Regular household computers—even those with incredible power by today’s standard—will not see any success in the modern Bitcoin mining ecosystem.

The first and most important piece of equipment needed to mine bitcoin is specialized mining hardware called "application-specific integrated circuits," or ASICs. A new ASIC device can cost anywhere from several hundred dollars to $10,000, but the price of mining hardware is only a fraction of the expense involved. ASICs consume tremendous amounts of electricity, the cost of which can quickly exceed the cost of the device using it. 

You’ll also need to choose Bitcoin mining software to join the Bitcoin network. This isn’t nearly as expensive as hardware. In fact, plenty of reliable software options are available for free.

To determine the profitability of Bitcoin mining, all expenses must be considered: hardware, software, and electricity. The current value of Bitcoin, which consistently fluctuates, must also be taken into account, as well as taxes you might pay

Each block takes roughly 10 minutes to mine. If more power and resources are dedicated to mining, and if the time required to mine one block falls under 10 minutes, Bitcoin’s mining difficulty will increase to bring the average per-block mining time back to 10 minutes.

Can You Make Money From Mining Bitcoin?

At first glance, Bitcoin mining appears profitable. In 2021, the reward per block was 6.25 bitcoins, and one bitcoin is worth around $30,000. According to these figures, Bitcoin generates more than $200,000 worth of value every 10 minutes. If that sounds too good to be true, that’s because it is—in part.

A single ASIC can consume as much electricity as 500,000 Playstation 3 devices, which is why Bitcoin mining simply isn’t profitable from home. 

The profitability of Bitcoin mining depends mostly on the cost of electricity. For example, if you live in Louisiana and access electricity at an industrial rate of 4.58 cents per kilowatt-hour—which is the cheapest in the United States—you will lose money, even with top-notch ASIC hardware.

Fortunately, Bitcoin mining enthusiasts without direct access to cheap electricity have another option.

Mining Pools

One way in which Bitcoin mining can still be profitable—and perhaps the only way—is through mining pools. These arrangements enable miners to pool their resources, adding power but splitting the difficulty, cost, and reward of mining Bitcoin. There are several well-known Bitcoin mining pools across the globe, including F2Pool, Poolin, and BTC.com.

When a mining pool is rewarded, the individual miners get a very tiny piece of this reward. One bitcoin can be divided by eight decimal places, meaning that a transaction of 0.00000001 BTC can be facilitated by the Bitcoin network, thus accommodating thousands of Bitcoin miners who collaborate through mining pools.

But miners might still wait a long time to successfully reap their reward. Though this is highly speculative, one analysis found that top-notch ASIC hardware would require about 1,200 days to receive one bitcoin from mining efforts as part of a pool.

Taxes

The IRS treats cryptocurrencies (including Bitcoin) received from mining as income. A miner needs documentation proving when a bitcoin was mined. The bitcoin will be valued based on its price on the day it was mined. If a bitcoin is later sold at a higher price, the miner will need to pay capital gains tax on the difference.

If a mining operation is not part of an established business, additional tax obligations could apply. Such miners are likely to owe a self-employment tax of 15.3% on their annual income.

How To Start Mining Bitcoin

Though it is extremely difficult and rarely profitable, Bitcoin mining is still feasible. While the best results will derive from joining a mining pool, the following steps can be taken to venture into Bitcoin mining: 

  1. Calculate profitability: Primary expenses will include cost of electricity and mining hardware. Any profit will largely depend on Bitcoin’s value, which is volatile.
  2. Get mining hardware: Once initial calculations are made, expect to spend anywhere from several hundred to several thousand dollars on mining hardware.
  3. Choose mining software: Next, you need a platform through which you can access the blockchain and manage your mining. There are a lot of popular Bitcoin mining software options to choose from.
  4. Install a Bitcoin wallet: When you’ve mined bitcoins, you’ll need a place to store them, called a "Bitcoin wallet." Digital wallets let you store your bitcoins in “the cloud” but are a common target for cybercriminals. An offline wallet stores bitcoins in a device that is disconnected from the Internet, offering added security. 
  5. Enter a mining pool: Joining a mining pool offers the greatest chance of success.
  6. Get started: Once the previous steps are complete, you can start mining. This is a very passive enterprise, but equipment should still be routinely checked to ensure that everything is working properly.

Frequently Asked Questions (FAQs)

How do you join a Bitcoin mining pool?

Bitcoin mining pools can help make the most of your efforts. To find a mining pool, start by looking for one compatible with your mining device and your preferred software. Pools may also have certain network and speed requirements, so that may eliminate certain options. Once you decide which pool you're interested in, contact the pool to find out its stratum addresses and add them to your mining software.

What is Bitcoin cloud mining?

Cloud mining involves buying into a pool and participate in cloud mining remotely. You can rent or lease hardware that's kept in a mining facility, or you can lease hash power, which is the computer power needed to mine cryptocurrency. This allows you to participate in Bitcoin mining without having to invest in equipment. Be sure to screen any potential cloud mining opportunities to ensure they aren't scams.