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Chances are you hear the phrase bitcoin mining and your mind begins to wander to the Western fantasy of pickaxes, dirt, and striking it rich. As it turns out, that analogy isnt too far away.
Far less glamorous but equally uncertain, bitcoin mining is done by high-powered computers which solve complex computational math problems (read: so complicated that they cannot be solved by hand). The luck and work demanded by a computer to solve one of these problems is the equivalent of a miner striking gold in the ground while digging in a sandbox.
The end result of bitcoin mining is twofold. First, when computers resolve these intricate math issues on the bitcoin network, they create new bitcoin, not unlike when a mining operation extracts gold from the ground. And second, by solving computational math issues, bitcoin miners create the bitcoin payment network trustworthy and protected, by verifying its transaction information. .
Theres a fantastic chance all that only made so much sense. In order to explain how bitcoin mining functions in greater detail, lets begin with a process thats just a little bit closer to home: the regulation of printed currency.
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Consumers tend to trust printed currencies, at least in the United States. Thats because the U.S. dollar is backed with a central bank known as the Federal Reserve. In addition to a host of other responsibilities, the Federal Reserve modulates the production of new money and prosecutes the usage of counterfeit currency. .
Even electronic payments using the U.S. buck are backed with a central authority. When you make an online purchase using your debit or charge card, for example, that transaction is processed by a payment processing company like Mastercard or Visa. In addition to recording your transaction history, these companies verify that transactions are not fraudulent, and that's one reason your credit or debit card may be suspended while traveling. .
Bitcoin, on the other hand, is not regulated by a central authority. Instead, bitcoin is backed by millions of servers throughout the world known as miners. This network of computers performs the identical function as the Federal Reserve, Visa, and Mastercard, but using a few key differences. Like the Federal Reserve, Visa, and Mastercard, bitcoin miners record transactions and check their accuracy.
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When someone makes a purchase or sale using bitcoin, we predict a transaction. Transactions made in-store and online are documented by banks, point-of-sale systems, and physical receipts. Bitcoin miners achieve the exact same effect without these institutions by clumping transactions together in cubes and adding them into a public record called the blockchain. .
When bitcoin miners put in a new block of transactions to the blockchain, part of their job is to make sure that these transactions are accurate. (More on the wonder of the way this happens in a second) In specific, bitcoin miners make sure that bitcoin are not being duplicated, a unique quirk of digital currencies called double-spending.
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Once you spend $20 at the shop, that bill is in the clerks handson. With electronic currency, however, it's a different story. .
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When the numbers were identical, the clerk this post would know the money had been replicated. This analogy is similar to what a bitcoin miner does when they verify new transactions. .
With as many as 600,000 purchases and sales occurring in a single day, nevertheless, verifying every one of these transactions can be a great deal of work for miners, which gets at one other crucial difference between bitcoin miners and the Federal Reserve, Mastercard, or Visa. As compensation for their efforts, miners are awarded bitcoin whenever they add a new block of transactions to the blockchain.
In 2009, it had been 50. In 2013, it was 25, at the time of writing it is 12.5, and sometime in the middle of 2020 it will halve to 6.25. .
At this speed of halving, the total number of bitcoin in circulation will approach a limit of 21 million, making the currency more scarce and precious over time but also more expensive for miners to produce.
Here is the catch. In order to get bitcoin miners to actually earn bitcoin from verifying transactions, two things have to occur. To begin with, they need to confirm 1 megabyte (MB) worth of transactions, which can theoretically be as small as 1 transaction but are far more often several thousand, depending on how much information each transaction stores.