Cryptocurrencies like Bitcoin, Litecoin, and others, are unique in many ways when compared to traditional currency, but perhaps none more so than how they are created. They are mined. They are not printed, like paper money, but instead they are carved out of a large numerical mountain. It’s a concept that is both obscure and brilliant. It is difficult to understand for many, especially given how virtual and ownerless it all seems. Here is a summary of how mining works. This post will refer to Bitcoin specifically, but the principle is similar for most other virtual currencies – at least those that use mining. Not all do. Bitcoin Mining is not done with pick-axes and shovels. It is done with computers. Many thousands of them; powerful CPUs that must pool their resources to get the job done. It’s not pretty, it’s not cheap, and it can’t be done in your basement.
Why is it called mining? Because creating Bitcoin has more parallels to traditional mining than it does to the printing of paper money or the minting of coins according to a government mandate. Here’s what I mean:
Bitcoin was created in such a way that only 21 million bitcoins can ever come into existence. Currently, just over three-quarters of this total, over 16 million bitcoins, have already been mined. In this way, it is like a mountain, still one-quarter of which contains more bitcoins, just like a functioning diamond mine still contains value, somewhere in those millions of tons of dirt.
Let’s extend the analogy a little further. If you wanted to become a prospector of diamonds, you would have to know roughly where to look, stake a claim, and then spend your energy, time, and tools trying to find a stone. Ultimately, the value of your treasure must exceed the cost of your efforts. Mining for gems might pay off or it might not.
With Bitcoin mining, there is no mountain of dirt. It is all numbers and computers. But to explain the Bitcoin Mining process, we first have to understand the blockchain. So, bear with me for two paragraphs.
Blockchains are networks of connected computers that act as a gigantic general ledger, approving transactions, including purchases made with Bitcoin and other cryptocurrencies, contracts, deeds, pretty much anything that requires proof of a transaction. If I send you some money, or I buy a house from you, the transaction between us can be witnessed unanimously by all the computers currently participating on a blockchain. Proof of that transaction is sealed mathematically inside a record along with a whole lot of other transactions. This collection of transactions is called a block. That block is then sealed up, and parts of its code are embedded in the next block, thus creating a chain of sealed blocks, aka a blockchain.
I like to analogize a block in the blockchain to be like a sarcophagus. Once you lock it, metal claws or spikes poke out of your box and fuse themselves to the metal of the next sarcophagus, and the same will happen to the next. This means it will be impossible for grave robbers to break in to your sarcophagus and steal the family jewels. To get to it, they will have to break into every sarcophagus that surrounds yours in the chain, break through the fused metal and work their way backwards. That’s a lot of work that is resource heavy and easily noticeable.
So, the blockchain acts as a ledger that is immutable. The transactions recorded in a block must be witnessed by a group of connected computers. These computers must then prove they did the hard work to record the transactions. This is called a proof-of-work. The proof-of-work is really hard to get. It involves solving complex mathematical riddles that require quintillions of moves to resolve. Once a group of computers proves it has approved the transaction and provides the proof-of-work, they are paid for their efforts in Bitcoin. So, bitcoins are “created” mathematically as a result of computational effort.
Once these bitcoins have been created, they can be traded or sold. They become usable pieces of currency. Once all 21 million bitcoins have been created, then there will be no more to create.
To go back to the diamond prospecting analogy, you, the prospector, might take your bag of rough diamonds to a broker in town, who will purchase them. In that way, you have been rewarded, and you can use that money to cover the costs of your mining expedition, hopefully with a little profit left over. Often though, individual diamond prospecting becomes useless. People must band together to dig in the dirt, using tools and paying for food and lodgings as they do so. Soon it becomes impossible even for small groups to do this, and that’s when multinational diamond mining companies come in with trucks, cranes, and mining equipment. They, too, must cover their costs through successful diamond mining, but that’s where the industry is at. Bigger is better.
Back to Bitcoin mining. Bigger is better. The computational power required to solve the riddles and claim ownership of a block’s transactions requires more processing power and electricity than any one person could afford to provide. So, mining has gone to an industrial scale, using skilled labor, cheap electricity and 24/7 operations across hundreds of CPUs, whether in the same facility or pooled across the planet, to solve the riddles and generate Bitcoin for payment.
In a nutshell, Bitcoin miners are paid to perform the computational approval of transactions. The bitcoin is created or allotted through a proof-of-work. The amount, whether it is one bitcoin or a fraction thereof, is pulled from a finite pile like diamonds from the earth, until there are no more to extract, and Bitcoin Mining ends.