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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 science issues (read: so complex that they cannot be solved by hand). The luck and work demanded by a computer to solve one of those 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 solve these intricate math issues on the bitcoin networkthey create new bitcoin, not unlike when a mining operation extracts gold in the ground. And second, by solving computational mathematics issues, bitcoin miners create the bitcoin payment network trustworthy and protected, by verifying its transaction information. .
Theres a fantastic chance all of that only made so much sense. In order to explain how bitcoin mining works in 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 by a central bank called the Federal Reserve. In addition to a bunch of additional responsibilities, the Federal Reserve modulates the production of new money and prosecutes the use of counterfeit currency. .
Even electronic payments using the U.S. dollar are backed by a central authority. When you make an online order using your debit card or credit card, for instance, that transaction is processed by a payment processing company such as Mastercard or Visa. In addition to recording your transaction history, these companies verify that transactions are not fraudulent, and that's one reason that your credit or debit card could be suspended while traveling. .
Bitcoin, on the other hand, is not controlled by a central authority. Instead, bitcoin is endorsed by millions of servers across the world called miners. This network of computers plays the identical function as the Federal Reserve, Visa, and Mastercard, but with a few key differences. Like the Federal Reserve, Visa, and Mastercard, bitcoin miners record transactions and assess their accuracy.
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When someone makes a purchase or sale using bitcoin, we call that a transaction. Transactions generated in-store and online are documented by banks, point-of-sale methods, and bodily receipts. Bitcoin miners achieve the 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 how this happens in a second) In particular, bitcoin miners make sure bitcoin are not being reproduced, a unique quirk of electronic currencies known as double-spending.
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Once you spend $20 in the shop, that bill is in the clerks handson. With electronic currency, however, it is a different story. .
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When the numbers were identical, the clerk could know the money had been replicated. This analogy is similar to what a bitcoin miner does when they confirm new transactions. .
With as many as 600,000 purchases and sales occurring in a single day, nevertheless, verifying each of these transactions can be a great deal like this 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 was 50. In 2013, it had been 25, at the time of writing it's 12.5, and sometime in the middle of 2020 it will halve to 6.25. .
At this rate of halving, the entire 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 for bitcoin miners to really earn bitcoin from verifying transactions, two things must occur. First, they need to verify 1 megabyte (MB) value of transactions, which can theoretically be as small as 1 transaction but are more often several thousand, depending on how much information each transaction shops.