Bitcoin Mining For Dummies
If you are reading this article, you are probably a dummy but so was everyone else until they took the time to learn about this topic.
If you are reading this article, you are probably a dummy but so was everyone else until they took the time to learn about this topic. There is an incredibly steep learning curve, but it gets exponentially easier when you get exposure to the space. In this article, I will discuss proof of work, electricity, and mining hardware, to give you some exposure to the basics of what Bitcoin mining is.
What is Mining
Bitcoin Mining solves the problem of securing a distributed network that does not rely on a central authority to function. Bitcoin Mining is the process of individuals competing with each other, trying to solve a cryptographic problem, that's generated by the Bitcoin protocol. This process is used to help secure and ensure the function of a distributed monetary network, which is Bitcoin. The more people and resources dedicated towards mining, the more difficult the protocol makes it solve the problem. Miners are incentivized to dedicate resources towards trying to solve a block with what's called a block reward. When miners mint a new block, they also bring new Bitcoin into circulation.
Why is it called Mining?
Obviously, no one is going into the ground to dig up Bitcoin, but the term mining is used because there must be energy expended to extract value, similar to mining metals. For there to be new gold mined and brought into circulation, there needs to be a massive amount of energy dedicated to going and digging up the gold. The cost to do this limits the amount of new gold coming into circulation. In Bitcoin, there needs to be a massive amount of energy dedicated towards bringing new Bitcoin online.
Block Rewards and the Halving:
When Bitcoin launched, there were no coins in circulation and coins were brought into circulation by individuals mining them. Mining is process of creating new "blocks" which is the process of processing transactions. When someone sends a transaction, they pay a fee which then enters into a marketplace for miners to process. The higher the fee, the quicker the transaction will be processed as the miners are incentivized to prioritize the higher fee. The market price of transactions is determined by supply and demand. When a lot of people are trying to broadcast transactions at the same time, it will raise the fee market. The simple way to think about a block is all the transactions that happen within a ten minute period. When a miner mines a block, they receive what is called a block reward consisting of new coins coming into circulation as well as the transactions fees. Bitcoin's creator, Satoshi Nakamoto, determined that this was the most effective to distribute coins.
"This adds an incentive for nodes to support the network and provides a way to initially distribute coins into circulation, since there is no central authority to issue them. The steady addition of a constant amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended."
-Satoshi Nakamoto, Bitcoin White Paper
When Bitcoin first launched, the block reward was 50 Bitcoin per block. At the time, Bitcoin had no monetary value, but today, that would be valued at $2 Million (calculated at $40,000 a block). This block reward is set to cut in half, every four years. This is why the event is called the halving. Today the block reward is 6.25 Bitcoin (2022).
Bitcoin's price has increased dramatically after every single halving. It has been speculated that this is a result of the new supply coming online each day getting cut in half, meaning that the overall inflation rate is dramatically reduced.
Bitcoin has a difficulty adjustment in order to keep each block as close to 10 minutes apart. If a bunch of new machines were turned on, it would increase hashrate and blocks would get minted at a quicker rate. If there was never a difficulty adjustment implemented, all the Bitcoin would have already been mined almost immediately, and there would be little to no incentive to continue mining. Bitcoin's difficulty adjustment is far more than a technical implementation, but also a very important economic mechanism, which works to protect the network. Block times vary depending on chance, as well as network hashrate. If 25% of the network went offline overnight, blocks would be solved a lot slower. This would mean that it would be more difficult to send a transaction. The same thing goes in the inverse. If there was an increase in overall network hashrate of 25%, this would mean that blocks would be getting solved a lot quicker. The difficulty adjustment means consistency and stability of the economic incentives that encourage miners to participate in competition.
History of Mining Hardware:
Bitcoin mining started on laptops, desktops and traditional servers. Today it is done on industrial computers called ASICs or Application Specific Integrated Circuit. ASICs are designed specifically for one use, and Bitcoin Mining ASICs are designed specifically for Bitcoin Mining. To put into perspective how impressive these machines are, it could take an individual about 15-20 minutes to generate one SHA-256 hash by hand. One TeraHash (TH) is 1,000,000,000,000 hashes. That means that a 100 TH/s S19 is generating 100 trillion hashes per second. Machines are constantly progressing not only in total hashrate, but also in efficiency of watts per TH (W/TH). Many people are predicting that we are reaching the peak of chip development, in regard to overall hashrate increases. However, this does not mean that the overall efficiency increases are not going to be seen going forward. Electricity is the biggest cost for miners, and if a machine will be able to produce the same or more hashrate, for less electricity, there will be a massive demand for that machine.
ASIC manufacturers, just like many industry participants, have been plagued with controversy. Many ASIC suppliers have come and gone through the years, for a variety of reasons. The biggest of which is that manufacturing ASICs is tremendously difficult. Today the market is at a crux, as a few notable hardware manufacturers such as Intel and AMD are looking at entering the ASIC market. This is a massive shift from the wild west that the ASIC marketplace has been in the past. Established players have the ability to really disrupt the industry by creating a tremendous amount of competition for companies such as, Bitmain and Micro BT, who are currently the industry leaders.
Profitability of Mining:
A typical question someone new to mining has is, "How profitable is this machine." Profitability depends on electricity cost and the network difficulty. Any machine capable of generating SHA-256 hashes will be profitable if there is free electricity. The higher the electricity costs get, the more difficult it is to make a profit. That is why one of the biggest competitive edges you can have in the mining space is not necessarily the newest hardware, but cheap and reliable electricity. The price of electricity is determined by supply/demand but also proximity to the production of electricity. Bitcoin miners are incredibly creative at finding inexpensive electricity even it means generating electricity themselves by running generators on oil and gas fields.
A miner's profitability is also highly dependent on the price of Bitcoin, as well as the network hashrate. The higher the hashrate, the more difficult it is to mine as the protocol will raise the difficulty. Also, if the Bitcoin price plummets, and hashrate stays constant, that means that the price of electricity grows more expensive, compared to the rewards you are earning. Overtime, the network hashrate grows as more participants join the market, so that means that the amount of Bitcoin earned grows smaller. Miners stay profitable as the price of Bitcoin goes up. The economics of mining are incredibly difficult and is why this industry is incredibly difficult to compete in.
Mining Hardware Prices:
It is incredibly difficult to predict the future price of Bitcoin mining rigs, just as it is incredibly difficult to predict the price of Bitcoin. Supply and demand are major factors in influencing the price of hardware, but so is shipping costs, Bitcoin price, network hashrate, etc. The current profitability of miners has a massive influence over the price of equipment as well. If a S19 was making $80 a day, the price would shoot up well into the five figures. On the inverse, if a S19 was making $5-10 a day, it would shoot back down into the lower four digits. Attempting to predict when a good time to buy equipment is incredibly difficult because there are so many variables that can't be predicted confidently.
Some things that are constant is the assumption that network hashrate will continue to go up, and the price of Bitcoin will continue to go up over time. This means that your revenue in amount of Bitcoin will most likely go down per machine, but the value in dollars of that Bitcoin may go up. Another constant that is fairly safe to assume is that every two years, a new generation of machines will be released by the major suppliers. This correlates with increased network hashrate and a decrease in dollar value of older machines.
A whole other monster is dealing with other equipment you need. Lead times on transformers, PDUs, cables, immersion equipment, and electricians to install these things can be terrible. The ASIC itself will always be the biggest upfront cost, but all the auxiliary equipment needed to power the machine is a cost too.
Solo Mining and Mining Pools:
Competition in the mining space has grown to be incredibly difficult with so many network participants. Mining pools have organically formed to help individuals navigate this. A mining pool is a business that allows individuals to join their resources together to improve their odds of winning a block. A mining pool allows payouts to be more consistent and predictable, which is incredibly important because costs are constant. Without mining pools, the barrier to entry for individuals to mine, would be incredibly high. For example, if you were mining at home with a S19, your chances of hitting a block would be about 1 in a million per day. Despite dedicating a lot of electricity towards mining, the payout may not happen. If a payout did happen, you would receive the full block reward, which is a tremendous amount of money. In comparison, when you mine with a mining pool, you will have an estimated daily reward that will allow you to expect a regular amount of income.
Solo mining is generally done today by using a pool's infrastructure, rather than setting up the infrastructure yourself. You will point your hashrate towards a pool that allows you to "solo mine", where if your particular miner hits a block, you get the full payout minus the pool fees. Most people do not do this because their likelihood of getting a reward is similar to playing the lottery.
History of Network Hashrate:
Hashrate is constantly increasing as a result of more participants in the market, as well as increase of efficiency of machines. This is a trend that we will see going forward in the future. When a new generation machine comes out and begins to get deployed, older machines start to get obsoleted. The S9 for example has been an incredibly popular machine since its release in 2016, but is now getting phased out as their profitability is dropping.
What Happens When all the Bitcoin is Mined?
The entire Bitcoin supply will be in circulation sometime around 2130. That means effectively that the Bitcoin block subsidy will go to zero and miners will be rewarded only by transaction fees. As long as people use Bitcoin, there will be a use case for mining. Bitcoin has changed tremendously in the past 13 years of its existence, and will continue to change over the next 100 years. It is not too hard to believe that . It is hard to imagine what the price of Bitcoin will look like over a hundred years from now. Also it is difficult to imagine what energy prices will look like.
Is mining bad for the environment?
Everything has tradeoffs, but when this question is posed, it's important to also compare Bitcoin to other financial systems such as fiat money. Centralized systems will always be far more efficient, but centralized systems also allow for a small number of individuals to control them, most likely at the detriment of others. Bitcoin is unique in the fact that it is not centrally controlled, does not require permission to participate, and has set rules that users can know will not arbitrarily change. Fiat means "by government decree." A country's currency is a country's currency not because it has been adopted through market conditions but instead it was decreed upon the citizens. Bitcoin for the most part is an entirely voluntary system of money that people can participate in or leave at will. Inflation is an incredibly destructive force that has caused immense devastation and will continue to cause immense devastation.
Ultimately it is up to you to determine whether or not Bitcoin has utility, and whether you deem its energy usage worthwhile. On the other hand, it is not up to you whether or not Bitcoin continues to exist and whether or not it continues to use energy. The cost to kill Bitcoin is so immensely high due to its distributed nature, as well as its proliferation, that it is incredibly unlikely that a government or set of governments would have the willpower to attempt to eliminate its use or users. Even if they tried, it is highly questionable whether they could be successful.
The Fiat apparatus is massive when you think of all the ATM's, bank branches, and negative externalities. There are massive institutions that exist to prop up and perpetuate this system that many Bitcoin users argue are a waste and market inefficiency. What makes this question difficult to engage in is that this question is not being argued in good faith or accurately represented by many in the political sphere. Most people reading this will have already made up their minds and may struggle to take a nuanced approach to begin to discuss this.