Cryptocurrency has offered tech enthusiasts and anyone looking to generate an additional source of income the ability to earn extra money for themselves. Some of the ways that people can generate extra money for themselves is staking, yield farming, liquidity mining, and the one that will be covered in this article – cryptocurrency mining.
What is a Cryptocurrency?
A cryptocurrency is a digital currency built on top of a blockchain network, which is a distributed network of computers that each hold a copy of all of the transactions on the network.
These digital currencies have enabled seamless cross-border payments and have opened up access to a financial framework for people that were not able to get access to the traditional financial framework.
A feature that has everyone excited about blockchain networks is that these networks are not owned or maintained by a central company or organization. Instead, these blockchain networks and their coins rely on internal network validators to process and verify transactions in the network, as well as ensure the security and integrity of the information stored on the blockchain.
Cryptocurrency Mining Defined
Cryptocurrency mining is the process of verifying transactions on a blockchain network and earning rewards for doing so. These rewards are paid in the native cryptocurrency of the network that is being mined. For example, mining the Bitcoin blockchain will payout rewards in bitcoin.
Mining is possible on blockchain networks that implement the Proof of Work consensus mechanism, with the most popular blockchains to mine being the Bitcoin blockchain and the Ethereum blockchain.
What is a Consensus Mechanism?
A consensus mechanism is a critical part of every blockchain network and is sort of like the rule book for a blockchain network that defines how transactions are processed and validated, and sometimes which nodes in the network get to process transactions for a given time period.
There are several consensus mechanisms employed in the blockchain space, and each network may not use the same consensus mechanism as the other. However, the two most popular consensus mechanisms in the market are Proof of Work (PoW) and Proof of Stake (PoS). Proof of Work is the consensus mechanism linked to cryptocurrency mining.
What is Proof of Work?
As mentioned, Proof of Work is the first consensus protocol used in a blockchain. It was the first protocol to enable an autonomous and distributed network. The premise of Proof of Work is that nodes in the network compete with each other to see who can calculate the hash of the next block on the network first.
To calculate this hash, each node in the network takes a bunch of information including a batch of unprocessed transactions, the hash of the previous block, a random value called a nonce, and other network information. It then pushes this information through a hashing function. This hashing function then generates an output.
Now, the network sets a value called the difficulty. The reason for this is to set the difficulty of calculating the hash for the next block. By having a difficulty value, the network is able to increase or decrease the difficulty depending on the collective computing power of the nodes in the network. This is done to keep the average block formation time relatively consistent.
Once the nodes get the output from the hashing function that they pushed the information through, the network compares each node’s output to the set difficulty. If one node’s output is lower than the difficulty set by the network and lower than any other node’s output, then that node wins the competition for that round.
The whole process repeats for all of the next blocks. This is repeated indefinitely as each new block gets appended to the network. Each node tries different values for the nonce until they get an output that is lower than the network’s difficulty.
Now that we have taken a look at what Proof of Work is, let’s take a look at some of the pros and cons of the consensus protocol.
Proof of Work Pros
The Pioneering Consensus Protocol
Proof of Work is the first blockchain consensus protocol that was used to enable fully-distributed networks. It is also used as the basis for most of the newer consensus models.
Difficult To Hack
In order for a cyber criminal to gain control of a Proof of Work network, they will have to find a way to control 51% of the nodes in the network. This is called a 51% attack, and is not financially feasible to carry out with large Proof of Work networks.
The main reason for this is because the cost and effort to gain control of 51% of the network far exceeds the financial reward for doing so. Furthermore, with very large networks, such as Bitcoin, it is extremely difficult to simultaneously gain control of 51% of the nodes in the network.
Proof of Work Cons
Low Throughput
A blockchain network’s throughput refers to how many transactions can be processed per second by the network. A Proof of Work blockchain is unable to achieve the throughput required to handle large volumes of transactions.
Let’s take a look at Bitcoin, the most well-known Proof of Work blockchain, as an example. Bitcoin can currently only achieve a throughput of 4 transactions per second. Compared to other blockchain networks, Bitcoin has the lowest throughput of them all, and we see that blockchains with other consensus protocols achieve at least three times the throughput of Bitcoin.
Large Environmental Impact
As the difficulty on the Proof of Work network increases or the network begins to scale, so does the impact that the network has on the environment. This is because more computers or nodes enter the network, which increases the collective energy demand of the network.
Centralization of Rewards
If a node, or group of nodes, guesses the correct hash for the next block on the network they will receive a network reward for the work that they did. The more computing power a node has, the better their chances of winning a reward in the network are.
With networks as large as Bitcoin, it’s almost impossible for a single node to stand a chance at winning a reward because of the collective amount of computing power of all of the nodes in the network. To increase their chances of winning rewards, individual miners contribute their computing power to a mining pool.
This way they have a better chance at winning a reward. However, the rewards in the network are still fairly centralized due to large tech companies spending billions on computing power and nodes.
These tech giants earn a majority of the rewards in the network without having to join a mining pool, meaning that they get to keep everything that they earn without having to pay pool fees. Not only does this make the network rewards more centralized, but it also raises the barrier to entry for anyone that wants to mine cryptocurrency.
Components of Cryptocurrency Mining
When it comes to estimating the profitability of cryptocurrency mining, there are several factors to take into consideration. This includes the cost of electricity to power the mining machines, the availability and price of machines, and the mining difficulty of the network.
Hash Rate
The hash rate measures the rate of solving the problem and the difficulty changes as more miners enter, as some blockchain networks are designed to produce a certain number of their native cryptocurrency at network-defined intervals. This difficulty increases as more miners enter the network to ensure that the number of the native cryptocurrency remains the same.
Due to the fact that each hash is created randomly, it is impossible to predict what the next hash will be. It may sometimes take a million or more guesses before the target hash is met and a miner wins the right to fill the next block and append it to the network.
Each time this happens, a block reward of newly minted coins is given to the successful miner along with any fee payments attached to the transactions stored in the new blocks.
ASIC
Before the advent of the cryptocurrency mining software, early miners used personal computers and were able to generate a profit. Miners owned their systems, so equipment costs were negligible and they could change the settings on their computers to run efficiently.
Also, professional cryptocurrency mining centers with massive computing power had yet to begin. Miners competed only with other individual miners on home computer systems.
In 2013, a China-based computer hardware manufacturer called Canaan Creative released the first set of application-specific integrated circuits (ASICs) for bitcoin mining. Individuals were competing against powerful mining rigs with more computing power.
Mining profits were therefore slashed by the growing expenses for computing equipment, higher energy costs, and the continued difficulty of mining.
Cryptocurrency Mining Difficulty Rate
To ensure blocks in a Proof of Work network are discovered at every network-defined interval, an automatic system is in place that adjusts the difficulty depending on how many miners are competing to discover blocks at any given time.
The difficulty rate is a measure of how difficult it is to mine a block in a network or to find a hash below a given target. The higher the difficulty rate, the less likely it is that an individual miner can successfully solve the hash problem and earn the cryptocurrency native to that specific network.
The rate associated with mining some cryptocurrencies is variable and changes every few days or weeks to maintain a stable production of verified blocks for the blockchain.
In recent years, the mining difficulty of the cryptocurrency market leader, Bitcoin (BTC), has skyrocketed. When Bitcoin was first launched, the difficulty was 1. As of June 2022, it is more than 30 trillion, confirming the growth of difficulty associated with mining compared to a decade ago.
Profitability
Mining some cryptocurrencies remains profitable for some individuals since equipment is more easily obtained, although competitive ASICs’ costs vary from a few hundred dollars up to about $10,000. To stay competitive, some machines have adapted. For example, some hardware allows users to alter settings to lower energy requirements, thus lowering overall costs.
Prospective miners should perform a cost-benefit analysis to understand their break-even price before making the fixed-cost purchases of the equipment. Variables to consider include cost of power, efficiency, time, and the market value of the cryptocurrency that you’re looking to mine.
A profitability calculator, such as the one provided by CryptoCompare, helps would-be miners analyze the cost-benefit equation of cryptocurrency mining. Profitability calculators differ slightly, and some are more complex than others.
Mining Pools
To compete against the mining mega centers, individuals can join a mining pool, which is a group of miners who work together and share the rewards. This can increase the speed and reduce the difficulty of mining, putting profitability within reach.
As difficulty and costs have increased, more miners have opted to participate in a pool. Although the overall reward decreases among multiple participants, the combined computing power means that mining pools stand a much greater chance of actually completing a hashing problem first and receiving a reward.
Two common payout methods used in cryptocurrency mining pools include proportional mining and the pay-per-share method. In a proportional mining payout method, miners receive rewards proportional to the amount of effort expended by them in finding a block.
The payout amount also depends on whether the pool finds a block and this payout method is profitable during times when the price of the cryptocurrency that you’re mining surges.
The pay-per-share method distributes payouts based on the mining power of the entire pool and is the opposite of a proportional mining system. A miner’s share is determined not by their effort but by an equitable division of the rewards received by the pool.
A miner receives their reward regardless of whether the pool finds a block. Since it guarantees a flat fee, this payment model is best suited for periods when the cryptocurrency prices are low.
To answer the question of whether cryptocurrency mining is still profitable, you can use a web-based profitability calculator to run a cost-benefit analysis. Determine if you are willing to lay out the necessary initial capital for the hardware and estimate the future value of the cryptocurrency as well as the level of difficulty.
When both the cryptocurrency’s prices and mining difficulty decline, it usually indicates fewer miners and more ease of receiving the cryptocurrency. When prices and mining difficulty rise, expect the opposite—more miners competing for fewer coins.
Current Bitcoin Mining Landscape
According to recent research, Bitcoin mining is a highly concentrated business, with 10% of bitcoin miners controlling 90% of mining capacity on Bitcoin’s network. Even more telling is another statistic from the research: 0.1% of all miners own 50% of the network’s mining capacity.
This means that bitcoin rewards are distributed disproportionately in bitcoin’s network. When you sign up to mine independently, bear in mind that you are competing against established outfits that have enormous capacity, amounting to megawatts, at their disposal.
The Merge
The Ethereum blockchain is the most popular blockchain to mine on because it has a lower barrier to entry than mining the Bitcoin blockchain. However, the Ethereum blockchain is in the process of transitioning from Proof of Work to Proof of Stake. This will make the Ethereum blockchain more scalable and lessen its impact on the environment.
This shift in consensus means that Ethereum mining may no longer be possible to take part in since Proof of Stake does not support blockchain mining. The available options for mining will then be Bitcoin (BTC), which has a higher barrier to entry, and smaller capped coins that may not yield adequate mining returns.
Is Cryptocurrency Mining Worth it?
The biggest thing to keep in consideration when deciding whether to start cryptocurrency mining or not is the cost of the electricity that will be required, as this will impact how long it will take for you to start generating a return on investment after breaking even.
Furthermore, on average, there is a new and more superior ASIC miner that enters the market around every 18-24 months. Fortunately, it is possible to find an ASIC machine that generates an acceptable profit for two generations of ASIC machines – giving you a longer period to earn a profit after breaking even.
Mining machines are also high maintenance somtimes and require cooling solutions. The large repetitive computing task sometimes leads to mining machine breakdowns.
To Recap
Cryptocurrency mining is the process of verifying transactions on a blockchain network and earning rewards for doing so. These rewards are paid in the native cryptocurrency of the network that is being mined.
Cryptocurrency mining may be expensive to get started with if you want to generate a good nett return on your investment. If you do get started, it is best that you join a mining pool to increase your chances of processing a block on the network and earning a reward.
The best blockchains to mine in terms of profits are the Ethereum blockchain and the Bitcoin blockchain. However, Ethereum mining may soon no longer be possible with the chain’s transition from Proof of Work to Proof of Stake.
