Bitcoin miners are not really miners. You knew that, right? Despite the analogy, and the existence of my very favourite block explorer (sound up!) which shows little miners literally digging up blocks, the process of creating bitcoins is more like accounting than mining.
Because Bitcoin is a purely digital protocol, there is no need to print paper money or mint metal coins, as is still the case for government-issued currencies. However, the fixed total supply of bitcoins (which will end up at 21 million, around 2140) has been designed so that issuance reduces over the 130-year period.
In very simple terms, bitcoins are created as the incentive for people to purchase and run the computers that process transactions on the Bitcoin network. Computers and electricity cost money, and creating an incentive for people to make this expenditure is a key part of maintaining a decentralized network.
The tokenomics of the Bitcoin blockchain dictate that the number of bitcoins that a miner receives as their reward for winning the race to create a block of transactions reduces over time. This reduction is dramatic: the number of bitcoins in the prize halves. The original block reward was 50BTC. Since 11 May 2020, miners have received 6.25BTC per reward. Miners’ decisions about profitability hinge on many interconnecting factors, such as the cost of electricity at their location, the conversion rate of Bitcoin in fiat currency and their investment in the specialist equipment needed.
Mining may have started out as something largely conducted by individuals running specialist software on their gaming machines, but it is now a much more corporate affair – and it’s big business.
For example, the 1-gigawatt facility in Rockdale, Texas, was sold to Riot Blockchain by Germany’s Northern Data in a deal worth more than $650 million.
Working on the principle that during the gold rush, many people got rich by selling pans and other equipment to gold prospectors, rather than digging for gold themselves, investing in various publicly listed Bitcoin miners through buying their shares has become a popular option for those who want exposure to Bitcoin profits without directly holding the cryptocurrency itself.
So, why is Bitcoin mining so specialised – and so energy-intensive?
In the very early days, the same computer may have held the copy of the blockchain data and also carried out mining, but these days, computing equipment has evolved for specialist purposes.
A number of people who hold Bitcoin or transact with it will run themselves what is known as a “full node” in order to validate themselves that transactions are legitimate – which is, after all, the purpose of a peer-to-peer payments network. When we talk about full nodes, we mean a computer that holds the entire transaction history of the Bitcoin network, and which contributes to its validity by providing a record of all payments ever made, as well as current wallet balances, and reaching agreement on a shared version of the network’s history. A light node does something similar but holds a stripped-down version of the record.
In contrast, the purpose of a mining node (or miner) is to create new blocks of validated transactions. I can’t explain this better than Andreas Antonopoulos, so I’m going to quote directly from Mastering Bitcoin, which you should definitely read if you haven’t already:
“Miners validate new transactions and record them on the global ledger. A new block, containing transactions that occurred since the last block, is “mined” every 10 minutes, thereby adding those transactions to the blockchain. Transactions that become part of a block and added to the blockchain are considered “confirmed,” which allows the new owners of bitcoin to spend the bitcoin they received in those transactions.
Miners receive two types of rewards for mining: new coins created with each new block, and transaction fees from all the transactions included in the block. To earn this reward, the miners compete to solve a difficult mathematical problem based on a cryptographic hash algorithm. The solution to the problem, called the proof of work, is included in the new block and acts as proof that the miner expended significant computing effort.”
Bitcoin’s code dictates that a new block is produced around every 10 minutes. This means that if there is a sudden influx of computing power to the network, we do not suddenly see an increase in the number of blocks being produced and an increase in the number of bitcoins being mined. Instead, the difficulty of the mathematical problem increases, so that miners have to expend more computing power and this means the supply of new bitcoins remains constant and predictable.
When Satoshi Nakamoto mined the first block on January 3, 2009, there was only one computer on the network. No specialized equipment was needed as the CPU (central processing unit) of a normal computer was sufficient.
Even after other machines joined the network, the lack of competition meant that CPUs were sufficient. In 2010, shortly after Bitcoin was considered to have an exchange rate against fiat currencies, miners began experimenting with first GPU devices such as gaming computers, and then later, field programmable gate arrays.
By 2013, interest in mining had risen to the point where companies devoted resources to developing hardware optimised for the purpose, and the first ASIC miners (application-specific integrated circuits) were created. Since then, the rising dollar value of Bitcoin has made mining more and more profitable, and companies competed to release more and more efficient and specialized devices. However, in recent years, the efficiency gains have slowed, and miners are looking to other factors than simply hardware improvements in order to optimise their profitability. Software is also important, with some firms innovating to create
One of the most important factors influencing miner profitability is the price of energy and the proximity to plentiful energy that is not required for other local use. The climate is another factor: in warmer places, as much as 40 per cent of energy usage can be consumed by cooling, which explains why some miners have decided to set up shop in Iceland, with its colder climate and plentiful sources of geothermal energy.
The majority of Bitcoin mining is carried out in China, although the USA is taking a growing share: the Cambridge Bitcoin Electricity Consumption Index uses a map to visualise how geographical distribution has changed over time. The regulatory attitude of governments is also a contributor, with miners less likely to commit to the daunting infrastructure costs if the future is uncertain.
It is impossible to mention the cost and type of electricity without mentioning the controversy surrounding Bitcoin’s energy consumption. Bitcoin’s detractors argue that the sheer quantity of energy consumed by the mining process – more than that consumed by some countries – is wasteful and dangerous, at a time when the movement towards net zero is gathering pace.
In this excellent article by Nic Carter, he argues that looking at energy consumption per transaction is inaccurate, or as he puts it: “Bitcoin’s 300,000 daily transactions and 950,000 outputs do not tell the whole story”. He suggests, along with making the point that the entire sum of human endeavour and consumption, including the entire banking system, is energy intensive, that the value of maintaining a global settlement system has an inherent worth which should be counted.
There are additional arguments around the movement away from transactions that happen on chain that will increasingly be carried out on the second layer or on side chains – see my earlier Scaling Bitcoin post – that suggest that the whole debate is more nuanced than some people suggest.
As mentioned in the intro, buying stocks in mining companies or hardware manufacturers is a popular way to gain exposure to Bitcoin either in addition to, or instead of, holding it directly Riot Blockchain, Marathon and Canaan are all listed on the Nasdaq.
It is also possible to invest privately in other companies or participate in mining pools, but as with everything else in life, scams abound and potential investors should always do their own research first.