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Chances are you hear the term 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 off.
Far less glamorous but equally uncertain, bitcoin mining is performed by high-powered computers that solve complex computational math problems (read: so complex they cannot be solved by hand). The fortune and work demanded by a computer to solve one of these 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. To begin with, when computers solve these intricate mathematics issues on the bitcoin network, they produce new bitcoin, not unlike when a mining operation extracts gold from the ground. And second, by solving computational math problems, bitcoin miners create the bitcoin payment network dependable and protected, by verifying its transaction information. .
Theres a good chance all that only made so much sense. In order to explain how bitcoin mining functions in detail, lets begin with a process thats a tiny 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 regulates the production of new money and prosecutes the use of counterfeit currency. .
Even digital payments using the U.S. dollar are backed by a central authority. When you make an online purchase using your debit or charge card, for example, that transaction is processed by a payment processing company like Mastercard or Visa. In addition to recording your transaction history, those companies affirm that transactions are not fraudulent, which is one reason your credit or debit card could be suspended while traveling. .
Bitcoin, on the other hand, is not regulated by a central authority. Instead, bitcoin is endorsed by millions of servers throughout the world known as miners. This network of computers plays the same function as the Federal Reserve, Visa, and Mastercard, but using a couple of important differences. Like the Federal Reserve, Visa, and Mastercard, bitcoin miners record transactions and assess their accuracy.
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When someone find out here makes a purchase or purchase using bitcoin, we predict a transaction. Transactions made in-store and online are documented by banks, point-of-sale systems, and bodily receipts. Bitcoin miners achieve the same effect with no institutions by clumping transactions together in blocks and adding them into a public document known as the blockchain. .
When bitcoin miners add a new block of transactions to the blockchain, part of the job is to make sure that these transactions are true. (More on the magic of how this happens in a second.) In particular, bitcoin miners make sure bitcoin are not being duplicated, a unique quirk of digital currencies called double-spending.
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Once you spend $20 in the store, that bill is in the clerks hands. With electronic currency, however, it is a different story. .
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If the numbers were identical, then the clerk could know the money had been replicated. This analogy is very similar to what a bitcoin miner does when they verify new transactions. .
With as many as 600,000 purchases and sales occurring in a single day, however, verifying every one of these transactions can be a lot of work for miners, which gets at one other key difference between bitcoin miners and the Federal Reserve, Mastercard, or Visa. As compensation for their efforts, miners are given bitcoin whenever they include a new block of transactions to the blockchain.
In 2009, it was 50. In 2013, it was 25, in the time of writing it is 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 costly for miners to produce.
Here's the catch. In order for bitcoin miners to actually earn bitcoin from verifying transactions, two things have to occur. To begin with, they need to confirm 1 megabyte (MB) worth of transactions, which can technically be as little as 1 transaction but are far more often several thousand, depending on how much data each transaction shops.