5 "Bitcoin mining explained"

5 "Bitcoin mining explained"

When I previously heard the word mining, I was associating this with physically digging for gold. Bitcoins are not physical, but we still mine them. The similarity is in the fact you have to put in the effort to produce new bitcoin. Not all Bitcoin has yet been brought to light, just as there is still gold to be excavated. The Bitcoin protocol is programmed in such a way that no more than 21 million bitcoins will exist. What the miners do is mine the bitcoins a little by little. The miners are creating blocks with validated transactions and including them in the Blockchain. As a reward, they receive newly mined bitcoin.

To understand mining, we also have to talk about what a node is. A node is a powerful computer that runs the Bitcoin software and helps keep Bitcoin active by participating in information forwarding. All you have to do to run a node is download the free Bitcoin software. All the nodes keep a copy of the full Bitcoin ledger with all the transactions and send this ledger to other nodes, which also pass the information on, etc. In this way, the data is spread over the entire network. There are a lot of people around the world that hold such a copy. There isn't one computer, system, or authority that controls it. This is why we call Bitcoin decentralized.

Some nodes are mining nodes (also called miners). This group adds open transactions to the ledger in blocks and then adds them to the Blockchain. A basic explanation of this is; they solve a complicated mathematical puzzle part of the Bitcoin code. Bitcoin miners solve the puzzle by finding a number. The code is written so that it is impossible to predict what the output will be. So, miners guess the number. It obviously is more complicated than this, but just to keep the explanation simple.
The first miner that solves this puzzle announces his win to the rest of the network. All other miners immediately stop working on that block and try to find the number of the next block. As a reward for his work, the winning miner receives bitcoins. At the moment, the reward for the winning miner is 6.25 bitcoins. The number of new bitcoin rewarded to the miners gets cut in half every four years. This event is called the halving. As the halving event approaches, miners need to sell more bitcoin they have mined to remain solvent, which usually holds back a price increase. The growing demand from long-term bitcoin holders adds to the price rising again, and since miners are paying electrical expenses denominated in fiat, they can stay profitable.

Think about gold mining companies globally finding half as much gold, but only every four years. There would be less gold sold by miners, and the price would go up. If you know the supply will get tighter every four years, the miners will hire more workers to front-run the future gains. This would cause an increase in supply, more selling, and torpid prices in the short term.

Bitcoin has found a way to make the amount that can be mined more challenging to find, relative to the number of ‘people' working each day. There is no difference in the number of new bitcoins issued per day, irrespective of how powerful they are. It is no different if 10 or 1 million people show up to mine. They will still mine the same amount every day.

Another factor in solving this puzzle is the difficulty of the calculation. This is adjusted every two weeks to make sure it takes about ten minutes on average to process a block. Which ensures a steady and diminishing stream of new bitcoins until it reaches the maximum of 21 million.

Bitcoin is designed to slowly enter the existing financial system and eventually take over as a global reserve asset. If it happens too quickly, there will be attempts to shut it down. But if it happens slowly and volatile enough, deep penetration is possible. A lot of time, effort, and money have gone into making bitcoins. When you combine this with the fact that Bitcoin is scarce, its network is growing on a global scale, and that it is decentralized. That is why I believe Bitcoin will have an enormous impact in the coming years.