What is Cryptocurrency Mining?

What is Cryptocurrency Mining?
TabTrader Team
TabTrader Team
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What is Cryptocurrency Mining?

Cryptocurrency mining is the process by which network participants validate a blockchain and create new units of a coin or token, increasing its available supply.

Mining cryptocurrency can involve various types of hardware, differing network rules and cost bases which depend on their personal circumstances and the exact coin being mined.

How Does Cryptocurrency Mining Work?

Cryptocurrency mining increases a coin’s supply and often runs in tandem with maintaining its network security.

The way mining works depends on the cryptocurrency itself — a Proof-of-Work (PoW) algorithm token such as Bitcoin (BTC) has an entirely different mining process to that of a Proof-of-Stake (PoS) algorithm token such as Cardano (ADA), which is ‘staked’ rather than ‘mined’.

One general phenomenon, however, is more or less common to all mining. Miners — network participants — achieve consensus in order to validate the blockchain, or ledger of transactions. In doing so, they often receive transaction fees as well as remuneration for their work, commonly called a ‘block subsidy’ or ‘block reward’, which increases the coin’s overall supply.

Mining has evolved into an entire industry within cryptocurrency itself, and especially in the case of Bitcoin has attracted considerable venture capital investment much like any other startup industry.

For individuals, however, it is generally no longer profitable to mine Bitcoin alone, as the equations involved — the ‘difficulty’ of mining — make it possible only with a large amount of specialized hardware. 

This normally comes in the form of so-called Application-Specific Integrated Circuit (ASIC) mining devices which are specifically built to mine a specific cryptocurrency. These are expensive and have a limited lifespan due to the intensity of mining 24/7, and are a major factor to consider when opting to mine privately instead of joining a mining pool or using cloud mining. 

Cryptocurrencies can still be profitably mined with GPUs — a lower-power, lower-cost hardware option — but today’s ASICs are an order of magnitude more suitable. Regardless of the blockchain concerned, miners have a cost basis, and a dramatic decrease in a cryptocurrency’s price can cause them to stop operating due to financial losses, impacting network security.

Cryptocurrency mining is therefore constantly in a state of flux, adapting to both external conditions and changes in network usage.

Different Methods of Cryptocurrency Mining

Cryptocurrency mining is not the same everywhere, and different algorithms employ different mining processes.

With Bitcoin, a PoW cryptocurrency, miners compete to be first to produce a “hash” for each block of transactions. This gives rise to the term “hashrate,” which refers to each miner’s ability to produce these hashes. Once this is done and the network accepts the hash as valid, the block of transactions is validated, earning the winning miner that block’s transaction fees and block subsidy, currently 6.25 BTC as of June 2022.

The competition involved is what gives Bitcoin’s algorithm its name — without dedicating resources to produce a result, the ‘work’, miners cannot participate in validating the blockchain.

Contrast this with PoS mining, which is in fact difficult to call ‘mining’ at all due to the fact that there is hardly any energy expenditure in return for receiving coins.

PoS mining comes in all shapes and sizes and the exact method depends on the coin itself. Generally, PoS miners use their existing coins — their stake — to have the right to validate the blockchain and receive a percentage of the outstanding supply as a reward, along with transaction fees.

It is thus the size of one’s holdings, not one’s hashing power, which is the clinch factor in PoS mining.

Mining Pools

As time goes on and cryptocurrencies gain popularity, the cost of mining them has increased relative to the cost of electricity, hardware and other contributing factors.

Because of this, individuals who would otherwise not be financially capable of turning a profit on their own group together in order to ‘pool’ their hashing power or stake. Their combined input makes it more possible to validate transactions and they share any rewards which result.

Such setups are known as mining pools, and they are by far the most common mining entity for the majority of popular cryptocurrencies.

As with investment, Bitcoin mining pools have become an industry in their own right, with the largest players presiding over huge amounts of combined hashing power from a worldwide distributed network of hardware and participants.

Those who do not have hardware themselves, however, can still participate in cryptocurrency mining. To do this, they usually use cloud mining, where they pay a service provider to lease mining hardware and essentially do the mining for them. 

Is Crypto Mining Profitable?

Bitcoin mining profitability

The financial profile of mining has changed over the years. In the early days of crypto, there were so few miners and such low trading values for major coins that competition was much lower.

PoW competition required less power and thus less capable hardware. Bitcoin’s network difficulty, for example, was a fraction of what it is today.

Individuals could turn a profit simply by using home computers to validate blocks, with the period that that was possible varying by blockchain.

As such, mining is not only profit; it has costs attached, and these vary by both mining algorithm and circumstances unique to each miner.

For Bitcoin’s PoW algorithm, investment is required in the form of mining hardware, power to run it and associated costs.

PoS, however, rewards miners based on the amount of the token they pledge as collateral to participate in validating transactions, reducing the initial costs in terms of hardware and power. 

A standard computer processor is now all but useless for solo physical mining; a miner requires a specialized piece of equipment called an application-specific integrated circuit (ASIC) mining rig. These are both expensive and have a limited profitable lifespan due to changing conditions on the blockchain, and should thus be viewed as a constant, rather than one-off investment.

Electricity costs

Electricity costs also vary from location to location. It may be that a mining rig is placed somewhere where power is not consistently available or is rationed, something which could severely impact profitability of even the most efficient machines.

Concerns over power consumption are also a key factor in determining legislative approaches to mining, and authorities in some countries have been known to target miners they consider to be destabilizing fragile power grids.

Regardless, in today’s circumstances it is unlikely that the average prospective miner could turn a profit on their own. Now, the norm is to join a mining or staking pool to increase the odds of validating a block and receiving a portion of the attributed rewards.

Cloud mining is also an option for those who do not wish to purchase and maintain hardware. Here, customers pay a mining provider to act on their behalf.

Crypto price action

While hardware and electricity costs can be calculated and budgeted for in advance, one variable that cannot be is the market price of the token being mined. 

Crypto is famous for volatility, and large market swings can completely change a miner’s profitability profile over a period of months, weeks or even days. 

Miners’ so-called production cost is thus of key importance, not only to them, but to a cryptocurrency’s blockchain security. Taking Bitcoin as an example, too high a production cost relative to spot price forces miners to quit, reducing competition and decentralization. The self-adjusting Bitcoin mining difficulty is the protocol’s answer to balance miner participation with price.

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Trading mined coins

Miners can help offset price volatility by trading units of a token gained by being involved in the mining process.

This could involve trading BTC for stablecoins, for example, reducing uncertainty over expenses in the future.

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Algorithm changes

A rare but not impossible scenario is that a cryptocurrency changes its algorithm. 

A key example is Ethereum (ETH), which as of 2022 is transferring from PoW to PoS, a project known as Ethereum 2.0. Here, mining will be deliberately penalized to make staking more attractive — difficulty will increase so much (an event called the “difficulty bomb”) that mining ETH will no longer be economically viable. 

As such, ETH miners will need to sell their hardware or migrate to another cryptocurrency. 

Such algorithm changes are rare, and Ethereum’s has been years in the making. As attitudes towards PoW, PoS and others change over time, it is probable that the desire to “migrate” between algorithms will remain less popular, not least due to the costs involved for all participants in the process.

What is a Cryptocurrency Mining App?

When it comes to cloud mining, there is more to the sector than meets the eye.

Over time, businesses have appeared seeking to make what was once a highly technical field more mainstream orientated. 

If ten years ago users were (and are still) managing mining rigs remotely using command line prompts, in 2022, there are ways of mining straight from a phone without any hardware maintenance or even ownership involved.

This is where cryptocurrency mining apps come in. These apps perform various functions based on the product itself.  

For example, Kryptex Miner pays users to dedicate their spare computing power to mining, making use of idle processing activity and thus converting otherwise wasted electricity into cryptocurrency.

NiceHash, arguably one of the best-known mining products, also allows customers to use their standard domestic computers to control hash rate which they can then direct towards major mining pools.

Is it Legal to Mine Cryptocurrency?

As with other aspects of cryptocurrency, mining faces a changing legislative environment around the world.

While governments turned a blind eye to the industry in its early days, recent years have seen lawmakers take a stance, and this stance varies considerably by jurisdiction. 

Famously, has China sought to rid itself of cryptocurrency mining altogether, a move which has reportedly had mixed success. Bitcoin miners moved their operations to the United States, but even there, policy looks different from state to state.

As of June 2022, New York is in the process of attempting to ban PoW mining over concerns about its power consumption. 

Elsewhere, hostile official attitudes to mining revolve around various issues such as destabilization of old or poorly-maintained power grids. Some countries ration electricity, and this presents problems for miners who require a stable source of power 24/7. 

The issue of how to tax mining profits is also a topic of debate. Too high a tax rate and a miner could see their profitability destroyed at the final stage of the process.

Anyone seeking to mine must thus consult local laws regarding both mining itself and the tax requirements related to the profits that result.

Cryptocurrency Mining FAQ

What is mining cryptocurrency?

Cryptocurrency mining is the process of validating transactions on a cryptocurrency’s blockchain in return for new units of that cryptocurrency and other rewards.

How does mining cryptocurrency work?

Mining cryptocurrency works in different ways depending on the coin. Bitcoin miners compete to solve complex equations, while Proof-of-Stake miners earn the right to validate blocks based on their holdings.

Is mining cryptocurrency legal?

The legality of mining cryptocurrency varies around the world. Some countries have no restrictions, while others have imposed a full or partial ban on the practice. 

What does mining cryptocurrency mean?

Mining cryptocurrency tends to refer to generating new units of a coin or simply earning units by validating transactions on its blockchain.

What happens if a coin changes its mining algorithm like with Ethereum 2.0?

A cryptocurrency swapping one algorithm for another implies significant upheaval for miners. Ethereum 2.0, as a PoS blockchain, will make PoW miners redundant unless they adapt — their PoW rigs will no longer be profitable for mining ETH at all. While a major event, algorithm changes are a rarity among popular cryptocurrencies.

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