Have you ever wondered where Bitcoins come from? How do they go into circulation? Well, Bitcoins are mined into existence. So, we can say that Bitcoin mining is a process by which transactions are added to the public ledger after verification. This is also the means where a new Bitcoins are released. People with suitable hardware or an internet access can take part in the mining.
During the mining process, the recent transactions are compiled into blocks and then try to solve a puzzle that is computationally difficult. The participant who manages to solve the puzzle gets the first chance to place the other block on the chain to claim the rewards. Rewards usually incentivize mining and may include a newly releases Bitcoin or the transaction fee that is paid to the miner.
So are the puzzles hard? Well, that usually depends on the effort that is put in 1the entire mining process across the network. It’s possible to adjust the mining difficulty, and this can be achieved by adjusting the protocol after each two weeks or every 2016 blocks. The difficulty can adjust itself so as to keep the block discovery rate constant. This means that if more computation power is applied in the mining, its difficulty will adjust itself upwards making the mining harder. Also, in case the computational power is removed from the network, the difficulty will adjust downwards making the mining easier.
If the difficulty level is higher, mining becomes less profitable. Thus, if more people are mining, it becomes less profitable for each participant. The Bitcoin price, block reward, and transaction fees also determine the total payout.
How was Bitcoin mining done in the early days?
During the early days, miners made use of CPUs for the desktop computers. Graphics processing units (GPUs) or graphical cards are efficient at mining compared to the CPUs. This has helped in making Bitcoin more popular. Graphics processing units became dominant and then hardware known as Application-Specific Integrated Circuit (ASIC) was designed purposely for mining Bitcoin. The first ASICs were released in the year 2013, and various improvements have been made on them ever since. Today, there are more efficient designs that have come to the market.
Because Bitcoin mining is becoming more competitive day by day, one has to use the latest ASICs. Making use of the CPUs, GPUs or the old ASICs will end up increasing the energy consumption costs and the revenue generated will be minimal.
The mining rewards are given to the miner who manages to discover the puzzle first. The probability of the participant to find the puzzle solution is equal to the total mining power portion on the network. Participants who have a small mining power percentage have the minimal chance of discovering the blocks on their own. For example, in the case of an individual having a mining card that can buy a couple of thousand dollars, this will represent less than 0.001 percent of the mining power in the network. Such a small chance of finding the next block isn’t sufficient enough to guarantee a win. The miner might never be able to recoup their investment. So the solution to such a problem is mining pools.
The mining pools are run by coordinate groups and third parties of miners. When participants work together in a pool, they share the payouts amounts among themselves and miners can get a stable flow of Bitcoins starting from the day they have activated the mine. You can find some statistics about the mining pools at Blockchain.info.
The operational costs for Bitcoin mining are mainly power and hardware costs. They are used for offering adequate ventilation and cooling and for running the miners. Most mining operations are normally located near cheap electricity on purpose. This is because a lot of electric power is needed during the mining process so the cheaper the electricity, the more the revenue.
The IRS recently issued tax guidance in regards to the Bitcoin and claimed that the income can constitute to self-employment income so that it could be subjected to taxation. The Fin CEN (Financial Crimes Enforcement Network) has already issued a guidance claiming that the Bitcoin miners aren’t considered to be money transmitters. This is as per the Bank Secrecy Act. Also, the providers of the cloud mining services aren’t considered as money transmitters too.
The bottom line
The mining of Bitcoins is the only way in which new Bitcoins are brought into circulation, and the total will be capped the day 21 million Bitcoins are mined. The miners are in a race to deploy the current Bitcoin mining chips, and they prefer doing the mining at places that are near cheap electricity. Since more computing power is being utilized in mining, the puzzles difficulty keeps increasing, hence keeping the profitability in check.