Mining Bitcoins

Bitcoin mining is the competitive process of collecting transactions and adding them to the blockchain in the form of blocks. Why is it called mining? The term is derived from how bitcoins are initially distributed. Although the total supply of bitcoins is capped at 21 million, this total is reached slowly over time. In the beginning, the initial supply of bitcoins was zero. Bitcoin miners receive a reward for processing other people's transactions; each reward is a small sum of newly minted bitcoins that increases the total supply in circulation. In this sense, Bitcoin mining is similar to gold mining: Earth has a fixed amount of gold, and miners slowly dig it out over time.

As mentioned earlier, miners must find a certain winning number by generating numbers at random repeatedly to win these newly minted bit-coins. Because fast computers can generate these random numbers more rapidly, this creates an incentive for miners to use increasingly powerful computers to mine bitcoins. In the very early stages of Bitcoin, personal computers were commonly used to generate random numbers, but soon people started building special-purpose computers designed solely for Bitcoin mining. Today, mining bitcoins requires significant capital, expertise, and access to inexpensive electricity. In fact, the evolution of Bitcoin mining resembles the way gold mining has changed over times. At one time unearthing gold could be done by a person panning in a riverbed, but now excavation is performed by large companies with expensive drills.

The mining reward for finding a block has two components: The first part is transaction fees. When you send bitcoins to someone, a small amount of additional bitcoins is added as a transaction fee.[1] Transaction fees are typically a few cents and are part of the reward that miners receive when they win the lottery and add a new block to the blockchain. Because a block is a collection of hundreds or thousands of transactions, the miner's reward is the sum of all the transaction fees in that new block. The second component of the reward is a certain number of newly minted bitcoins.

The number of newly minted bitcoins that is provided as a reward diminishes gradually over time. The first 210,000 blocks—which based on a 10-minute spacing took about 4 years to mine—provided every winning miner with 50 newly minted bitcoins per block in addition to the transaction fees. The next 210,000 blocks (blocks (210,001 through 420,000) reward miners with only 25 newly minted bitcoins per block. Thereafter, the reward drops to 12.5, then 6.725, and so on. Because this mining process is the only source of new bitcoins, it is the reason no more than 21 million bitcoins will ever be in circulation.

Although every four years the number of newly minted bitcoins rewarded per block halves, the transaction fees per block will continue to grow as the Bitcoin user base grows. Eventually, the user transaction fees will be greater than the reward of newly minted bitcoins. At that point, the Bitcoin network will be sustained entirely through transaction fees.

The Complexity of the Bitcoin System

Most of us are used to using centralized payment services (e.g., PayPal, credit cards). We place our trust in the companies that run those services and don't need to know how the payment system works. But Bitcoin doesn't have a company to trust; instead, we can examine the system to decide whether or not we trust it.

If you investigated the system major credit card companies use to facilitate payments, you might be surprised by how complicated it is. Because we don't normally think about how digital payment systems work, it is not unusual that the Bitcoin system is befuddling and complicated to most. After reading this chapter, you should have a fairly good idea of how the entire system works. In later chapters, we'll delve further into certain details, such as the specific hardware and programs that Bitcoin miners use; however, the overall explanation of the Bitcoin system will not change from how it is described in this chapter. From this point on, we can focus on acquiring bitcoins and thinking about how they'll impact our global economy!

  • [1] Strictly speaking, this transaction fee is voluntary, but miners may ignore transactions that have no attached fees.
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