Let’s explore what it means to mine a digital currency and why such a system needs to be present in the first place. We’ll also discuss nuanced aspects such as its profitability and potential impact on the environment along the way.
What is cryptocurrency mining and why is it so important?
The term mining in the context of digital currencies can evoke different images in your head, with parallels to the mining of gold or coal from the earth.
In reality, cryptocurrency mining is an entirely digital paradigm that simply facilitates honest collaboration among strangers. While mining sometimes generates economic value in the form of rewards, the main purpose of mining is to maintain a functioning and secure decentralized network.
If this description sounds too complicated, don’t worry, it is surprisingly simple. In the following sections of this article, let’s examine what it means to mine a digital currency and why such a system should exist in the first place. We will also discuss nuanced aspects such as profitability and possible environmental effects.
While most of this article focuses on Bitcoin mining, the same principles apply to most other cryptocurrencies. The only exceptions are digital assets that use alternative methods to reach consensus, such as Cardano.
Why is cryptocurrency mining necessary?
The first and most famous mining application concerns Bitcoin, which was created by the pseudonym, Satoshi Nakamoto. While attempts to create electronic currencies were nothing new in 2009 either, Bitcoin stood out for being the first truly decentralized currency.
Before Bitcoin was created, all currencies depended on some sort of central authority. This approach is not ideal for a number of reasons, not least because you need to trust the issuer and anyone in the hierarchy. Even a common service. Like PayPal, for example, it has complete autonomy over the funds stored on the platform and can freeze them at any time. However,
Bitcoin has flattened this centralized hierarchy. You don’t need permission from a central bank or intermediary to use it, nor do you have to sign anything. All you really need is an internet connection. And once you acquire a cryptocurrency, no one can confiscate it behind your back.
Bitcoin achieved this level of decentralization and security through an algorithm called Proof of Work. Mining is simply the real application of this algorithm. In simple terms,
Bitcoin uses a system in which anyone can propose new transactions, but these transactions are only considered valid if other network participants agree on their legitimacy. The system also guarantees that transaction passports are not processed or processed be able. reversed by someone with malicious intent, giving Bitcoin the property of immutability.
While reaching such a unilateral agreement may seem easy, it is actually an extremely difficult endeavour, especially when it comes to real money. Would you trust a group of strangers to give your money to the right person? Most likely not.
To this end, Satoshi Nakamoto believed that the only way to reach a consensus on a cryptocurrency network is to have some users work for it in exchange for a reward, and hence the system has been called “Proof of Work”.
We will examine this interplay of “work” and incentives in a later section. For now, know that everyone involved in the cryptocurrency ecosystem has an incentive to act in the best interests of the network so they are very unlikely to confirm facts.
What does mining do?
Let’s take a look at a typical cryptocurrency network to answer that question. Participants can be divided into three groups:
Users: These are end-users, participants like you and me, who send and receive money in a crypto wallet, which is essential software. This in turn forwards relevant details (such as quantity and destination address) to the rest of the network.
Nodes: Nodes are volunteer users who maintain a copy of the Bitcoin blockchain on their computers. You are also responsible for detecting new transactions submitted by users. Finally, the nodes enforce a comprehensive list of network-specific rules that all incoming transactions must adhere to. to.
Mining Nodes: They are specialized nodes that voluntarily verify the above-mentioned incoming transactions, there is no risk or an entry fee as long as the miner can bring computing power to the verification process, in return they receive compensation in the form of token rewards, transaction fees or both.
As you probably already know, there is a very clear symbiotic relationship between the three groups. Nodes do not accept illegal transactions from users. In the meantime, the miners must follow the rules of the network in order to receive their compensation.
Large amounts of computing power are neither cheap nor infinite, so miners willingly spend them wisely.