Just like how a stock investor should know everything about a business before buying stock, an investor or user of Bitcoin should understand the fundamentals of bitcoin mining make the best decisions.
Bitcoin mining is one of the most important processes in the infrastructure. However, it can be quite technical and many investors have not understood it well enough when they decided to invest.
Let me introduce the evolution of Bitcoin mining from its humble beginnings…
What do you mean by Mining?
In our normal use, “mining” refers to the extraction of minerals, metals and fuels from the Earth, an activity that started millennia ago. This is how many of our commodities such as gold, copper, diamonds and crude oil are produced.
By design, bitcoin was intended to simulate a scarce commodity like gold. Unlike commodities, which are physical, virtual and online resources tend to be easily copied, such as a CD full of music or a doc file.
Bitcoin has proposed a solution which is able to make virtual properties finite. This is done by using cryptographic proofs, which are hard to duplicate.
This makes it difficult to create new bitcoin and it involves a lot of work, just like in commodities mining.
In metals and natural resources mining, this work involves blasting rocks, digging up the ore, milling and extracting the resources. Production of commodities is finite, because all this work required labor, was time consuming and often difficult and dangerous.
By analogy, mining bitcoin is the process of doing work to create more new bitcoins. In bitcoin, this work is to confirm and record transactions that are made on the Bitcoin network which involves solving a computationally difficult problem that uses a lot of time and energy.
It includes putting together information from transactions in the last 10 minutes, the hash from the last block, other general information, and a number known as the “nonce”.
The aim is to trial-and-error with different nonce values until, you get a hash that is below the target value when plugged into the hashing algorithm.
These types of problems are called the Proof-of-Work (PoW), and in Bitcoin, the Hashcash PoW system is used.
The mining process ensures that the ledger of transactions cannot be easily changed by anyone, and can be checked by anyone. This ensures the security of bitcoin transactions.
Adjustable Bitcoin Mining Difficulty
Mining bitcoin is difficult, and just like mining in the real world, the difficulty of mining a resource is not constant across time.
The aim of the difficulty setting is to make the rate of production of each block roughly 10 minutes apart.
The difficulty changes based on how quickly the previous 2016 blocks have been mined.
Higher difficulty means that you will need more trials, known as “hashes”, before you find a solution solution. Computers repeatedly calculate the hash using trial-and-error to find a valid hash. When a hash calculated meets the target defined by the difficulty level, a new block is “mined”.
Due to competition, difficulty increased tremendously, and miners are constantly expanding on their hashing capabilities. Processors used for mining have become faster, more energy efficient and more specialized for mining.
Bitcoin Mining Arms Race
In commodities mining, as you mine more, there is less left in the ground, and miners have to use more advanced technologies to mine the same amount.
In the past, gold can be found by “panning”
For example, during the Californian gold rush, it was possible to extract gold from the ground through panning, a process where you use a “gold pan” to separate gold from the riverbeds.
Mining gold profitably today is a capital intensive operation
Whereas you can still do so today, most of the gold comes from big gold mining companies which use heavy machinery and buy huge gold mines, and dig deep into the ground to find ore.
Similarly, the mining of bitcoin started with small-scale hobbyists running the mining software from their computers, and has evolved into the industrial scale mining operations operated by big mining pools that we see today.
The adjustable difficulty of bitcoin mining coupled with the scarcity of new blocks and hence block rewards to miners drove an arms race by miners to increase their hashing power. This has resulted in a rapid advancement in the technologies used to mine bitcoins.
Let’s start from the very beginning, a very good place to start…
CPU mining: Humble beginnings (2008-2010)
CPUs were the first type of hardware used to mine Bitcoins
A CPU, or central processing unit, is the main executive center in a computer. It is the part of a computer which acts according to the software executed. CPU mining is the earliest form of bitcoin mining, because CPUs are widely available on personal computers.
The first CPU mining software was released by Satoshi Nakamoto, the original creator of Bitcoin, and allowed the pioneers of bitcoin to maintain the network.
Due to the widespread availability of CPUs, many people started running nodes and mined bitcoins on their computers.
GPU mining: Your hash rate looks good (2010-2012)
A GPU mining setup
The intense competition meant that CPUs quickly became outdated, and this led miners to look for faster ways to mine bitcoin.
They looked into GPUs. Also known as the graphics processing unit, these chips were made for rendering video effects. They were ubiquitous on computers as they were needed to display 3D graphics and visual effects.
A GPU was more effective at mining bitcoins because GPUs are designed for repetitive work required for graphics processing, instead of executive decision making.
As compared to CPUs, GPUs are faster at taking huge batches of data and performing the same operation repeatedly quickly.
Bitcoin mining requires repeated hash calculations to find a solution, so GPUs were more suited for mining than CPUs.
The first open-source program to enable GPU mining, was released in October 2010. This opened the doors to home miners using their GPUs to mine bitcoins.
Specialized hardware: a paradigm shift
As the competition for bitcoins heated up, so did the arms race. GPUs were insufficient to keep up with the competition. It became increasingly difficult for home miners to profit from hashing using their personal computers.
To optimize bitcoin mining, specialized hardware was developed specifically to mine bitcoins faster than ever before.
Field-Programmable Gate Array: Scaling mining power
FPGA allowed for more scalable Bitcoin mining
The introduction of FPGAs into bitcoin mining marks a transition from hardware that can be used for everyday consumer applications to specialized hardware made just to mine bitcoins faster.
FPGA stands for field-programmable gate array. It is an integrated circuit chip that can be configured by the user after manufacturing. Its functionality can be updated after delivery and the ability to reconfigure gives it versatility to be used for another purpose. Other than application in Bitcoin mining, FPGAs have been used in applications as diverse as signal processing, medical imaging etc.
At larger quantities, ASICs were cheaper
However, FPGA mining did not take off. As seen above, FPGAs are cheaper than ASICs at a small scale, due to lower R&D costs. However, the cost of each additional unit add up quickly, and they are expensive and inefficient for large-scale mining operations. FPGAs are more suitable for smaller scale testing and prototyping the ASICs which would become the main source of mining power.
They may be more versatile, but at large quantities required by bitcoin mining, costs and energy consumption made mining unprofitable.
Furthermore, the architecture of FPGAs also makes them slower than ASICs as ASICs can be more optimized for its purpose. FGPAs are also less energy efficient than ASICs, and electricity consumption is a major decision factor for many miners.
FPGAs have trumped ASICs in some fields because they had faster time to market. However, in bitcoin mining, ASIC development was so fast that using FPGAs did not result in competitive advantage.
Due to these factors, FPGA never took off, and we rapidly entered the age of ASIC mining.
Industrialized production: ASICs bitcoin mining (2012 – now)
A Bitcoin mining operation can contain thousands of ASIC units
This is where we are today, in 2016.
ASICs stand for Application-Specific Integrated Circuits. These are the source of hashing power today.
The name by itself doesn’t tell you much about what the chip actually does. ASIC refers to types of chips specifically designed for a purpose. They are designed and used in various industries for machines that have specialized functions.
In the case of Bitcoin, ASICs are chips specially designed just to calculate hashes for mining.
As of 2016, Antminer S9 by BitMain is the most power efficient miner that a Bitcoin enthusiast can buy on the market to mine bitcoins at home.
Antminer S9 is one of the fastest Bitcoin miners you can buy in 2016
Each unit is able to calculate 14,000,000 Hashes each second, with an efficiency of 10,000Mhash/J, more than twice the efficiency of its predecessor, the S7, which was released just 9 months earlier.
BitMain is not the only ASIC producer. If you are a large miner in the Bitfury pool, you might be able to get their containerized datacenter, which is a 3 TEU container sized bitcoin mining unit. The size of this unit means that it is only practical for professional bitcoin miners to purchase and use.
Bitfury’s containerized datacentre
Koomey’s Law
What really matters for many miners is not just speed, but also energy efficiency. For miners who do not have free electricity, electrical bills are the marginal cost of continuing to mine bitcoins.
Koomey’s Law: Exponential improvement of efficiency over the years
You are probably more familiar with Moore’s Law, a prediction first proposed in 1965 by Gordon E. Moore that chip performance would double every 18 months. This is a trend that has been observed in the chip manufacturing industry for more than 40 years. In 2010, Jonathan Koomey of Stanford University described the trend that “at a fixed computing load, the amount of battery you need will fall by a factor of two every year and a half.”
In Bitcoin ASIC miners, we also see an exponential growth trend:
Antminer ASICs double its energy efficiency every 8 months
However, we see a much faster rate of growth in energy efficiency. Energy efficiency of the Antminer series doubles every 8 months according to past trend with every new model so far. This is twice as fast as Koomey’s law would suggest.
Bitcoin miners become obsolete fast. As of July 2016, the fastest chips are 16nm chips, with energy efficiency of more than 10GHash/J. Given the trend, these chips will be superseded by ASICs with twice the efficiency by Q1 2017.
Furthermore, next-generation 10nm chips are expected to be produced by end 2016 to 2017. ASICs have been catching up rapidly with mainstream chip manufacturing technologies, so this development will be a boost to bitcoin ASIC performance.
The rate of difficulty increases even faster, suggesting that miners are increasing capacity by increasing the number of miners they have in addition to switching to faster miners.
Beyond PoW
Given the large number of coins traded on the markets today, there are also many different variations on the PoW algorithm proposed in Bitcoin. The most notable mining algorithm is called Scrypt, which can be found in Litecoin
Proof of stake tries to solve the problem of gradual concentration of mining power. In proof of stake, the amount of new coins you can produce depends on the amount of coins you own, and not how much you have invested in mining equipment. This concept is demonstrated first in Peercoin.
These methods do not have an arms war that escalates as fast as Bitcoin’s and hence do not have the same power consumption and environmental concerns.
The road ahead
Mining will continue to be the way bitcoin transactions will be validated in the foreseeable future. It has proved to be a resilient way to create bitcoins and verify transactions, even as the businesses that were built around it came and went.
However, the hardware arms race due to the mining algorithm have led innovators away from mining as the validating process in blockchain applications beyond virtual currency.
They are looking for alternatives to PoW, or even doing away with it completely, and only focusing on distributed ledger system proposed by Bitcoin.
Most notably, Ethereum, the cryptocurrency with the 2nd largest market capitalization, has also decided to move away from proof of work to proof of stake, which does away with the need for computational muscle power to validate. Ethereum’s solution, known as Casper, is currently under development and is expected to be released in 2017. This will end the hardware arms race in Ethereum mining.
Banks and business have been interested in using blockchain and distributed ledgers to record information. However, their needs differ from those who use bitcoin, because they prefer privacy, and they have trusted parties. This means they need a distributed ledger that differs from those of cryptocurrencies today.
Hence, these distributed ledgers will not come with mining algorithms to verify information. Instead, they would rely on transactional validators, trusted 3rd parties to validate transactions.
An example comes from R3CEV, an international consortium of banks, which includes some of the biggest names, to come up with blockchain solutions that will revolutionize the business. They developed Corda, a distributed ledger platform to record and manage financial agreements. This system does away with mining completely. It does not have an embedded cryptocurrency native to the system, and does not have hundreds of miners competing to solve a computing problem. Instead, they will rely on trusted “validators” to ensure that the transactions are correct, and only these 3rd parties have access to the information within the transaction.
Implications for an Investor
Bitcoin mining has come a long way from an early adopter mining in his room, to a multinational operation that involves specialized equipment
Whereas bitcoin enthusiasts would be able to mine to learn about bitcoin, it is very difficult for an individual miner joining a mining pool to profit from mining bitcoin at current prices.
If you are interested in mining, you must do their own calculations, taking into account electricity prices and cryptocurrency prices.
Scammers have exploited the lack of understanding of bitcoin mining to establish scamming operations. There are companies which “educate” users about bitcoin mining, and promote so called “cloud mining” investment schemes. These are generally pyramid schemes and investors will do well to stay away from them.
The best way for an individual to get bitcoin today is through a reliable exchange, like CoinHako.
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