What is Cryptocurrency Mining?
Mining softwares makes guesses to solve the algorithm before other miners, to earn mining rewards.
Getting involved in cryptocurrency mining is a profitable opportunity for those who can invest in the appropriate hardware and are ready to conduct the research. $63 million in mining revenue was raised on a single day in 2021. Miners at various scales can realize lucrative returns from mining cryptocurrencies such as Bitcoin, Ripple, and Ethereum.
However, like the stock market, a successful venture relies on an investor knowing how and where to focus efforts. Even at small scales, cryptocurrency miners can get returns on investment, depending on the cryptocurrency they choose to mine, the hardware at their disposal, and how they opt to manage it.
Bitcoin introduced back in 2008 as the first decentralized virtual currency is a peer-to-peer payment system operating without a central repository or intermediaries. Since the initial transaction in 2009, it has remained the most favored cryptocurrency, although there are currently more than 1000 types of cryptocurrencies.
Every cryptocurrency transaction is recorded in the publicly distributed ledger of records or blockchain. A peer-to-peer network verifies a batch of transactions, referred to as "blocks." Every block has a timestamp and an identification "hash." The hash belongs to the preceding block in the chain.
Cryptocurrency transactions are secure since once a block is verified, it cannot be modified without altering the entire blockchain. Here is where cryptocurrency mining comes in. Miners are vital to the function of the blockchain.
Every miner validates cryptocurrency transactions and produces complaint hashes. These hashes are added to the blockchain in return for a specific amount of the cryptocurrency. Cryptocurrency miners play the role of maintaining the blockchain, record-keeping and ensuring the security of the blockchain.
A block has to contain a Proof-of-Work (POW) for the validation of each block in the chain. POW is created by generating a certain hash value. Hash values are cryptographic identifiers referred to as Secure Hash Algorithms (SHAs).
For instance, verifying a bitcoin transaction uses SHA-256. A hash is akin to a fingerprint of data. Making a hash from some data is simple. However, it is impossible to create the data from this hash. Compared to the input data, hashes will appear random.
Cryptocurrency miners utilize a lot of computing power to play the guessing game. The computationally expensive game involves attempting to guess a number that, when added to a block and run through the aforementioned algorithm, produces a hash that meets specific criteria.
It is virtually impossible to predict the hash value. Cryptocurrency mining relies on trial and error. The mining software makes billions of guesses attempting to solve the algorithm before other miners. If a miner guesses right, which usually takes about 10 minutes on average, then the block is published to the rest of the chain or network.
The computers on the networks (referred to as nodes) validate that the block meets the criteria and store the block into their blockchain. The competition resumes again with the next batch of unconfirmed transactions. The network alters the difficulty of the computationally expensive game such that a block is created every 10 minutes, regardless of the number of transactions or computing power on the network.
Cryptocurrency mining is rewarding to early adopters. The most lucrative avenue for individual investors starting in crypto mining is to research the "next big thing" in the market. This means identifying the newer currencies that are likely to deliver high returns and have longevity.
As this new currency becomes popular, it will gain value, and consequently, the mining difficulty will increase. Investors who act fast can benefit the most. Today, established cryptocurrencies hold opportunities but to improve the odds of earning a profit; miners organize into mining pools.
Mining pools combine resources enabling them to solve SHAs faster. The rewards are then shared amongst members of the mining pool. This is the most reasonable approach for a miner seeing consistent returns without the huge investments needed in computing power.
Another more accessible and ideal avenue investors can realize profitability in the cryptocurrency market is through yield farming. In the decentralized finance ecosystem, yield farming is among the most popular trends since last year. At the basic, yield farming refers to a process that enables cryptocurrency holders to earn on their holdings.
An investor deposits cryptocurrency tokens into a lending protocol and earns interest from trading fees. Some investors can be awarded additional yields from the governance token of the protocol. Yield farming functions similarly to banks loans. When banks loan out money, the debtors pay back the loans with interest. With yield farming, the investors or cryptocurrency holders assume the role of the bank in this scenario.
Yield farming utilizes idle cryptocurrencies to provide liquidity in decentralized finance protocols in exchange for returns. These cryptocurrencies are not productive sitting in exchanges and wallets. Yield farming functions with a liquidity pool (a smart contract with cash) that powers a decentralized finance market and with a liquidity provider. A liquidity provider, in this case, is any investor who deposits their funds into a smart contract.
Yield farming employs the automated market maker (AMM) model popular on decentralized exchanges. Liquidity pools are the backbone of most decentralized finance markets where users swap, lend and borrow cryptocurrency tokens. Users pay fees to the exchange, which then shares the fees with the liquidity providers (investors) based on their share of the liquidity pool.
Yield farming offers higher profits than most traditional investment vehicles such as stocks, real estate, and bonds. Investors can further increase their earnings through liquidity mining. Yield farming also has a lower barrier to entry. Investors do not need to invest in the expensive elite hardware that's necessary for cryptocurrency mining.
However, yield farming does have its risks. Below are some notable risks of yield farming:
Smart Contract Risk - Smart contracts eliminate intermediaries and provide for safer and cheaper transactions. However, they are susceptible to a bug in the code and cyber attack vectors. Exchange users can incur losses to smart contract scams.
Impermanent Loss Risk - In yield farming, liquidity providers must supply funds into liquidity pools to earn yield and fees from exchanges.
While this provides for market-neutral returns, there exists a risk during sharp market moves. This is because AMMs sometimes fail to update token prices to match market movements.
To mine Bitcoin, cryptocurrency miners need the right tools to support the venture. This means choosing the best hardware for mining, selecting a wallet to store transaction data, and the appropriate software client facilitating the mining process. Generally, miners need proper hardware, sufficient power, and a stable network to mine Bitcoin.
Bitcoin mining has become incredibly competitive. As such, the hardware is essential. Earlier bitcoin miners could use extra processing resources from their PC CPUs. As demand for processing power increases, miners have to move to graphics processing units (GPUs) and field-programmable gate arrays (FPGA).
Miners can configure this hardware to run mining-specific tasks. Recently, miners have shifted to application-specific integrated circuits (ASICs). This hardware is specifically customized for specific cryptocurrency mining. ASICs have a better energy-to-efficiency ratio and are designed optimally for speed.
As such, ASICs are a superior mining option to GPUs and FPGAs. To mine Bitcoin, miners can only use ASICs designed to solve SHA-256. This is because ASICs can only be used to mine blockchains utilizing a specific algorithm.
ASICs and GPUs consume a lot of power. With new chip iterations, efficiency is increasing, but the general power consumption is not decreasing. As such, the power density needed to run this hardware is extremely high. This is more so when miners factor in the cost of cooling the hardware.
A reliable and stable network connection is vital for mining Bitcoin. It ensures access to the network, and the blockchain itself is consistent. Miners combining resources in a mining pool must have a reliable connection to ensure their contributing processing power rewards.
Below are the steps for mining Bitcoin once a miner has the aforementioned prerequisites:
Downloading Bitcoin mining software - Miners download and install their preferred software facilitating their connection to the Bitcoin blockchain. This software distributes work to the users and adds blocks to the chain.
Joining a mining pool - Individual miners combine their computing power via mining pools. If the pool wins a block, the rewarded Bitcoin is shared between the participants of the pool.
Starting Bitcoin mining - Once a miner chooses a mining pool, they can start mining Bitcoin. They complete their connection to the blockchain using their preferred software and fill in the details of their Bitcoin wallet and their mining pool.
ASICs, GPUs, and CPUs play a very important role in cryptocurrency mining. Below is a comparison of these three types of mining hardware:
An ASIC miner utilizes microprocessors to mine a specific digital currency. For instance, a Bitcoin ASIC miner can only mine Bitcoins and other cryptocurrencies built on the Bitcoin blockchain, such as Peercoin. ASICs are designed to solve only specific hash algorithms. ASIC miners are much more powerful, efficient, and faster than GPUs and CPUs.
The advantages of ASIC mining include lower power consumption, the high hash rate for the specific cryptocurrency, a high-profit margin, and a smaller form factor (physical size) for similar performance. On the flipside, ASICs can be pricey, have low resale value, and are non-upgradeable.
GPUs, also known as video cards, are not as powerful as ASICs but have a more flexible application. Miners can mine different types of cryptocurrencies, including Bitcoin, Ethereum, and Ripple, using the same hardware setup.
The advantages of GPU mining include the ability to perform complex computation, easier sourcing, high resale value, standard hardware, and upgradability. The notable drawbacks of GPU mining include high power consumption, less overall efficiency and power when compared to ASICs, large form factors, and the inability to mine certain coins.
At the onset of cryptocurrencies, mining was conducted solely using intel and AMD CPUs on PCs. CPUs have fewer arithmetic logical units, meaning they are relatively slow in regards to large and complex calculations. Certain protocols utilize the improved processing power of today's CPUs.
Altcoins, including Zcash and Bytecoin, are better suited to CPU mining than ETH and BTC. The advantages of CPU mining include no specialized hardware requirements and an ideal entry point for beginners. Unfortunately, CPU mining consumes a lot of power and is no longer profitable with the mining landscape today.
As mining gained popularity, especially of Bitcoin, many miners find it increasingly difficult to earn returns for their mining efforts. Mining needs a lot of processing power, which is increasing all the time. This is the result of competition.
More miners attempt to solve the same SHA, and it thus becomes increasingly difficult to be the first to generate the correct hash value. This leaves joining a mining pool as the only realistic option for individual miners to earn returns. However, the major challenge to mining is the blockchain itself.
The blockchain runs on a self-regulating code. To keep the time necessary to solve each SHA at 10 minutes on average, the code adds a layer of complexity to the hash criteria. This makes finding the correct values even more difficult, with difficulty increasing after a specific period. This means that it is increasingly difficult for private miners to see returns for the amount invested.
Cryptocurrency trading is a more suitable vehicle for entry-level investors to earn money. Investors make money by purchasing and selling cryptocurrencies. The trades are conducted on cryptocurrency exchanges where traders can earn money from rate fluctuations. A trader buys cryptocurrency on a dump/light decline (at a low price) and sells when the value increases.
Trading is more suitable for entry-level investors for several reasons. Trading requires only basic knowledge of computer software and hardware, unlike mining. The barrier to entry (entry threshold) is also low.
Crypto traders don't need to invest in the high-end hardware setups required to mine cryptocurrency profitably and the power costs that accompany them. A laptop or smartphone is enough to get started. Another notable advantage of cryptocurrency trading over mining is that trading allows investors to work with multiple cryptocurrencies at once, thus providing more opportunities to earn profits.
Trading also allows for fast deposits and withdrawal from a cryptocurrency exchange. However, successful cryptocurrency trading requires proper money and risk management. A cryptocurrency trader can improve their trading balance by gradually gaining skills and experience.
While potential risks in crypto trading are higher than in crypto mining, a profitable research-based strategy, emotional control, and money management can help new investors achieve high consistent profits. The competition and entry threshold in cryptocurrency mining is incredibly high. Large mining farms force individual miners to join mining pools to earn returns.
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