Coin Miners: The forgotten link in the crypto food chain

15 April, 2019

Imagine you are a brilliant computer programmer with an idea to create an alternative monetary system using digital currency instead of fiat. Imagine that in creating your digital currency, you decide that you should create some 20 million coins. How will you determine who gets those coins? Furthermore, how will you get those coins into circulation? The answer to both questions is the same: coin miners.

In all the talk about cryptocurrency investing, using bitcoins to gamble online, and governments considering setting up crypto payments for taxes, it is easy to lose sight of coin miners. So rarely do we talk about them that some consider miners the forgotten link in the cryptocurrency food chain. But make no mistake about it, there would be no Bitcoin, or any of the other cryptocurrencies that sprang from it, without mining.

Coin mining as an incentive

Our understanding of coin miners begins with understanding how cryptocurrencies manage coin supply. It would be neither feasible nor economically safe for a new cryptocurrency network to release all of its coins on day one. Imagine what would have happened if Satoshi had immediately flooded the market with all 21 million coins his blockchain called for.

There would have been a mad scramble to get hold of those coins as quickly as possible. Once all coins were obtained, there would have been nothing left of Bitcoin other than an ongoing accounting of coins trading hands. There would have been no incentive to keep accurate records of the trades for the simple fact that the coins would not have had any value.

As such, Satoshi only released a certain number of coins initially. That instantly gave them value. Limited supply has a way of doing that. Meanwhile, he wanted to create an incentive to maintain the blockchain Bitcoin was built on. That incentive was mining.

Satoshi created a system by which individuals and organizations could mine coins and be rewarded for doing so. He assumed that mining would provide the incentive to maintain the Bitcoin ledger from top to bottom and simultaneously give his digital coins real value that would be desired on the open market. His thinking was spot on. Using coin mining as an incentive worked so well for Bitcoin that every other cryptocurrency created since then utilizes it.

What coin miners do

The next obvious question is one of what coin miners actually do. Coin miners essentially verify cryptocurrency transactions and then modify the distributed ledger in order to make transactions permanent. Every time you deposit bitcoins so that you can play a couple of rounds of slots online, you are getting a coin miner involved in the transaction. Actually, you're getting dozens of miners involved.

The process of mining is carried out by dedicated computer servers that use sophisticated software to do the work. Those computers, known as nodes, receive data pertaining to your deposit. All of that data is encrypted. It also comes with a mathematical equation that needs to be solved. Needless to say the equation is extremely long and complicated.

Now, let's say you deposit the equivalent of $100 in Bitcoin at your favorite online casino. The data generated by that transaction is sent across the entire Bitcoin network and picked up by every computer node that mines. Those computers immediately get to work decrypting information and solving the equation. This process is known as proof-of-work.

Every time one of the computers solves the mathematical equation it declares the transaction verified. Once all the computers have finished the work and adjusted their copies of the ledger to add the information to the current block, the transaction is considered permanent and irreversible. But there's a catch: all of the computers have to arrive at the same mathematical conclusion. All the modifications to their individual copies of the ledger must also agree.

As long as that happens, your deposit is made a permanent part of the blockchain record. If all of the nodes do not agree, the transaction is aborted and the coins you attempted to deposit with your online casino are returned to your digital wallet.

How the incentive works

All of this is well and good on its own, but where does the incentive come in? Why would a person or company go through the hassle of mining coins in the first place? Because miners are rewarded for the work they do. They are rewarded with coins.

Processing transactions generates information that gets added to the blocks that form a cryptocurrency's ledger. For the record, that is where the term 'blockchain' comes from. Each individual computer node is building those blocks and then adding them to the ledger as they go. But guess what? They compete.

You may have dozens of coin miners all working on the same block simultaneously. The first miner to complete that block and add it to its copy of the ledger earns a single coin - but only after the block has been verified and agreed to by the other computer nodes. So it is a competition among miners to complete the work as quickly as possible AND get it right. If you are second in line you don't get paid. If you're first in line but get it wrong, you also don't get paid.

When Satoshi instituted this coin-mining process for Bitcoin, he created an incentive for miners to do what they do. He created an incentive for maintaining a consistent, secure, and trustworthy ledger that is very difficult to hack. And he created a system that simultaneously pays miners for their work and gradually puts new coins into circulation.

Mining is resource hungry

You may consider Satoshi brilliant for coming up with his coin-mining plan. A lot of people do. And yet, mining comes at a cost. Coin mining is a resource-hungry process that requires a significant financial investment to pull off. At least that's the way it is with Bitcoin right now. You can mine lesser-used coins without requiring as large an investment.

Back in the early days, just about anyone with a modern desktop PC and broadband internet connection could effectively mine bitcoins. You wouldn't get rich doing it back then, but you could at least mine enough to cover your costs and put a little money in your pocket. Things have changed substantially since then.

With every Bitcoin transaction that takes place, Bitcoin's blockchain ledger grows. It will keep growing in perpetuity. That means every block created requires more work by the computers processing transactions. More work requires more computing resources. That means more hard drives, more servers, more memory and, most of all, more electricity.

Today's mining servers are no longer single desktop PCs sitting in someone's bedroom or basement. A modern mining operation consists of dozens of servers, if not hundreds, housed in a data center running all the latest technology. These data centers consume tremendous amounts of electricity.

As such, mining is no longer profitable for individuals or small-time operators. At least that's the case with Bitcoin. That's why Bitcoin mining in 2019 is controlled by a limited number of very large companies that have invested millions in their hardware.

Coin prices and mining profitability

If you have a keen mind for math, you have probably already started thinking about how mining can really be profitable. After all, investing tens of millions of dollars in a mining operation doesn't make sense if you're not mining enough coins to pay your costs. If that's what you're thinking, you are spot on.

The crypto winter we have been in since autumn 2018 is starting to take its toll on the mining community. With Bitcoin seemingly unable to get beyond the $4,000 threshold, smaller mining operations are discovering they cannot mine fast enough to cover their costs. They are closing up operations one by one.

Larger miners are having trouble maintaining profitability as well, leading them to seek funding to keep them going until Bitcoin prices rebound. So no, crypto winter is not just bad news for large-scale investors; it's also bad for coin miners.

Exacerbating the current price challenge is the fact that mining actually gets harder the further along we go. This is by design. With every new coin released to the Bitcoin network, more power is required to mine the next coin. The degree of difficulty grows exponentially so as to prevent miners from accessing too many coins too quickly.

By the way, building this into the Bitcoin code was another brilliant move by Satoshi. By making it harder to mine coins the further along we go, Satoshi created a way to increase the value of individual coins over time. The harder they are to mine, the more valuable they are.

Hopefully you can now see how valuable coin miners are to the whole cryptocurrency thing. Without them, there would be no Bitcoin or Bitcoin Cash. There would be no Litecoin, Ethereum, Monero, XRP, etc. Miners may be the forgotten link in the cryptocurrency food chain, but they are a critical link that could never be removed from the chain without causing total collapse.