Bitcoin mining is the process required to create Bitcoins. While it is no longer mathematically lucrative for anyone who is not already involved, it is still a process that is worth knowing.
The thoughts associated with the term 'mining for gold' are filled with images of panhandlers sifting through the labors of their pick-axe hoping to strike it rich. The same mentality drives Bitcoin mining. Bitcoin mining has generated all of the fervor associated with the gold rush of the 1850s. However, the miners are machines rather than people and the mine is virtual rather than physical. Just like their historical counterparts, Bitcoin miners take and embrace risk in the hope that doing so will yield large profits.
Bitcoin mining refers to the use specially built machines to run a specialized program designed to perform algorithms. Speed is the key; the faster the machines perform the work, the more likely they are complete it faster than competitors and are rewarded. The analogy is very similar to a pay for performance or a piece work reimbursement system, which rewards the computer which processes updates to the Bitcoin manifest log most quickly. That log is called the blockchain and its purpose is to track the history of who owns what Bitcoin both at the present and historically. Bitcoin miners are users who agree to devote some (or all) of their computers power to processing Bitcoin transaction. Such a set-up in which many machines share the work load is referred to as a peer-to-peer network. In exchange for processing the transactions the machine which does so first is given a reward of a block of bitcoin. i
Bitcoin is a currency which is designed to transfer money from one user to another user. Initially, the brain child of Satoshi Nakamoto (pseudonymous person), the currency was initially a tech-trade curiosity. The transactions are designed to be anonymous which has led Bitcoin to be referred to as a cryptocurrency. Anonymity is ensured via public-key cryptography which utilizes both a public and a private key. Each user has a virtual wallet and the number of their virtual wallet can be seen and distributed to others. Each user also retains a private key, of which only they are aware. Rather than exchanging money either the user or seller makes a request to alter the Blockchain. That request is then processed by the Bitcoin miners and alterations are made to the Blockchain. The attractiveness of the anonymity of the exchanges has led to Bitcoin to be used as trade for black market goods and services, such as those that were offered on Silk Road.
The value of Bitcoin has been particularly volatile since its inception. Recently there has been a keen interest in Bitcoin which has caused the value of the currency to exceed $1100 per Bitcoin on 30 November 2013. ii There are several factors which contribute to the volatility of Bitcoin. First, there is no government backing for Bitcoin which means that the value is determined primarily through speculation. Speculation has been sensitive to the government attention which has resulted as a result of bitcoins involvement in illicit activity. For example, the FBI shut down of Silk Road in April of 2013 caused a dip in the value of Bitcoin. Furthermore, the Chinese government enacted legislation on December 5, 2013 that barred financial institutions from participating in Bitcoin exchanges. These attempts to regulate the use of Bitcoin resulted in dips in the speculative worth of Bitcoin and generated rumors of collapse. The largely speculative nature of the currency has lead to dramatic price volatility, which represents a large gamble for potential Bitcoin miners.
Bitcoin mining also represents a significant investment in computer equipment, infrastructure and energy. Given the importance of speed in determining who gets paid in Bitcoin mining, it is necessary to build large machines capable of processing information quickly. Machines designed to engage in Bitcoin mining sell for more than $20,000 on the open market. The machines require significant amounts of electricity to run, which offsets the profitability of Bitcoin mining. Furthermore, the machines are prone to over-heating given the large amounts of heat produced and need to be kept cool in order to run efficiently. As such, many Bitcoin mining operations tend to occur in cooler locales which facilitate the cooling process naturally via vents designed to deliver blasts of cooler air to the machines.
Over time, the decentralized network is projected to release approximately 21 million Bitcoin to miners. At this time it is estimated that 11 million the projected Bitcoin have been released into the system. New operations continue to open in order to capitalize on availability of Bitcoin and the current high speculative value of the currency. However, the rate of release is reported to be slowing and is projected to continue to slow as more become available within the network. Specifically, the reward for completing each algorithm becomes less as there are more Bitcoin in the virtual network. The slowing of the rate of release suggests that it will likely take several decades for all 21 million to be released.
The Bitcoin mining industry parallels the gold rush of the 1850s with the initial discovery of wealth causing a flood of individuals flocking in for their chance at fortune. If history proves to repeat itself, the popularity of Bitcoin mining will continue to increase but become less profitable for most and many will operate Bitcoin mines at a loss. Remember that in the latter days of the gold rush, after the big nuggets, the ones who made the money were those selling the picks and shovels and other equipment.
i) Bitcoin.it. How are new Bitcoins created.
ii) Coinbase.com. Charts