Many aspects of Bitcoin echo the core characteristics of gold.
Gold is scarce, hard to mine and a great store of value. Bitcoin emulates these traits as best it can. It’s scarce, as only 21 million Bitcoins will ever exist, it’s hard to mine, and it has quickly become a great store of digital value in this ever-progressing digital world.
Mining can be a weird concept to get your head around but, before ploughing into it, we’re going to go into a bit of background using the Bitcoin network as an example.
Every time a transaction is made, the details of that transaction get stored in a block. Every ten minutes we have a new block filled with all the transactions made during that ten-minute period. Imagine holding a bucket under an ice dispenser for ten minutes and every ice cube dispensed being a transaction. At the end of that ten-minute window, the bucket would be sealed and replaced with a new bucket. Each bucket (or block) is then added to the chain of buckets before it, thereby creating a blockchain.
Now imagine that this blockchain is simply a spreadsheet that details a big list of blocks: open source, decentralized, transparent and immutable. That’s the basics of blocks and a blockchain. Currently, Bitcoin blocks are 1 megabyte in size and contain an average of 2,000 transactions.
Rewarding the bitcoin miners
This is where the miners come in. They act as auditors. They go through every single transaction and verify it. But in order to motivate people to verify and keep the blockchain audited and functioning, you have to reward them. The way this works is that every block has a password and whoever comes up with the closest guess within a ten-minute timeframe wins the block and gets rewarded.
The creator(s) of Bitcoin wanted to make it a scarce and a deflationary asset like gold, so they programmed the Bitcoin algorithm to decrease the reward paid out for each mined block over time. At the start, the reward was 50 Bitcoins per block, but it halves every four years. As of November 2017 the reward is 12.5 Bitcoins. The algorithm will get harder and harder, with ever-decreasing rewards until the last Bitcoin is mined in the year 2140.
This is a bit like me writing down a number between 1 and 1,000, putting it in an envelope with 12.5 BTC (Bitcoins), then giving a group of friends ten minutes to guess the number. They can have as many guesses as they like and, at the end of the ten minutes, whoever guesses it first, or gets closest, wins. The guess has to be either equal to or lower than the actual number to count. In the event of a draw, whoever made the most guesses and put the most work in wins the reward. It’s called a ‘proof of work’ system and it’s extremely energy-intensive.
Back in the real world, miners have to guess a 64-digit hexadecimal password – in other words, a password that includes numbers and digits and looks something like this: 0000000000000000032frc108cf6130q99i27c5702303e1w169tt50m7pl3338eb. As you can imagine, it takes a lot of computing power to guess something like this and, as time goes by, it’s becoming increasingly difficult to be a profitable miner unless you have an expensive, fully dedicated mining rig. A mining rig is basically a large number of specially designed single-purpose GPUs that just crunch numbers in order to guess as many combinations as possible. The biggest cost is electricity. It burns through it and the rig produces a lot of heat, so you need to spend more on cooling equipment to prevent it from burning itself out. That’s why so many of the world’s biggest mining operations are either done in cold countries like Iceland or in areas where electricity is cheap, either through government subsidies or hooked into renewable energy plants like dams and wind turbines. Gone are the days where you could mine a few hundred Bitcoin from your laptop.