Understanding Cryptocurrency Mining

Austin Knight: Welcome to the DecryptingCryptoPodcast! This is Series 1, Episode 4. We’re gonna be discussing how you can understand mining. I’m Austin Knight, and I’m joined by my co-host Matthew Howells-Barby.

Matthew Howells-Barby: Hey, Austin! Hey, everyone! So we’re gonna be talking about mining today. And honestly the best way to think about mining is mining’s like the farm-to-table of cryptocurrency. We showed you in Episode 2 how you can get some of those delicious bitcoins into that wallet of yours. Now we’re gonna actually help you to learn where they actually come from.

Austin Knight: We’re gonna do this by discussing the three major functions of mining. First, how new coins are release into circulation. Second, how transactions are processed on the blockchain. And third, how security is provided to the network.

Matthew Howells-Barby: Right. And this is a pretty technical topic. And I have to be honest, me and Austin have like bounced back and forth a lot on how do we distill this down into something that doesn’t just sound like complete gibberish. So bear with us a little bit during this episode. We feel pretty good that we’ve got enough though that’s gonna give you a good enough grasp of mining that you’re gonna at least be able to figure out that it’s not someone digging with a shovel in their backyard and getting some bitcoins out of the ground.

So, let’s start a little bit here with what actually are some basics behind blockchain technology. We’ve talked a bit about this in a few previous episodes, and we’ve been hinting towards us covering what is blockchain in a bit more detail. And I wanted to talk about this in the context of a payment for some goods being made with bitcoins. We’ve talked in Episode 1 how you would transfer some bitcoins in relation to how you transfer normal USD. We haven’t actually talked about how you kind of pay for something.

So let’s imagine we’re gonna buy some coffee and we’re gonna pay for that with bitcoins, which coincidentally you can do in some places. Funny story, not to go on a tangent. I saw recently an article that KFC in Canada … I’m not sure if you heard this Austin … KFC in Canada released the Bitcoin Bucket, where you can get a bucket of Kentucky Fried Chicken for $20 worth of bitcoin.

Austin Knight: Nice.

Matthew Howells-Barby: Oh!

Austin Knight: Soon to be $100 worth of bitcoin.

Matthew Howells-Barby: Exactly, right? So I need to buy my Bitcoin Bucket. What’s the first thing I need to do? So first of all, I need to understand what’s the amount of bitcoins required that I need to send? Second, I need the public address of the seller. So one thing to kind of think about here is I think we’ll move into a time where we almost have like bitcoin debit cards, but for now we would just need this public address, kind of like a bank account number. I create the transaction in my wallet and that transaction is sent to the blockchain. And the blockchain being the public ledger that we’ve kind of talked about that stores all of these different transactions will have that transaction so that everyone can see it there that not necessarily me, Matthew Howells-Barby, has sent this, but my public address has sent this amount of bitcoin to this other public address.

This is then where things get a little bit more technical. So when we say this transaction is sent to the blockchain, what does that kind of mean? Because for KFC to be able to give us our, I’m sure, delicious Bitcoin Bucket, they need to see that that transaction has been confirmed and that the bitcoins have been received in their own wallet. This is done through mining.

Now, one thing that I want to cover with the blockchain, and it’s important to understand this, is that each individual cryptocurrency has a blockchain that operates slightly different to one another. Bitcoin has the bitcoin blockchain. Ether has the Ethereum blockchain, et cetera, et cetera. A lot of different rules, but a large amount of the general basics apply.

And that is that a blockchain as a piece of software is broken down into what we call blocks, hence the word “blockchain”. Those blocks, you guessed it, are connected in a chain. And these blocks are created to store transactions. So when a new block is created on the blockchain, this happens every ten minutes automatically with the software. A new block is created and new transactions can be added to that individual block until the block is full.

Austin Knight: Yeah and on average there is about 2,000 transactions per block on the bitcoin network. If we take that as an example, that’s at its current one-megabyte block size.

Matthew Howells-Barby: Yeah, and it’s useful to almost think about a block kind of how you would a USB flash drive. Like this flash drive has a certain amount of capacity that it can store files. Now, in the same way transactions actually have like a file size in bytes almost like a Word document, right? And in this case, the blocks on bitcoin have a one-megabyte size. Kind of like a little bit less than an old floppy disk if you remember. So there’s only a certain amount of transactions that can go into each block.

When a block is completely filled, and it’s been what we call completed, it’s stored permanently on the blockchain. Cannot be changed by anyone, is visible for everyone to see, and that confirms all of the transactions within it. They are now set in stone. Those bitcoins have transferred into KFC Canada’s hands, and I am thoroughly full with my Bitcoin Bucket. It’s also worth knowing that we have not been sponsored by KFC Canada.

Austin Knight: Though, if they’re interested.

Matthew Howells-Barby: We could like eat some chicken live. I think that would add to the sponsorship deal maybe. But when, and this is the important part of all of this … well, I mean, it’s all pretty important, but here’s like an important part from a bitcoin-point-of-view is when a block is completed, which happens like every 10 minutes, new bitcoins are freshly minted and added into circulation. Right now, for like every block that is confirmed and added and completed successfully and added to the blockchain, 12.5 bitcoins are added into circulation. And this is exactly how new bitcoins are released into the economy. Every 10 minutes as blocks are filled with transactions, they’re added to this ledger.

Think about a block almost like a page on an accounting ledger, as soon as that page is turned new bitcoins are added, and it’s every 10 minutes. That is then the basic overview of how the blockchain really works.

Austin Knight: So where does mining come into all of this then? That’s the word that we hear getting tossed around, right?

Matthew Howells-Barby: Right. So you’re probably thinking as I’m going through all this. “It’s like, alright, cool. So, a transaction goes into a block. A block is completed and bitcoins come out, like how does that happen. Who does it? Is there a person spinning a large room in a wheel somewhere, maybe like in China, that’s just powering all this?” Maybe, we don’t know yet, but really what’s happening here is if you think about powering a piece of software like this. Let’s think about Google, when I type a search into Google and I get all these results, that happens through software, but electricity needs to power that software. There needs to be that data stored somewhere? Like where is Google’s data stored? Google has huge data warehouses that are like probably the size of countries now and that’s what powers all of this.

Bitcoin uses miners. And a miner really is, one thing I need to make clear, is not a small child. It’s a miner, E-R-S, not O-R-S. And they will use the processing power of their computer, also known as a node, to power the transactions and power the blockchain. Now that sounds a bit sci-fi, something out of Star Trek right now, but basically having a huge warehouse full of 100,000 different servers or computers all powering these like complex transactions and algorithms, what you have is you may have the same amount 100,000 computers, but they’re each individually owned by anyone around the world.

So what’s happening here is mining actually begins at the moment a new block is created. So as an individual miner, you hook up your computer with some software, like the Bitcoin Mining Software, and it runs completely automated. So you kinda, for all intents and purposes, just press the button and go. Leave your computer on and it uses the processing power of your graphics card or processing unit.

Austin Knight: And to be clear, in order to do this effectively, you’re not gonna buy a Chromebook and run this on it. You need a bit of a powerful machine.

Matthew Howells-Barby: Right, and I think we can come into like what makes it profitable a little later on because that’s a whole different story. But I mean, in reality, could you buy a Chromebook? Could you use your exact computer that you’re using right now? Absolutely if you don’t care about “are you gonna make a profit?” And we’ll explain even what that even means “make a profit,” right?

So, the important thing here is you hook up your computer, use over that processing power, and what it will do is whenever a new block is created the whole goal of the miner is to solve a complex math problem that the software creates that takes a lot of processing power to be able to complete. So usually, it’s focused around understanding the prime number used to basically be multiplied against a number of numbers, which enables once solved for the block to be completed.

Now it kind of sounds like a weird thing, wait so a computer goes on, solves a math problem and now all of a sudden we have transactions? What we’re doing here is, it takes very little processing power to actually just pile in a bunch of transactions that are being sent into the blockchain, but to secure that block and to make sure no one can change it, it requires a huge amount of processing power.

And let’s say one single person was able to sovle the math problem. These math problems are incredibly intensive on the processor of your computer and your graphics card. You’d probably need a warehouse that’s the size of a small town to be able to solve like a block on your own. And this is where the collective power of all of the different computers on the network actually come into play to solve these complex math puzzles.

Austin Knight: So this term, “mining” or “miner” it can be a little bit misleading. Makes you think of somebody that’s actually physically digging for a bitcoin, but that’s not exactly what’s happening. A little bit more of an accurate description would be that they are powering and securing the blockchain by lending their computers processing power. And the more computers are involved, the more miners are involved, the more nodes are involved, the more secure the network is because you’re reaching consensus amongst a much larger network of computers. But the miners aren’t just doing this out of the goodness of their heart, there is a financial incentive. And so that kind of brings us to the question like how does this work? What motivates people to become a miner in the first place?

Matthew Howells-Barby: Good question. As much as I would love for the incentives of powering the whole bitcoin movement to be through completely altruistic motives there is a financial incentive for this. So near the start of the episode I talked a bit how when a new block is completed new bitcoins are pushed into circulation. What I meant by when I said they’re pushed into circulation, they are given as a reward to the miners that helped solve that block.

So let’s say I’m an individual miner. I have this like a number of machines that I use to help power the bitcoin network and I maybe contributed towards 10% of solving the previous block that just got completed. I will get 10% of the reward that’s given out for that block. And the reward right now is 12.5 bitcoins. This is the financial incentive. Not only that, but there’re also transaction fees for every transaction.

So one big thing that’s been happening that’s a kind of contentious point is that bitcoin’s transaction fees have been rising a lot. I think we’re talking around December of last year there were periods of times where transaction fees were above $10 per transaction, sometimes even more. I think sometimes they hit like $15. Times that by 2,000 in terms of the number of transactions in that block. And all of those fees get distributed out to miners.

Austin Knight: And when we say $10, $15, $4 that’s not actual dollars that they’re receiving, they’re just fractions of a bitcoin.

Matthew Howells-Barby: Exactly, so it’s the dollar equivalent of bitcoins.

Austin Knight: And because the value of bitcoin is in flux, the dollar equivalent can get pretty out of control.

Matthew Howells-Barby: Exactly, and that’s where we tend to just kind of work on a general average. Now, the interesting thing here is around the reward. So I said, look, the current reward for completing a block on the blockchain, processing all those transactions as a miner, is 12.5 bitcoins. But it hasn’t always been that. When the bitcoin blockchain first started, it was actually 50 bitcoins per block reward. So you would have had significantly higher returns in terms of raw bitcoin you would have been rewarded with compared to now. Now why is that?

So the main reason behind this is the rewards for miners solving a block actually cut in half every 210,000 blocks, which roughly works out at four years because there’s a new block every 10 minutes. Actually the next date when we’re due to half this down again is I think around the 12th of June in the year 2020. This is interesting when you get into this because you realize well, this is incredibly predictable. And there’s another interesting thing, which we will not touch on in this episode, but eventually all of the bitcoins that are going into circulation will be in circulation. And then the only reward for miners will be transaction fees. That’s a whole like rabbit hole here, but that’s how you can think about how people are financially incentivized.

Austin Knight: Let’s say this sounds good to you. You’re listening to this episode. And you’re like, alright, I’m starting to understand this. Can I become a miner? Is this something that I can actually do? Is that possible, Matt? Can literally anybody with a computer and internet connection become a miner?

Matthew Howells-Barby: You know, every time you say that all that comes into my head is someone transforming into a child. It’s kind of like the reverse Peter Pan. I think like it’s very off-putting. I wish there was a better word. So the answer is, can anyone become a miner? Absolutely. There are even some blockchains that allow you to mine by your smartphone. And look, you’re not gonna be able to mine a huge amount because it’s all proportional to the processing power. You have a really expensive desktop PC that’s maybe like a gaming PC that’s like really high-end, that’s probably gonna mine at a much better rate than you would at your iPhone 3G original, right? Like you can’t make a good comparison there.

But in short, all you actually need to do regardless of your device, is download the mining software to your computer and you can pretty much get up and running with a few little bits of setup, there-and-then today. You just need to decide okay, which coin am I going to mine? Because you can mine most coins, and do I need to have a wallet set up for that so that where do they actually pay me for my block rewards. And then you just kind of leave your computer on.

One thing I would say as someone who has mined a whole host of different cryptocurrencies over the past few years, don’t expect to be using your computer while you do it. It’s basically having a consistent heart attack for the entirety for like the mining stage. It’s completely maxed out. You’re not gonna be able to start like running slide deck presentations whilst you’re mining your precious bitcoin.

Austin Knight: You can try.

Matthew Howells-Barby: You can absolutely try. And if you find a way-

Austin Knight: Please do.

Matthew Howells-Barby: Yeah, show me.

Austin Knight: So then the question is, okay, anybody can mine. We kind of know what goes into that, but you’re dealing with a lot of competition, right? In fact, there are entire conglomerates that are focused on mining, so is this something that even if you can do it, can you do it profitably? Is it worth doing as an individual?

Matthew Howells-Barby: Mm, that is a good question. So if we phrase it as “can anyone mine profitably?” Not really. Like you say, you’re competing against other miners. The reason why you’re competing is everyone wants to solve the block or at least solve the largest proportion of it so they get the most rewards. If you have a really low-spec computer and you’re trying like to do mining with that, and you’re competing with someone who has 10 times the processing power of your computer, they are always going to do better than you so your rewards are going to be much, much smaller. And in particular when you’re on more established blockchains like bitcoin, people have been mining for a long time. And they’ve been investing in more and more machines.

The irony of all of this is that actually if you look at some of the mining operations, there’s whole businesses, in particular in China, that have just built huge data warehouses that will basically just all they’ll do is mine bitcoin. And they’re actually responsible for an alarming amount of the whole processing power on the bitcoin network. I mean, when you think about Bitmain, which is a Chinese company that focuses more on like building hardware for mining. They also mine a lot themselves. I think they own near enough 40% of all of the processing power of bitcoin. That’s-

Austin Knight: That is absurd.

Matthew Howells-Barby: Is one word for it, right? And I think that’s being very polite. Like it doesn’t seem very decentralized when you look at it like that. That’s a problem.

Austin Knight: Mm-hmm (affirmative).

Matthew Howells-Barby: But coming kind of back to this there’s also, there’s a lot of ways that there’s been specialized hardware, in particular, what are known as ASIC computers, computers specifically designed to perform mining at an incredibly high rate. Kind of like how a smartphone has a processing unit designed specifically designed to run applications. And it’s designed to perform well at doing that. It’s a one-specific-use-case basically. Same with these ASIC miners. People invest a lot into these types of hardware so they can mine at a much greater rate, get much more of the rewards. This kind of brings onto if you feel, “Okay, maybe I’ll have me a piece of that. Where am I gonna get my ASIC of my own from?” There’s where you kind of get into the costs and there’s two layers to this when you’re thinking about … if you’re sitting there saying “Matt, Austin, I’m in. I wanna mine some cryptocurrency. I just need to figure out the costs. What would it take for me to become profitable?”

Now the first thing, which are the fixed costs. The fixed costs is basically building what’s known as your mining rig. That’s just a term that makes it sound more awesome for computer. And that’s what you’re gonna be running your entire mining operation through. So you need to figure out alright, if I invest in this graphics card that costs say $1000, I’ll be able to mine at a much higher rate. But I need to make that $1000 back, so what do I predict I will make? And there’s some like online calculations. There’s a good website actually called whattomine.com that goes through some of this.

And then the ongoing more variable costs, which are much tougher to think about, and in the case of bitcoin and most blockchains that run what we call proof-of-work, is the electricity costs.

Austin Knight: And that can get complicated. Especially, interestingly, depending on where you’re located in the world at the time of mining, this can be a huge advantage or a disadvantage. If you’re located in the states, electricity is expensive here. This alone could be the thing that makes this not-profitable for you. Yet, in Brazil electricity is cheaper and easier to get your hands on and the equation can kind of work itself out that way.

Matthew Howells-Barby: And I think that’s why we see a lot of the mining industry flooding to like rural China because electricity is so cheap. One of the big worries that people will say with bitcoin is, well, what happens if … I mean we mentioned a couple of episodes ago about at one point China banned all ICOs. And we’re gonna be talking a bit about ICOs in a later podcast. But what if China said, do you know what? It’s illegal to mine bitcoin from tomorrow. We just talked about how 40% of bitcoin’s network is run by pretty much just one Chinese company. I think when you look at China as a whole, it’s around about 70% of the network. That would not be good. That’s risky, right? And it creates this dynamic of okay certain places are cheap, they can make it profitable. I’ve even seen subscription-based services, where you pay-

Austin Knight: It’s like a software as a service, almost.

Matthew Howells-Barby: 100%.

Austin Knight: You’re renting a server to mine coin for you, so you don’t have to build a rig, you just go to a service where they have a huge data warehouse and you can buy in. Almost like the ostrich egg pyramid scheme. Buy an ostrich egg and never see it in your life. Buy a mining rig, never see it in your life. But of course the question there is continually, like, is that a profitable venture?

Matthew Howells-Barby: Right, because your ongoing variable costs are predictably lower, you’ve just got to pay for the upfront fees. The challenge is with all of this is defining what profitable is. Now, if costs could remain all the same and bitcoin could double in price. Let’s say you’re mining bitcoin, bitcoin doubles in price, all of that bitcoin that you mined before is now worth twice as much, which means you’re twice as profitable. Happy days, that’s great. It could also halve in price and then all of that bitcoin that you mined that you thought was profitable is now not profitable. In fact, you’d lost a lot of money. That is the dynamic here that’s tough. And when you’re thinking about mining, a lot of people love running to smaller cryptocurrencies because they say, “Well, this cryptocurrency is I believe under-valued and I’m going to mine it in an early stage and I’m going to make a loss for at least a year and I’m predicting that this will jump in price so that everything I’ve mined has all of a sudden jumped up and is gonna make me profitable in the future.” There is an element of spinning the roulette wheel here, but it’s all part of the idea of actually being able to determine whether something’s worth mining or not.

So what if you want to get started? And honestly, I personally think mining cryptocurrency, even if you did it for a day or a week, just to go through the process is one of the best ways to get your feet wet and learn about crypto. It’s a bit of a minefield as well because you’re gonna run through a bunch of forums when you’re trying to problem-solve stuff. And it’s just tons of really technical people that speak very technically and can be very intimidating, but one of the first things I ever did. And actually my introduction to cryptocurrency was mining bitcoin. And that was something that really I did without really knowing what I was doing at the time, but it helped shape how I understood the whole blockchain to work.

Austin Knight: Of course! It allows you to make a much more informed decision about what you’re going to be involving and investing your time and your resources into. Matt, you had an awesome analogy that you shared earlier that relates to this a lot where if you think about how people are choosing to invest in cryptocurrency right now most of it is based on the market cap or the value of the currency. And that’s what they’re using to guide their decision. “Oh, okay, bitcoin is worth this much. It’s grown this much. So I’m gonna buy bitcoin.”

But you had an interesting point and you said, “Well, you know, that’s not usually how you buy things necessarily.” You wouldn’t go looking to buy a car and say, “I’m going to just pick the car from the car company that’s worth the most money.” Similarly, you probably wouldn’t want to do that with a cryptocurrency. If you want to really understand a car, you spend some time in that car, maybe you’d look under the hood, maybe you’d give it a test drive. Mining is very similar to giving a car a test drive in that you’re giving the cryptocurrency a test drive.

Matthew Howells-Barby: Absolutely! And I think even if you’re not even thinking about “hey, I want to make some money.” And I think this is something me and you talk about a lot Austin is getting involved in cryptocurrency if it’s just to make some money is really not the good way to go about this right now. You need to invest time into understanding the technology and to do that, you can also help support these projects moving forward. Like you can set up with a new project, help mine some of the cryptocurrency of the project, and that helps secure the network, helps process transactions, helps it get off the ground.

Without mining, bitcoin doesn’t exist. That’s a really empowering thing I think from a community point of view, from a social point of view, that people that are, okay, economically incentivized to do this are also the ones that are ultimately putting the power into the network.

Austin Knight: Okay, so you’ve convinced me. How do we get started? How do we actually do that? As Matt said, first, you’re going to need to decide what you want to mine in the first place. And we mentioned a website, a little bit earlier, it’s whattomine.com, that’s really useful for this, gives you a good overview. And you can kind of get a sense for where you want to put your resources. Once you’ve decided on the cryptocurrency that you want to mine, you need to download the mining software for that crypto. And you can usually find this within that cryptocurrency subreddit on Reddit. You can see there’s a pattern for some reason, Reddit is driving a lot of this.

Matthew Howells-Barby: Yeah.

Austin Knight: Or maybe you just do a quick Google search.

Matthew Howells-Barby: Yeah.

Austin Knight: When in doubt, Google it. Then you’re gonna need to create a wallet or a link to your existing wallet so you can deposit those funds when you receive your rewards from the mining process, and you’re pretty good to go at that point.

Matthew Howells-Barby: Yeah! And just one thing, you may see a number of different mining software programs for different coins. Like just do a little bit of reading, some of them have their advantages, some of them don’t. In all honesty, like just get up and running and see how this is going.

One interesting thing, actually, that I came across when I was mining, playing around in all honesty, with Monero, which is like more of an anonymous, a much more anonymous version of bitcoin. There’s been an interesting application where certain websites when you visit them are leveraging your processing power as you visit their website to actually mine Monero. This is like a super shady area, but like businesses are trying to like think about how do we move away from just ad revenue to supplement our website. And some people are asking, “Hey, do you mind if we mine Monero when you visit our website?”

Austin Knight: Others don’t ask at all, your computer fan just turns on and you’re like “Hm? Somebody’s having a hard day on the internet.”

Matthew Howells-Barby: Right!

Austin Knight: And actually what’s happening is you’re mining a cryptocurrency, and you don’t even know it.

Matthew Howells-Barby: Yeah! Except you’re not getting the rewards.

Austin Knight: Exactly!

Matthew Howells-Barby: So, and I think we’re going to see more and more interesting applications of mining along those lines, but it’s definitely something to just bear in mind. So, I know we went through a lot in this super-technical … let’s just recap a few things. So mining ultimately solves three things, it mints or releases new coins into circulation, helps process transactions on the blockchain, and ultimately provides security across the whole of the blockchain that you’re operating within. Anyone can go in and be a miner, all you need to do is set up your computer, and download the software, and get going. Not everyone can be profitable, but at least using some of our general guidelines you should be able to go in and start figuring out how you would go about calculating how to become profitable. Or if it’s even worth your time. So, homework for the end of this episode, I would just recommend picking a random crypto, seeing what it’s like to go mine it, and you know what when you’ve made your millions, you can feel free to drop me and Austin some of those sweet cryptos over to us.

Make sure you join us for the next episode. We’re going to be talking all about the applications of wider blockchain technology beyond bitcoin, beyond payments. It’s going to be super interesting. I’m really amped to talk about it, and I think it’s going to broaden the spectrum of your knowledge as a listener as to what blockchain can actually do in the future.