Welcome to the first episode of our HashRate 2.0 series where we aim to explore the benefits of Bitcoin hashrate.
In the first episode, we want to take it slow and explore some of the basic concepts of the Bitcoin network and mining operations. We will go over some of the keywords and demonstrate how they are connected together from a high-level perspective.
Let’s just dive right in!
Alice and Bob Transacting with Bitcoin in BitLand
From a high-level perspective, the Bitcoin mining industry consists of some key elements that by working together, ensure the Bitcoin network is up and running. Let’s break it down into a simple transactional system like the one we have in a society called BitLand:
- Bitcoin is the currency used in BitLand
- Citizens of BitLand use Bitcoin to pay for services and are the main Users of the Bitcoin network. Each user can have an account with the Bitcoin network using an app called Bitcoin Wallet.
- These payments are made and processed in the form of invoices called Transactions. Like banks, users need to pay a fee for their transfers to take place (Transaction Fee). Each user signs their transaction and sends it to a place for processing called MemPool.
- Now generally as with every transaction, one person is paying the other for the services/goods/etc they have purchased. In a normal society, the bank uses its central system to transfer the funds from the buyer’s account to the seller’s. In BitLand, miners take care of this job through a process called Mining. We will explain in detail how this process works in another episode.
- Miners are specific computing devices that can be located anywhere in the world. By following a specific protocol, AKA Proof of Work (PoW), miners help the Bitcoin network process these transactions.
- To do this, miners select a bunch of transactions from MemPool and batch them together in a data structure called Block. A block is linked or “chained” to the previous blocks of transactions by a specific key. To find this specific key, miners have to do some extensive mathematical calculations.
- Once a miner finds a proper key, it puts it together with the transactions’ information, its wallet address for receiving the rewards and fees, and some other information in a specific transaction called CoinBase. The new block then gets formed and approved or confirmed.
- After confirmation, the new block gets added to the Bitcoin network. These chained blocks are what we call a Blockchain or a Ledger.
- Aside from processing transactions, these blocks are responsible for another quite important task.
- As a central bank prints money from time to time to ensure the supply of cash is enough to address the demand, the Bitcoin protocol is also set in a way to produce a specific number of bitcoins almost every 10 minutes. This number is called Block Rewards and the 10-minute production interval is controlled through a metric called Mining Difficulty.
- Block Rewards, along with the transaction fees, are given to the miner who finds the block key faster than others. This financial incentive can be quite rewarding, encouraging more people to join the Bitcoin network.
- As the competition grows, the keys can be found faster, leading to more Bitcoins being produced. Here’s when the Bitcoin protocol ensures that the 10-minute rule holds by adjusting the Network Difficulty and making it more difficult for miners to find the key.
- An individual can have a few of these mining devices (ASICs) and become a Solo Miner. There are also some companies that are purely dedicated to Bitcoin mining and operate thousands of ASICs inside a Mining Farm.
- Bitcoin network is quite huge right now and with this level of competition, it is really hard for miners to find the key to a block on their own. As a result, they join forces by joining a Mining Pool.
- Aside from the 10-minute rule, the Bitcoin protocol has put in place another important factor that ensures the limited supply of Bitcoin is distributed gradually. Every 4 years, the Bitcoin protocol cuts the Block Reward in half through an event called Bitcoin Halving. This helps the price of Bitcoin to grow as the supply stays limited, while the demand grows.
Now, let’s see how all these elements are linked together in a simple diagram.
Key Elements in the Bitcoin Network
Now, let’s go through the main elements one more time individually:
Crypto User
Someone like you!
Crypto Wallet
A Bitcoin wallet is like a special keychain that helps you keep your bitcoins safe. It doesn’t hold the actual coin but keeps a secret key that proves the money is yours. Think of the secret key as a magic password that lets you spend your bitcoins. The wallet also gives you an address, like your bank account IBAN. Other crypto users can use this address to send you Bitcoin.
Transaction
A Bitcoin transaction is the process of transferring Bitcoin from one wallet to another on the blockchain. It works like a digital message that includes the sender’s address, the receiver’s address, and the amount of Bitcoin being sent.
To authorize the transaction, the sender uses their private key (the secret key mentioned above) to create a digital signature, proving ownership of the Bitcoin being spent.
Transaction Fees
Fees that are paid by Bitcoin users to prioritize their transactions. Miners collect these fees as additional income alongside the block reward.
ASIC (Application-Specific Integrated Circuit)
An ASIC (Application-Specific Integrated Circuit) is a highly specialized hardware component built to perform a specific task with exceptional efficiency.
In Bitcoin mining, ASICs are optimized to execute the SHA-256 hashing algorithm, which is essential for solving the complex mathematical puzzles required in Bitcoin’s Proof-of-Work (PoW) system.
Unlike general-purpose processors like CPUs or GPUs, ASIC miners deliver superior performance makes ASICs vastly more effective for Bitcoin mining but limits their functionality to that specific purpose. As a result, they have become the preferred hardware in large-scale mining operations, driving innovation in mining efficiency.
Proof of Work (PoW)
Proof of Work (PoW) is a consensus algorithm used by blockchain networks like Bitcoin to maintain security and verify transactions.
Miners compete to solve complex mathematical puzzles using significant computational power, and the first to find a solution (that key in our diagram) broadcasts the new block to the network. Once the block is verified by other nodes, it is added to the blockchain.
This mechanism ensures decentralization and makes it extremely difficult to manipulate the system. We will have one episode dedicated to the mining operation and how it works!
CoinBase
A coinbase transaction is the first transaction in a newly mined Bitcoin block.
CoinBase transaction creates new coins as a reward for the miner who successfully mines the block. This transaction includes the block reward along with any transaction fees collected from the transactions within that block.
The miner designates their wallet address in the coinbase transaction to receive the reward.
This mechanism is the sole method for introducing new bitcoins into circulation, following Bitcoin’s fixed issuance schedule (the 10-minute rule) and monetary policy. Additionally, miners can include extra information, such as messages or unique identifiers, in the coinbase transaction for marking or personalizing the block.
We will talk about this transaction in more detail in the upcoming episodes.
Block
A block is a structured unit that holds a group of validated transactions, ready to be added to the blockchain. Each block is composed of a header and a body containing the coinbase and other verified transactions.
Once a block is successfully mined and appended to the chain, it becomes a permanent and immutable record, ensuring transparency and security. Blocks are cryptographically linked, forming a continuous chain that upholds the decentralized and tamper-resistant nature of blockchain technology.
Blockchain
These chained blocks are called a Blockchain. A blockchain is a decentralized digital ledger that records transactions in a secure, transparent, and tamper-proof way.
Block Reward
A block reward is the compensation miners receive for contributing to the Bitcoin blockchain by validating new transactions and adding them to the Blockchain Ledger.
This reward consists of newly generated bitcoins along with transaction fees from the transactions included in that block.
Block rewards play a crucial role in introducing new coins into circulation and incentivizing miners for their work and energy expenditure.
Bitcoin Halving
Bitcoin halving is an event that takes place roughly every four years (or after 210,000 blocks), where the block reward miners receive for adding a new block to the Bitcoin blockchain is cut in half.
This mechanism is programmed into Bitcoin’s protocol to gradually reduce the number of new bitcoins entering circulation, ensuring the total supply is limited to 21 million BTC. By slowing the rate of new Bitcoin creation, halving increases scarcity, which can potentially drive up its value over time.
Mining Difficulty
Mining difficulty is a measure of how hard it is for miners to solve the cryptographic puzzle required to add a new block to the Bitcoin blockchain.
It is adjusted automatically by the network approximately every 2,016 blocks (roughly every two weeks) to ensure that blocks are mined at a consistent interval of about 10 minutes, regardless of changes in the network’s competition.
If more miners join the network or the overall computational power increases, the difficulty rises to maintain block timing. Conversely, if miners leave the network, the difficulty is lowered. This dynamic adjustment ensures the network remains secure, stable, and predictable, preventing bitcoins from being produced too quickly or too slowly.
Mining Farm
A mining farm is a large-scale operation designed for Bitcoin mining, containing numerous miners like ASICs. These facilities are built to deliver immense computational power, allowing miners to efficiently work together to validate transactions and produce new blocks on the Bitcoin blockchain.
Mining Pool
A mining pool is a collaborative group of Bitcoin miners who join forces by combining their computational power to improve their chances of successfully mining a block.
Rather than competing individually, miners in the pool work together to solve the complex puzzles required by the Bitcoin network. When the pool mines a block, the resulting block reward and transaction fees are shared among the members based on how much work each contributed.
Solo Mining
Solo mining is a mining approach where an individual miner operates independently, without joining a mining pool. This method is often chosen by experienced miners or those who prefer to keep the entire reward without sharing it with others, despite the inherent uncertainty and challenges.
EndNote
In conclusion, the Bitcoin network operates through a set of fundamental components that ensure its security, efficiency, and decentralization.
At its core are blocks, which store transaction records, and the Proof of Work consensus mechanism that safeguards the network.
Miners, whether working solo or in mining pools, provide computational power to validate transactions and earn block rewards, a process influenced by events like Bitcoin halving to control the supply and ensure scarcity.
Users interact with the network through Bitcoin wallets, which securely manage their funds, while the mining difficulty automatically adjusts to maintain consistent block creation.
These interconnected elements create a transparent, secure, and decentralized system that has redefined how we approach digital money, trust, and global transactions.
See you in the next episode!