If you follow any news related to currency and finance, then you have heard about cryptocurrencies such as Bitcoin and Ethereum. They represent a new way of thinking about money with their emphasis on decentralization.
At Addition Financial, we’ve been getting a lot of questions from our members about cryptocurrency mining and other topics related to digital currency. Since this topic is both popular and can be a little overwhelming if you try to learn about everything at once, we’ve put together this post on crypto mining 101 to give you a solid grasp of the basics. Here’s what you need to know.
What is Cryptocurrency Mining?
One of the things that can make it difficult to learn about cryptocurrency is the use of familiar words in new ways. So, let’s start there: what is cryptocurrency mining?
Cryptocurrency mining is a competitive process that is used to mint new coins and verify cryptocurrency transactions by adding them to a chain of previous transactions.
The term chain refers to the blockchain, which is a distributed digital ledger – a decentralized database that securely stores cryptocurrency transactions and has a variety of other applications.
A cryptocurrency miner must compete with other crypto miners to solve the hash, a hexadecimal string of 64 digits. One of the things that can be confusing about this process is that the person or people who solve the hash don’t need to get it exactly right – they only need to calculate a chain of numbers that meets the criteria and fits at the proper place in the blockchain.
The reason that mining is required is that there is no central authority that governs the issuance or value of Bitcoin or any other cryptocurrency. Because Bitcoin is digital, there’s a high risk of counterfeiting or spending the same coin more than once. The mining process minimizes that risk.
How Does Cryptocurrency Mining Work?
There is something alluring about the idea of cryptocurrency mining. In theory, all you need to become a crypto miner is a computer, but due to the power requirements to solve a hash before anybody else, it’s not uncommon for individual miners to lose out to group endeavors.
Let’s use the Bitcoin blockchain (the world’s first blockchain, which is used for the world’s first cryptocurrency) as an example.
When new data is available for mining, the participants on the Bitcoin blockchain race to solve the hash to add the new block to the chain. The data is verified using a decentralized consensus system known as Proof of Work (PoW).
Any miner competing to solve the hash uses a mining rig (a computer or network of computers) to generate potential solutions to the hash. Once they solve it and the answer is accepted by consensus, a piece of code mints new coins and awards them to the miner in question.
It may sometimes happen that two or more miners or mining pools arrive at an acceptable hash at the same time. When that happens, the computers on the blockchain, which are called nodes, must agree to one solution by consensus. The losing block is called an orphan block and is rejected. Most commonly, the block reward is given to the miner or mining pool that has solved the most hashes.
What Do You Need to Start Mining Cryptocurrency?
On the surface, the equipment required for cryptocurrency mining is simple. However, the intense competition and power requirements make it difficult for anybody operating alone to do.
To start mining, you’ll need all the components of a traditional PC, including the following:
- Motherboard
- CPU (Central Processing Unit)
- GPU (Graphics Processing Unit)
- RAM
- A power supply
- Storage
A regular PC with a decent processing speed was the minimum requirement in the early days of cryptocurrency when individual miners could still compete to earn coins. Today, it’s rare for individual miners to be able to compete with huge mining pools and mining companies, and that means the standard equipment has changed.
The only way to make crypto mining competitive today is with the use of an Application-Specific Integrated Circuit (ASIC) miner, which is a type of preconfigured software that simplifies the mining process. An ASIC may have up to 100 billion times the computing power of other machines, meaning that owning one or more ASICs is an advantage for anybody wanting to mine crypto.
It is common for miners to band together in mining pools, stringing high-quality graphic cards and processors together to maximize their speed and increase their chances of solving a hash and minting a new coin.
How Much Can You Earn Mining Cryptocurrency?
It’s understandable why people get excited about the prospect of mining Bitcoin. As of April 25, 2022, the value of one Bitcoin was $38,746,10. Mining even one coin would represent a win in theory, but it’s important to dig deeper to look at the cost of crypto mining.
A crypto mining rig of any size requires multiple pieces of hardware, all of which must run consistently to work. While GPUs and ASICs have built-in fans, the equipment heats up quickly as it operates and requires external cooling as well.
What that means is that it requires an enormous amount of electricity to mine cryptocurrency profitably. One estimate says that mining a single Bitcoin transaction would use 1,544 kilowatt hours (kWh), which is what the average American household would require to power it for 53 days.
The other cost that can quickly erode your crypto mining profits is the cost of hardware. The most expensive (and fastest) ASICs can cost upwards of $10,000. When you add the cost of equipment to the cost of electricity, you can see that mining cryptocurrency is an expensive endeavor.
What does this mean for you if you want to try crypto mining? Our recommendation is to do a cost-benefit analysis to determine whether it’s worth your while. Here are five expenses to consider:
- Cost of equipment – Do you have the money to invest in ASICs and other equipment? If you’ll need to borrow to buy what you need, make sure to factor in financing charges and/or interest rates.
- Cost of electricity – What is the electricity rate per kWh where you live? Keep in mind that rates can change depending on the time of day or the season.
- Efficiency – Do you have enough equipment and power to allow you to beat out other miners? This calculation is related to the cost of electricity.
- Time – How long will it take you to solve a hash and win a block reward? You may need to run your equipment 24 hours a day as many miners do.
- Coin value – Finally, you’ll need to consider the market value of whatever coin you’re mining in US dollars. Will you earn enough if you win the hash to pay back your expenses and earn a profit?
One easy way to determine the likelihood that mining crypto will be profitable for you is to take advantage of a crypto profitability calculator, like this one.
You should know that the rewards for Bitcoin mining are halved every four years in an attempt to control the number of new coins minted. In the early days, the reward was 50 Bitcoin per mining transaction. Today, that number is 6.25 Bitcoin, making the reward worth $242,165 at the price we quoted above. That would mean your profit would be the reward amount less your expenses. Keep in mind that the profitability depends heavily on the value of the coins you mine.
Which Cryptocurrencies Can Be Mined?
We’ve talked about Bitcoin mining but what about other cryptocurrencies? As of April 2022, there are more than 10,000 different cryptocurrencies in existence.
Some of the miners who originally focused on Bitcoin have stepped away to support other digital currencies with a smaller environmental footprint. Here are some alternatives to Bitcoin:
- Ethereum Classic
- Litecoin
- Dogecoin
- Nano
- SolarCoin
- Powerledger
- Cardano
Many of the newer cryptocurrencies have placed an emphasis on energy conservation. For example, Cardano uses an alternative to Proof of Work called Proof of Stake to add blocks to the chain. It can generate up to 1,000 transactions in one second, compared with Bitcoin’s 7 transactions, giving it a significantly smaller environmental footprint.
What Are Some Alternatives to Crypto Mining?
You may decide that mining crypto isn’t the right choice for you because of the high costs and investment of time and effort. However, there are alternatives to help you invest in digital currency.
The first option is to buy cryptocurrency directly instead of mining it. Because cryptocurrency is volatile by nature, there are always people who are willing to sell it.
Another option is to invest in companies that manufacture crypto mining equipment. What we like about this choice is that it allows investors to capitalize on the growing popularity of cryptocurrency without experiencing the wild volatility of cryptocurrency prices. (Any stock can be volatile, but cryptocurrencies are volatile even by stock market standards.)
You could also invest in blockchain technology, which is the technology that makes cryptocurrencies possible. The technology itself has a wide array of practical applications and leaders in almost every industry are investigating how to use it.
Cryptocurrency mining may be worth pursuing if you can afford the up-front costs to acquire the necessary equipment and the ongoing expenses to run a mining operation. If you decide it’s not for you, then you can still invest in cryptocurrency by purchasing it directly or buying stock in companies that make mining equipment or use blockchain technology.Do you need help managing your investments? Click here to learn about the MEMBERS Financial Services program and meet with one of our Financial Professionals.
Posted on May 15, 2022
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