Bitcoin Mining - What Is It And How Does It Work

Bitcoin mining is the process of creating new bitcoins by solving extremely complicated math problems that verify transactions in the currency. When a bitcoin is successfully mined, the miner receives a predetermined amount of bitcoin.

Bitcoin is a cryptocurrency that’s gained wide popularity due to its wild price swings and surging value since it was first created in 2009.

As prices of cryptocurrencies and Bitcoin in particular have skyrocketed in recent years, it’s understandable that interest in mining has picked up as well. But for most people, the prospects for Bitcoin mining are not good due to its complex nature and high costs. Here are the basics on how Bitcoin mining works and some key risks to be aware of.

Bitcoin mining statistics:

  • A miner currently earns 6.25 Bitcoin ($250,000 as of April 2022) for successfully validating a new block on the Bitcoin blockchain.
  • Creating Bitcoin consumes 143.5 terawatt-hours of electricity each year, more than is used by Ukraine or Norway, according to the Cambridge Bitcoin Electricity Consumption Index.
  • It would take nine years of household-equivalent electricity to mine a single bitcoin as of August 2021.
  • The price of Bitcoin has been extremely volatile over time. In 2020, it traded as low as $4,107 and reached an all-time high of $68,790 in November 2021. As of April 2022, it traded for about $40,000.
  • Odds of solving for a hash: 1 in 22 trillion
  • The United States (35.4 percent), Kazakhstan (18.1 percent) and Russia (11.2 percent) were the largest bitcoin miners as of August 2021, according to the Cambridge Electricity Consumption Index.

Table of contents:

  • Understanding Bitcoin
  • How Bitcoin mining works
  • Is Bitcoin mining profitable?
  • How do you start mining Bitcoin?
  • Risks of Bitcoin mining
  • Taxes on Bitcoin mining

Understanding Bitcoin

Bitcoin is one of the most popular types of cryptocurrencies, which are digital mediums of exchange that exist solely online. Bitcoin runs on a decentralized computer network or distributed ledger that tracks transactions in the cryptocurrency. When computers on the network verify and process transactions, new bitcoins are created, or mined.

These networked computers, or miners, process the transaction in exchange for a payment in Bitcoin.

Bitcoin is powered by blockchain, which is the technology that powers many cryptocurrencies. A blockchain is a decentralized ledger of all the transactions across a network. Groups of approved transactions together form a block and are joined to create a chain. Think of it as a long public record that functions almost like a long running receipt. Bitcoin mining is the process of adding a block to the chain.

How Bitcoin mining works

In order to successfully add a block, Bitcoin miners compete to solve extremely complex math problems that require the use of expensive computers and enormous amounts of electricity. To complete the mining process, miners must be first to arrive at the correct or closest answer to the question. The process of guessing the correct number (hash) is known as proof of work. Miners guess the target hash by randomly making as many guesses as quickly as they can, which requires major computing power. The difficulty only increases as more miners join the network.

The computer hardware required is known as application-specific integrated circuits, or ASICs, and can cost up to $10,000. ASICs consume huge amounts of electricity, which has drawn criticism from environmental groups and limits the profitability of miners.

If a miner is able to successfully add a block to the blockchain, they will receive 6.25 bitcoins as a reward. The reward amount is cut in half roughly every four years, or every 210,000 blocks. As of April 2022, bitcoin traded at around $40,000, making 6.25 bitcoins worth nearly $250,000.

Understanding Bitcoin

Bitcoin is one of the most popular types of crypto, which are digital mediums of exchange that exist solely online. Bitcoin runs on a decentralized computer network or distributed ledger that tracks transactions in the cryptocurrency. When computers on the network verify and process transactions, new bitcoins are created, or mined.

These networked computers, or miners, process the transaction in exchange for a payment in Bitcoin.

Bitcoin is powered by blockchain, which is the technology that powers many cryptocurrencies. A blockchain is a decentralized ledger of all the transactions across a network. Groups of approved transactions together form a block and are joined to create a chain. Think of it as a long public record that functions almost like a long running receipt. Bitcoin mining is the process of adding a block to the chain.

How Bitcoin mining works

In order to successfully add a block, Bitcoin miners compete to solve extremely complex math problems that require the use of expensive computers and enormous amounts of electricity. To complete the mining process, miners must be first to arrive at the correct or closest answer to the question. The process of guessing the correct number (hash) is known as proof of work. Miners guess the target hash by randomly making as many guesses as quickly as they can, which requires major computing power. The difficulty only increases as more miners join the network.

The computer hardware required is known as application-specific integrated circuits, or ASICs, and can cost up to $10,000. ASICs consume huge amounts of electricity, which has drawn criticism from environmental groups and limits the profitability of miners.

If a miner is able to successfully add a block to the blockchain, they will receive 6.25 bitcoins as a reward. The reward amount is cut in half roughly every four years, or every 210,000 blocks. As of April 2022, bitcoin traded at around $40,000, making 6.25 bitcoins worth nearly $250,000.

Is Bitcoin mining profitable?

It depends. Even if cryptocurrencies miners are successful, it’s not clear that their efforts will end up being profitable due to the high upfront costs of equipment and the ongoing electricity costs. The electricity for one ASIC can use the same amount of electricity as half a million PlayStation 3 devices, according to a 2019 report from the Congressional Research Service.

As the difficulty and complexity of bitcoin mining has increased, the computing power required has also gone up. Bitcoin mining consumes 143.5 terawatt-hours of electricity each year, more than some countries, according to the Cambridge Bitcoin Electricity Consumption Index. You’d need 9 years worth of the typical U.S. household’s electricity just to mine 1 bitcoin as of August 2021.

Risks of Bitcoin mining

  • Price volatility. Bitcoin’s price has varied widely since it was introduced in 2009. In just the past year, Bitcoin has traded for less than $30,000 and nearly $69,000. This kind of volatility makes it difficult for miners to know if their reward will outweigh the high costs of mining.
  • Regulation. Very few governments have embraced cryptocurrencies such as Bitcoin, and many are more likely to view them skeptically because the currencies operate outside government control. There is always the risk that governments could outlaw the mining of Bitcoin or cryptocurrencies altogether as China did in 2021, citing financial risks and increased speculative trading.

Taxes on Bitcoin mining

It’s important to remember the impact that taxes can have on Bitcoin mining. The IRS has been looking to crack down on owners and traders of cryptocurrencies as the asset prices have ballooned in recent years. Here are the key tax considerations to keep in mind for Bitcoin mining.

Bottom line

While Bitcoin mining sounds appealing, the reality is that it’s difficult and expensive to actually do profitably. The extreme volatility of Bitcoin’s price adds more uncertainty to the equation.

Keep in mind that Bitcoin itself is a speculative asset with no intrinsic value, which means it won’t produce anything for its owner and isn’t pegged to something like gold. Your return is based on selling it to someone else for a higher price, and that price may not be high enough for you to turn a profit.

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