Bitcoin Mining: What Is It And How Does It Work? | Bankrate

what is bitcoin mining?

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

Bitcoin is a cryptocurrency that has grown in popularity due to its wild price swings and rising value since it was first created in 2009.

As the prices of cryptocurrencies and bitcoin in particular have skyrocketed in recent years, it is understandable that interest in mining has also increased. But for most people, the prospects for bitcoin mining are not good due to its complex nature and high costs. Here are the basics of how bitcoin mining works and some key risks to be aware of.

Reading: How is bitcoin made

bitcoin mining statistics:

  • A miner currently earns 6.25 bitcoins ($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 Ukraine or Norway use, according to the Cambridge Bitcoin Electricity Consumption Index.
  • It would take nine years of electricity equivalent to a home to mine a single bitcoin starting in 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. in April 2022, it traded for around $40,000.
  • odds of solving 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 in 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 ?
  • bitcoin mining risks
  • bitcoin mining taxes

understanding bitcoin

bitcoin is one of the most popular types of cryptocurrencies, which are digital means of exchange that exist only 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 bitcoin payment.

Bitcoin is powered by blockchain, which is the technology that powers many cryptocurrencies. a blockchain is a decentralized ledger of all transactions over a network. Groups of approved transactions together form a block and come together to create a chain. think of it as a long public record that works almost like a long-form receipt. bitcoin mining is the process of adding a block to the chain.

how bitcoin mining works

See also: What Happens to Unconfirmed Bitcoin Transactions?

To successfully add a block, bitcoin miners compete to solve extremely complex mathematical problems that require the use of expensive computers and huge amounts of electricity. To complete the mining process, miners must be the first to get to 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 making as many random guesses as fast as they can, which requires a lot of computing power. the difficulty only increases as more miners join the network.

The required computer hardware 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 can successfully add a block to the blockchain, they will receive 6.25 bitcoins as a reward. the reward amount is halved roughly every four years, or every 210,000 blocks. As of April 2022, bitcoin was trading at around $40,000, making 6.25 bitcoins worth almost $250,000.

is bitcoin mining profitable?

it depends. Even if bitcoin miners are successful, it is not clear that their efforts will end up being profitable due to high initial equipment costs and ongoing electricity costs. 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, so has the computing power required. Bitcoin mining consumes 143.5 terawatt-hours of electricity each year, more than some countries, according to the Cambridge Bitcoin Electricity Consumption Index. it would take 9 years of the typical American. household electricity just to mine 1 bitcoin from August 2021.

Bitcoin electricity use

Source: Cambridge Bitcoin Electricity Consumption Index

See also: Many Crypto SPAC Deals Now In Jeopardy

One way to share some of the high costs of mining is to join a mining pool. Pools allow miners to share resources and add more capacity, but shared resources mean shared rewards, so the potential payout is less when working through a pool. bitcoin’s price volatility also makes it hard to know exactly how much you’re working for.

how do you start mining bitcoins?

These are the basics you will need to start mining bitcoin:

  • wallet – This is where any bitcoin you earn as a result of your mining efforts will be stored. A wallet is an encrypted online account that allows you to store, transfer, and accept bitcoins or other cryptocurrencies. companies like coinbase, trezor, and exodus offer wallet options for cryptocurrencies.
  • mining software: There are several different providers of mining software, many of which are free to download and can run on windows and mac computers. once the software is connected to the necessary hardware, you will be able to mine bitcoins.
  • computer equipment: The most prohibitive aspect of bitcoin mining has to do with the hardware. You will need a powerful computer that uses a huge amount of electricity to successfully mine bitcoin. it’s not uncommon for hardware costs to run $10,000 or more.

risks of bitcoin mining

  • price volatility. the price of bitcoin has fluctuated a lot since it was introduced in 2009. last year alone, bitcoin traded for less than $30,000 and almost $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 adopted cryptocurrencies like bitcoin, and many are more likely to view them skeptically because the currencies operate outside of government control. There is always a risk that governments could ban bitcoin or cryptocurrency mining like China did in 2021, citing financial risks and an increase in speculative trading.

bitcoin mining taxes

It is important to remember the impact taxes can have on bitcoin mining. The IRS has been looking to crack down on cryptocurrency owners and traders as asset prices have soared in recent years. Here are the key tax considerations to keep in mind for bitcoin mining.

  • Are you a business? If bitcoin mining is your business, you may be able to deduct the expenses you incur for tax purposes. revenue would be the value of the bitcoin you earn. but if mining is a hobby for you, it is not likely that you will be able to deduct the expenses.
  • mined bitcoin is income. if you can successfully mine bitcoin or other cryptocurrencies, the The fair market value of the coins at the time of receipt will be taxed at ordinary income rates.
  • Capital gains. If you sell bitcoins at a higher price than the received, which qualifies as a capital gain, which would be taxed in the same way as traditional assets like stocks or bonds.

See bankrate’s cryptocurrency tax guide for basic tax rules for bitcoin, ethereum and more.

end result

Although bitcoin mining sounds attractive, the reality is that it is difficult and expensive to do it profitably. the extreme volatility of the bitcoin price adds more uncertainty to the equation.

Please note that bitcoin itself is a speculative asset with no intrinsic value, meaning it will not produce anything for its owner and is not pegged to anything 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 make a profit.

See also: How Much Internet Speed Do You Need To Mine Bitcoin?

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