How Does Bitcoin Mining Work?

Interested in knowing how does bitcoin mining work and how to earn money mining cryptocurrency? Here is a detailed guide on what is bitcoin and how to can you join the ranks of bitcoin miners.

Plus some frequently asked questions from our Bitcoin Mining Club readers.

What is Bitcoin Mining?

Bitcoin mining refers to the process by which new units of digital currency are created. It also involves the validation of new transactions on a blockchain network and is crucial for the maintenance and development of the blockchain ledger.

“Mining” stands for the process by which an extremely complex math problem is solved. When a Bitcoin is successfully mined, the miner receives a certain amount of Bitcoin and the process begins again.

The transaction record is kept in multiple locations at once and is updated by the miners, which means that Bitcoin acts like a decentralized banking ledger.

Since digital platforms can easily be manipulated, Bitcoin’s distributed ledger only allows verified miners to update transactions on the digital ledger. By verifying transactions, miners are securing the network thus preventing the “double-spending problem.”

What is the Double Spending Problem with Bitcoin?

“Double spending” is a phenomenon in which a single unit of currency is spent twice. Namely, it is about digital money or assets which appear in a form of a set of numbers that can be easily copied. However, it is for this reason that blockchain miners check transactions to make sure that no illegitimate actions were performed like spending the same Bitcoin twice.

In order to ensure that only verified crypto miners are part of the network, a protocol named proof-of-work (PoW), which also secures the network from potential external attacks, has been put into place. In other words, PoW is a mandatory element of the process of finding the right answer for a numeric problem.

However, the work of miners can also be called speculation, because they do not really solve mathematical problems, but try to come up with a hexadecimal number of 64 digits, which consists not just of numbers, but also letters of the alphabet and is known as “a hash”.

What Is a Bitcoin Mining Hash?

A hash is defined as a digital signature of a chunk of data that is generated to provide data transmitted on a public network. As the number of possible solutions increases with each miner who joins the network, it can be concluded that this is a rather arduous job.

How to Start Mining Cryptocurrencies?

Above all, miners need a lot of computing power, so they need computers that have software specifically designed to solve complex cryptographic problems. In addition, they need to have a high “hash rate” in order for mining to be successful.

There are different mining methods such as CPU, GPU, ASIC, and cloud mining and they all require different amounts of time.

CPU Mining

CPU (central processing Unit) method was very popular in the early beginnings of cryptocurrency mining, but it is no longer today, as this mining method is considered too slow and impractical, as miners need months to make minimal profits whereas electrical and cooling costs remain high.

GPU Mining

The next method is the GPU (graphic processing units) mining method, which works by maximizing computing power by assembling a set of GPUs under one mining rig. In this case, the motherboard and cooling system play a big role.

ASIC Mining

ASIC (application-specific integrated circuit) mining can run from $500 into the tens of thousands of dollars. ASIC miners differ in their specific design for cryptocurrency mining which means they produce more units of cryptocurrencies compared to GPU miners.

ASIC bitcoin mining also has its drawbacks, and that is that they quickly become obsolete when mining difficulties increase, and at the same time they are expensive.

However, as the costs of both the GPU and the ASIC method continue to increase the costs, miners are increasingly turning to the cloud mining method. The cloud allows individual crypto miners to find both free and paid online hostels for cloud mining and also to rent mining rig for a certain period.

Taxes on Bitcoin Mining

It is very important to mention that there are also taxes for mining which are charged in different situations: either when miners are rewarded with cryptocurrency for their mining activities or when they sell or exchange reward tokens with other miners.

According to the IRS Notice, a miner is required to pay taxes if he sells Bitcoins at a higher price than the one at which he received them, as they are then considered capital gains. In that way, the tax is charged as it would be charged for traditional assets such as stocks and bonds.

Additionally, if a miner’s activities comprise a trade or business or the taxpayer acts as an independent contractor, the virtual currency payments are considered to be self-employment income and accordingly, subject to self-employment taxes.

Similarly, if a taxpayer performs mining activities as an employee, payments made in cryptocurrency are treated as wages and will be taxed at ordinary income rates.

Is Crypto Mining Legal?

If you are asking yourself if cryptocurrency mining is legal, the answer is YES in the US. 

The legality of mining depends mainly on the geographical location of the miners: in some parts of the world it is legal, in others not because it is considered to threaten the government’s control over the financial market. However, very few countries prohibit cryptocurrency mining.

Which countries have banned Bitcoin?

While a propensity to crypto mining can be seen in United States and Canada, Bitcoin mining is banned in countries such as Nepal, Bangladesh, Egypt, and even China.