3 questions about cryptocurrencies mining & bitcoin
A little while ago, mining was defined as an extraction of valuable minerals or other geological materials from the Earth. For hundreds of years, people are doing this hard and significant work in order to gain necessary resources. Now this definition can be amended. Mining still is a process of extracting resources, but for now, the word “resources” has expanded in its meaning.
One of the ways you can get bitcoin is mining them. Even though the process becomes harder, you can mine other cryptocurrencies and get Bitcoin in exchange (for instance exchange rate for ETH-BTC is 0.04 as of April 17th, 2017 on CEX.IO).
♦ Why Mining?
There are some points that are more likely to be clarified before coming up to a question about mining.
Let’s think of what money is in general. Money is also a commodity like a grilled chicken you buy in the supermarket, or like a guitar from a musical store. The only difference is that money has a higher level of liquidity, which means that you can exchange money for every product if you have a sufficient amount of money by itself and people who are ready to exchange it. To conclude, money is a sort of agreement between a big enough community of people, that helps them exchange their goods.
Returning to the subject of Bitcoin, just remember that it is another agreement between people, moreover, it more likely reminds us about gold. Why gold? Think why the gold has a cost that, by the way, grows each year. Because it has a demand among people, in other words, this, indeed, is the agreement we were talking about. The reason of a cost increasing is a limited amount of gold that we have on our Earth. At this very moment, you may see why we can call bitcoin — a digital gold:
1) The amount is limited. Which is different from other currencies, for example, US government can print as many dollars as they want to, but bitcoin is limited (21 million, remember?). That’s the reason why bitcoin has a tendency to a deflation just like gold does.
2) You don’t need to have a whole gold bar if you want to pay with gold, which means that gold can be split into tiny pieces. The same with bitcoin, its algorithms allow it to be split up to 8 decimal signs.
3) How do we get gold? MINERS dig thousands of meters into the ground, sometimes they spend huge amounts of resources in order to OBTAIN the sufficient amount of gold.
That’s what MINERS in bitcoin actually do — they OBTAIN bitcoins. Of course, they are not digging anything. They do another work without which the blockchain technology simply wouldn't exist. Using hardware, they are some kind of safety keepers, who check all the transactions that occur in the system and get bitcoins as a reward.
♦ What is mining?
Mining (in bitcoin) is the process of obtaining, or you could say, mining bitcoins by checking all the transactions on the validity. The block that contains all the transactions that have happened in an approximate time of ten minutes should be closed and attached to others. The only way to close the block is to check all the transactions in it and that’s what miners actually do. So what is it, how do they do that? The thing is that the algorithm of a blockchain is designed in a very smart and elegant way: it generates the equation, some numbers of which are constituted from certain digits that took place in the previous block and hash codes of current transactions, anyway, that means that these numbers are known in advance, and also there is a random-generated number by guessing which you will solve the equation, and if the equation is solved, that means that all the transactions are true and correct, so the one who solved it first will get bitcoins as a reward.
The question is: “Why do you need a random digit? You could probably check the validity of transactions without it.” Because this random number makes the process of mining unpredictable. Just like in a real gold mining: you can use the best equipment in order to find it faster or in bigger quantities, but there are other criteria that we cannot guess: luck or fortune, you can call it as you wish. This simple solution makes bitcoin unique, it helps keep the balance of bitcoins in the system and of those who own them.
♦ The difficulty of mining
It’s not more of a question about mining that can appear in your head, but it’s one thing that is very important and, moreover, exciting to know.
In order to understand it better, imagine yourself a small haystack with a needle in it. Let’s suppose that the task is to find this needle in ten minutes, not more or less. If one person finds it within a given time, that means when another guy comes up, they probably going to find it twice faster. In other words: the more effort, the faster you’ll get the result. Do you remember that it should be exactly ten minutes, so what would you do? You would increase a haystack twice its size, or decrease it if the number of people searching the needle decrease as well.
This idea of adjusting the difficulty is presented in the blockchain mechanism as well. Approximately, every two weeks the system analyses all the equations it had given and the time during which the whole “community” of miners solved it and makes the equation more difficult or less depending on the results, so that approximate time of all the solutions would be ten minutes, because it’s the most acceptable time during which the transactions in blockchain must be completed.
Although the difficulty of the equation can sometimes sway in both directions: more simple, or more complicated, as we can see by the statistics, mainly, it aims to be harder and harder. For example, when bitcoin had just appeared you could use your own PC to solve the equation. Now miners invest huge sums of money to buy a specific hardware, that, actually, occupies much more space than your PC does, and that would be able to solve the equation as quick as possible. Moreover, they try to find a place where the electricity is less expensive, because it also has it’s price which is far from being cheap.
Another important thing to know is that the reward for solving the problem is not an unconditional or absolute amount of bitcoins, it always diminishes twice its size every four years, in this way, at the very beginning the reward was 50 BTC, four years later it has decreased up to 25 BTC and now it’s 12 BTC, though, since the exchange rate of bitcoin is always growing, 12 BTC now is a larger sum of money than 50BTC at the very beginning. At the time, that was a breakthrough when one bitcoin was compared to one dollar and now one bitcoin costs $1195! So, you can see the intensity of its growth.
That brings us to the idea that the system is actually creating a healthy competition between miners, making the process of mining bitcoins more expensive within time and since the bitcoin demand is only increasing, precisely this is the answer to the question: “Why bitcoin has the immunity to inflation but an intention to a deflation?”.