Let’s start with a few fundamental questions.
What is a cryptocurrency?
How is it different from traditional forms of money?
And why has it been on top of every (Robinhood?) investors mind?
Cryptocurrencies are essentially currencies in the virtual world. We can’t withdraw them from an ATM and physically store it in our back-pockets. Well, if they just exist virtually, how does value get augmented to their existence. How are they different from say, Monopoly cash?
Well, the story goes like this.
Long, long ago, in the year of 2008 (not that long ago), with the backdrop of the global financial system collapsing and the faith in the monetary system deteriorating, a man who went by the pseudonym Satoshi Nakamoto floated around a white paper introducing a completely revolutionary concept (well it’s not quite known if it was a single individual or a group of people responsible for the paper). The paper spoke about the idea of conceiving a currency, free from the oversight of institutions, federal agencies and central banks. The paper outlined how “Bitcoin” worked and was officially launched in January, 2009.
While initially the idea was to use bitcoin as an alternate to traditional cash, its price volatility prevents it from being the standard along with a slew of other reasons of course (like regulatory restrictions).
21 million bitcoins, that’s all there will ever be, no more can be mined (while we can’t know the exact amount of gold that can be mined, 21 million is all that exists).
So, how does one access bitcoins? I mean, they are not physically printed like traditional cash is, we cannot withdraw them from ATMs, then how does one get these esoteric currencies in their wallet?
Enter, Bitcoin mining.
BTC Mining – Explained Simply
Bitcoin mining is the process by which new bitcoins are introduced into the circulation. We can draw a comparison to discovering and mining gold from physical reserves and adding more of it into circulation.
Why go through this painstaking process?
The main purpose of mining, is sort of different from that of gold. What we call as “Bitcoin mining” is essentially the process of legitimizing transactions and ensuring their authenticity. So, the term “mining” is a little misleading, the miners are more like auditors and they get rewarded with bitcoins for performing the validations.
By verifying transactions, miners are helping to prevent the “double-spending problem.” Double spending is a scenario in which a Bitcoin owner illicitly spends the same bitcoin twice.
1 MB and Money, Money
These bitcoin miners/auditors need to verify atleast 1 MB of transactions (known as a “block”) to be eligible for the reward. However, verifying 1 MB transactions doesn’t immediately guarantee that you will be rewarded. The miner who is the first one to verify 1MB transactions correctly and solves the numeric problem (cryptographic hash function) bags the reward.
Wait, what’s this numeric problem about?
I have gone into deeper detail about this in a separate post. But for now, think of it this way. There’s a mathematical puzzle the miners need to solve. These puzzles are inspired from the world of cryptography and have been introduced into the process of bitcoin mining to make the network more robust against DoS attacks. The miner who comes up with the closest estimate to the puzzle first, wins.
How many bitcoins does the miner earn?
Short answer, it depends.
A slightly longer answer, there’s a process called BTC Halving that determines the number of bitcoins the miners earn as a reward. Back in 2009, a miner could earn as many as 50 BTC for verifying 1 block of transactions. But every 210,000 blocks of verifications later, the number of bitcoins earned halves. It approximately takes 4 years to verify 210,000 blocks. So the “bitcoin-halving process” occurred in 2012, where miners earned 25 Bitcoins for mining 1 block and so on.
This mining process is another factor contributing to Bitcoin’s wild day-to-day swings.
Okay, great, now we have a basic overview of how BTC was introduced and how it’s mined. But now, the fundamental question remains…
Does the “right” price exist for BTC?
More on that in the next article.
From Coffee Time Finance