How Do Miners Create Coins and Confirm Transactions?
Unlike other currencies and monetary systems that rely on a centralized authority, such as banks, to track transactions, maintain records, and ensure balances remain accurate and current; cryptocurrencies operate without any type of centralized reporting system. Instead, cryptocurrencies, such as Bitcoin, utilize a decentralized network to verify and confirm transactions, track balances, flawlessly store and maintain records, and even generate new currency. While the exact manner in which this is accomplished is extremely technical and complex, it essentially boils down to giving every node, or peer, on the network access to all the records, including balances. Thus, everyone on the network has the ability to verify and confirm the validity of every transaction (Malva Style, MalvaStyle).
Additionally, unlike other currencies where only specific entities have the authority to perform these functions, a key element of any decentralized system is the absence of a central decision-making entity. Consequently, anyone who wants to become part of a cryptocurrency’s network, i.e. become a “node;” can do so by obtaining the necessary software, typically free of charge, and then leaving a port open to run the appropriate software. That being said, while anyone can potentially become a node, the computer being used must be powerful enough to run the software and have enough storage space to hold the entire network; which as of January 2018 required approximately 145GB (Noelle Acheson, Coindesk).
Another important element associated with any digital currency is the potentially fatal impact a single disagreement, or false transaction, can have on the stability of the entire currency. A single disagreement between nodes over the legitimacy and accuracy of even a seemingly insignificant transaction can cause the entire system to fail. The currency’s integrity and very survival is contingent upon maintaining an un-hackable and virtually unalterable system in which the entire network unanimously agrees to and confirms every transaction and every balance in real time. To accomplish these essential tasks, a system was established using what are commonly referred to as “miners” and “blockchains.”
The multi-stage process of confirming transactions and creating coins begins when a transaction, or transfer, is requested. Upon receipt, the request is almost instantaneously disseminated across the entire network, where the miners, who are the only ones capable of confirming transactions, group it with other pending transactions so they can all be analyzed and confirmed. Once a group of transactions is confirmed, the confirming miner creates a new “block” with all the relevant information and adds it to the existing blockchain. It is then added to the database of every node on the network; making it part of the network’s unalterable blockchain. Requiring every node on the network to store the entire blockchain makes it possible to prevent anyone from reversing, deleting, or modifying a block once it has been confirmed and added to the blockchain. In exchange for performing this vital function, a miner is rewarded with a predetermined amount of the cryptocurrency being “mined;” with the newly created “coins” becoming part of the corresponding block. As a side note, while it’s commonly referred to as “creating coins,” each cryptocurrency has a predetermined coin maximum. For this reason, the reward given to miners for confirming a block could more accurately be described as putting dormant, or previously unavailable coins into circulation; instead of creating new coins. Bitcoin, for example, is comprised of 21 million total coins. Moreover, based on the number of coins awarded to a miner for creating a block, being 12.5 coins at present, and the amount of time it takes a miner to solve the puzzle and create a block (currently around ten minutes), the last of the 21 million coins isn’t expected to be placed into circulation until around 2040. (Id.) Put another way, assume all the mountains and rocks on the planet contain a finite amount of gold. Regardless of what this total amount may be, for it to be useful as a tradable commodity it must first be located, mined, and brought into circulation. The same concept applies here. While there are 21 million total bitcoins, the number of bitcoins in circulation only increases when a miner creates a block and is in turn rewarded with a couple of “new coins.”
The block creation process begins with the miners gathering all the transactions presented during a set period; at which point all of the miners compete to solve an intense mathematical problem, known as a “proof-of-work scheme” (Alyssa Hertig, Coindesk). These puzzles are designed using hash functions, with the goal being to determine which input will produce a value that falls within a certain range. The catch is, the hash function makes it nearly impossible to predict the output of any given input, so miners are forced to continually input one guess after another until someone gets lucky and guesses correctly. Thus, while it only takes one right guess to win the block, a more powerful computer will be able to generate more guesses, thereby, increasing its chance of getting lucky. Additionally, all the mining nodes on the network work on the same puzzle simultaneously until a miner solves it. Once solved, the network relays the solution to all the other nodes, so the answer and the transaction can be verified and confirmed. The lucky miner then creates the block, collects its reward, and the process begins again.
The significant energy consumption required for effective mining, and the associated costs, has encouraged miners to illegally establish mining facilities in restricted development areas that offer cheap electricity. In fact, several individuals were recently arrested in South Korea for operating cryptocurrency mining facilities out of chicken farms located in protected parts of the city. (Joseph Young, Cointelegraph). Aside from taking advantage of low electricity costs, the massive amount of power being dedicated to mining also makes it a prime target for regulation. On this point, “there have been talks about banning cryptocurrency mining due to the high energy consumption associated with mining…[which] accounts for about 0.60% of the world’s total energy consumption (more than the total energy consumption of Argentina)” (Delton Rhodes, Coincentral). Finally, in the U.S., the Financial Crimes Enforcement Network (FinCEN) has suggested that cryptocurrency mining and trading will be subject to many of the same regulations as other money service businesses. (Andrew Norry, Blockonomi). In any case, with mining playing an essential role in the confirmation of transactions and putting new coins into circulation, the future of cryptocurrency mining is sure to include additional laws and regulations.