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The Bitcoin mining game

bitcoin mining
(© lucadp – stock.adobe. com)

Bitcoin miners aren’t well known, but they form the backbone of the entire ecosystem. They build the blockchain, process transactions and even decide the Bitcoin price. How is it possible?

Bitcoin is both a currency and a payment protocol

Even if Bitcoin is called a digital currency, it is not like any other currency in the world. Bitcoin is both a currency and a payment protocol. This is a significant difference.

You might be familiar with PayPal, Skrill or Neteller, which are so-called eWallets. You can process payments through these networks from one user to another. They are payment protocols, but not currencies. We can also flip this and say that currencies don’t need these payment protocols to exist. US dollar or euro would be just fine without PayPal as well.

This is not the case with Bitcoin. You cannot separate Bitcoin from its technology and vice versa. There are no Bitcoin bills or coins, which could be printed or minted either.

This also means that all players in the Bitcoin network have a role to play in the price discovery. If Bitcoin nodes would go down, the whole network would stop working. If miners would shut down, there wouldn’t be any new blocks in the blockchain.

The purpose of Bitcoin mining

Let’s dive a bit deeper into the Bitcoin tech.

Bitcoin is essentially a global network of computers, which are all running the Bitcoin Core software. This is an open-source software and the network is permissionless, meaning anyone can join it any time. There are two types of operators in the network: nodes and miners.

Nodes are just running the Bitcoin software and processing transactions. You can run a node even on a Raspberry Pi microcomputer. Nodes also store the blockchain, which is therefore a database distributed to thousands of computers.

Nodes don’t get any rewards. They just check the transactions and pass them (valid ones) on to a place called memory pool. This is where miners jump in. A Bitcoin miner is a specialized computer, also known as an ASIC.

Miners collect a bunch of transactions from the memory pool and put them together as a new block. They fight for the right to be the one, who can add a new block to the blockchain. This competition runs 24/7 and starts over every 10 minutes.

When a new block is produced, new bitcoins come to existence. This is called a block reward and it’s currently 12.5 bitcoins per block. With the current price of Bitcoin (~7,000$ per BTC), the reward is worth almost 90,000 dollars.

The Bitcoin mining game

There was a time when anyone could mine dozens or even hundreds of bitcoins with his (or her) laptop. Those days are long gone. Mining has become a very competitive and professional business. It’s dominated by huge mining farms, which are built to carefully chosen locations all over the world.

Mining farms can have hundreds or thousands of ASIC miners, which cost about 2000-3000$ per device as new. These machines consume huge amounts of energy every day. This is the reason why mining impacts Bitcoin’s price as well.

These mining farms operate on small margins and they must pay massive electricity bills every month. This means they must sell almost all bitcoins to the market to cover these costs. This is where the market supply comes.

For Bitcoin to have a stable price, there should be a certain amount of new money coming into the system every month to absorb these bitcoins. If there aren’t new buyers, the price will go down… and then miners are forced to sell even more bitcoins.

The Bitcoin halving

You should understand by now how important miners are to the Bitcoin ecosystem. They process all transactions, build the Bitcoin blockchain and they are also responsible for the Bitcoin supply to the market.

There is a new event on the horizon, which will disrupt the whole mining industry and the Bitcoin ecosystem. It’s called the Bitcoin halving. This means that the block reward (explained earlier) will be cut in half – from 12.5 bitcoins to just 6.25 bitcoins.

This halving is nothing new. In fact, it’s a hard-coded feature of Bitcoin. A halving takes place every 210,000 blocks, which means roughly four years. There have been two previous halvings already: one in 2012 and one in 2016.

It should be obvious by now, why this is such a disruptive event. If mining farms are operating on tight margins already, what happens when their rewards are cut 50%? It means a lot of mining farms will shut down almost immediately.

This will lead to a BIG mining re-organization. When lots of farms go out of business, the remaining operators can even grow their business because there is less competition.

More importantly, the Bitcoin supply to the market is cut 50% as well. There will be roughly 50% less Bitcoin selling pressure after the halving. If the demand stays the same… well, you do the math.

This math has been done two times before and each time it resulted in a massive bull run. The previous one ended in late 2017 when Bitcoin’s price moved from 1,000$ to 20,000$ in less than a year.

These four-year cycles have decided bull and bear markets of Bitcoin in the past. If history repeats itself, we’ll see the peak of the next cycle at the end of 2021. Estimates are that the Bitcoin price will reach even 100,000$ mark by then.