Bitcoin Mining – How it Works and Is It for You?

It is no secret that I’ve been fascinated with Bitcoin and Bitcoin mining and have written a couple of posts about Bitcoin, including one about my friend who made one million dollars through an investment in Bitcoin.

The other day someone asked me how Bitcoin mining worked and if it was something they should get into. So, in this post I’m going to attempt to explain how bitcoin mining works and answer the question I just posed – is it something an amateur should get into?

By now most of you know that Bitcoin (and the other Cryptocurrencies) are virtual currencies that increasing can be used as forms of payment. They are not (yet) regulated by governments and exist in the cloud without anything physical backing them. Initially many people (including me) thought that these Cryptocurrencies would collapse due to the lack of an underlying guarantor (a government) but to date that has not happened (but it still might!)

I’ll avoid the detailed technical description of how Bitcoin uses blockchain technology to secure the transactions as it doesn’t really matter for the sake of this discussion. But, as part of the underlying technology, there needs to be a group of distributed computers that process the transactions into the blockchain. In other words, there needs to be a bunch of computers, not owned by the same person, available to process the Bitcoin transactions since there is no “central computer” that runs Bitcoin. To create an incentive for computers to be connected to the network to run the Bitcoin network, the system was designed to give out Bitcoin rewards to computers available on the network. It awards these rewards randomly based on the processing power of the computer (more processing power = more rewards).

This created a world where people could connect computers to the network and earn passive income – income where no work is required (other than setting up the network and paying for the electricity). Not surprising people flocked to this opportunity and there became a computing arms race where people brought faster and faster processors to the opportunity. Since only a fixed number of rewards would be given, as more people joined the network and computing power rose, it became more difficult for people to make money.

Economics would tell us that in a free market economy, people would continue to add compute power and pay for the power consumption until the reward was only slightly more than the cost to get the reward and that is what has happened. While it was possible for the amateurs to make money in the early days, the free market has squeezed out the profit until the market is now dominated by professional organizations who build large operations in locations with cheap electricity.

So, I’m afraid that despite all the advertisements on the Internet about how easy it is to make money mining bitcoin, those advertisements are from people who want to sell you things to help you do it. Everything I’ve been able to read on the matter indicate that the time of the amateur bitcoin miner is long over.