What is Crypto Mining?
- Cryptocurrency mining is a term that refers to the process of gathering cryptocurrency as a reward for work that you complete
- Term crypto mining means gaining cryptocurrencies by solving cryptographic equations through the use of computers.
- This process involves validating data blocks and adding transaction records to a public record (ledger) known as a blockchain.
Example of How Crypto Mining Works
- A new transaction is entered
- Transactions are grouped together in a block and transmitted to a network of computers scattered across the world
- Network of computers compete with each other in solving an equation to win the opportunity to validate the transactions
- The computer that solves the equation first will then confirm the validity of the transaction. The blockchain will reward the computer with crypto currency.
- Once validated, the blocks are chained together creating a long history of all transactions that are permanent (aka. The ledger)
- The transaction is complete
Why Mine Crypto?
- The key benefit to mining crypto vs. buying crypto is profitability. The simple reason is that you only want to mine if it’s substantially cheaper to do so than buying the crypto from an exchange.
- If you buy ETH, you have a set price at the point of time for when you want to buy. If 1 ETH is worth $3,000 right now, that’s how much you need to pay to gain 1 ETH
- If you wanted to mine 1 ETH, the cost depends on how long you are willing to wait for your mining system to earn 1 ETH and your electricity cost
- Simple equation is more computing power = higher upfront cost = earn more eth month = higher electricity cost
- The secret to mining is about balancing that equation to your risk tolerance and how much you want invested into crypto
- Let say Ricky wants to mine Ethereum
- Ricky went out and bought 6 AMD 6800XT for $1,000 USD each
- Ricky also had to go out and buy the rest of the required computer parts to run the mining computer costing $500 and therefore has a total investment of $6,500.
- At the current ETH price of $3,500 USD, Ricky is expected to earn $27.6 USD per day, or 0.0075 ETH per day.
- But after accounting for electricity costs, Ricky is actually netting $24.5 USD. Therefore, Ricky is expected to break even on his investment in 9 months.
- In this basic example, Ricky can either buy 1 ETH for $3,500 or pay $6,500 in upfront costs but earn 1 ETH every 9 months
- This might seem like a no brainer to earn $3,500 every 9 months, but the calculation is not that easy as explained in the next sections of risks in mining crypto.
Risks in Mining Crypto
- Carrying Cost of Crypto: Depending on how large your mining farm is, you might be spending hundreds or thousands in electricity costs. Prices of crypto is extremely volatile and there can be months where the value of crypto you earn is less than the cost of electricity
- Network Difficulty: A relative measure of how difficult it is to mine a new block for the blockchain. The simple explanation is that the more people trying to mine, the harder it is to mine the crypto and therefore the less rewards you will earn. Network difficulty can increase by either more people willing to mine or technological advancements allow existing users to upgrade their rigs to more powerful mining computers with more processing power.
- Regulation Risks: Mining crypto currency is not free of taxes. Depending on your country and regulation, it might not be worth it to mine crypto because of the amount you need to pay in capital gains when you sell.
- Fire Hazards: Mining computers take significant amount of electricity and generates high amounts of heat. If you wired your mining rig incorrectly, used poor or cheap parts, or did not research your electricity draw and your house circuits, you can easily start electrical fires.
- Proof of Work vs. Proof of Stake: Not all crypto currencies can be mined. Even Ethereum, the 2nd largest crypto currency by market cap today is considering switching from proof of work to proof of stake, which would completely eliminate the need for mining. We will cover this topic in more detail in a later article.
Types of Mining Hardware
- CPU Mining: CPU stands for central processing unit. It is considered the brain of a computer because it controls the operations of all parts. CPUs perform all types of data processing operations. As mining became more competitive, CPU does not have the processing power to keep up and has fallen out of favour from miners.
- GPU Mining: GPU stands for graphics processing unit. GPUs are more powerful than CPUs in executing some very specific functions. GPUs are meant to be effective at doing massive amounts of calculations. For small to medium miners, this is the preferred option.
- ASIC Mining: An ASIC is a chip that can be used for one purpose only. Think of it as a specialized computer that is dedicated to mining 1 specific cryptocurrency. Because these machines are purpose built, they prove to be more effective and reliable at mining. The risk however is that if the cryptocurrency falls out of favour, the ASIC mining machines become obsolete as well. Secondary, there are cryptocurrencies that are ASIC resistance (e.g. Ravencoin) and therefore ASICs have a smaller selection of cryptocurrencies that they can mine.