Crypto Mining Explained: How It Works?

By Fotis Dixon


Reviewed by: Fotis Dixon


Crypto Mining Explained

Crypto mining is central to the existence of blockchain-based tokens. When a crypto token is launched, its total supply is fixed, but only a limited amount of the token would be there in the market. The rest of the tokens have to be mined out from the platform by people dedicated to the task. Whenever a new block of the concerned blockchain is mined and added to the blockchain, the value of the chain increases and the miners will be rewarded for this task.

In this article, you will learn more about the crypto-mining process to help you make investment decisions. 

 What Is Crypto Mining?

Crypto mining is an innovative on-chain activity and everyone who has come to this topic would be eager to learn more. It is the process of finding new tokens for the blockchain and adding them to the Proof-of-Work (PoW) consensus mechanism that usually operates. When a new token is unearthed, the concerned protocol network will validate and record the transactions, thus among the whole process less time-consuming.

Crypto mining is proofed by the Proof-of-Work consensus mechanism. The huge amount of computing work involved in the mining of each new block is rewarded through this mechanism. Mining is a highly competitive field as there are only a limited number of blocks for each blockchain protocol, and many miners are pursuing a particular block. So the fastest miner who unveils a block and adds it to the chain is rewarded. 

The rate at which the mining process is done is measured using the number of hashes per second. The variables involved such as transaction information are fixed to hashes, which are strings of characters. 

Crypto mining is an expensive process and requires many infrastructure and software facilities such as high-power computers, non-stop, high-speed internet connection, crypto mining apps and other software services such as Graphics Programming Units (GPUs) and application-specific integrated circuits (ASICs).

What Are The Processes Involved In Crypto Mining?

Crypto mining is a complex technical process that involves many technical, and mathematical processes and coding works. The exact processes involved in completing the mining are detailed in this section. 

Processes Involved In Crypto Mining

1️⃣Pooling of Transactions

The uncompleted cryptocurrency transactions, the transactions that have been initiated but not yet completed, are pooled together for the completion of the verification process. From this pool, miners extract information about each transaction.

2️⃣Creation of a Block

On the pool, a block is created by bundling together several unverified transactions. The transactions are grouped in the order of priority based on transaction size, transaction age, or the associated processing fee. 

3️⃣Solving Complex Maths Puzzles

Once a block is created with the unverified transactions, the quest for mining the block begins. Many miners have to compete with each other to complete a mining process. The mining process involves the miners finding a nonce, which is a number combined with the block using trial and error to find the right combination required to validate the existence of the block. 

4️⃣The Solution to the Puzzle is Broadcast and Verified by Other Miners

When a miner solves the mathematical puzzle required to validate the existence of a block, they publish the hash of the block on the network for verification by others. Other miners verify the accuracy of the hash and only after a specific number of miners validate the transaction and arrive at a consensus about the hash will it be finalised. 

5️⃣The Newly Mined Block is Added to the Network

After a consensus about the correctness of the block is arrived at, the miner who discovered the correct hash completes all the other required transactions and adds the block to the blockchain network. This process is officially confirmed by the blockchain network.

6️⃣The Miner is Rewarded

The miner who has discovered the new block and added it to the chain is rewarded. Rewards are given in the form of native tokens minted on the platform. 

What Are The Advantages Of Crypto Mining? 

Crypto mining is essential to the existence of a decentralized financial ecosystem. It validates the basis of the blockchain technology. 

The major advantages of crypto mining are given below.

  • Crypto mining is the basis of the existence of the blockchain network. Only if new blocks are mined and added to the chain will the whole system exist and grow. 
  • The complex mathematical puzzles involved in the validation process of a block also add to the security of the blockchain. The proof-of-work involved in crypto mining is a variation of the proof-of-stake consensus mechanism, which secures all the blockchain mechanisms. 
  • The active participants and successful miners are rewarded with the native tokens of each blockchain network. They are also compensated for the transaction fees involved in the mining process.
  • Crypto mining is the perfect process that will create new economic opportunities and job opportunities for technically trained people. The owners of the necessary infrastructure or those who can arrange for them through a pooled infrastructure can make huge profits with cryptocurrency mining.

What Are The Disadvantages Of Crypto Mining?

Despite the large-scale advantages of crypto mining, the disadvantages of the process should also be discussed.

  • The most pronounced disadvantage of crypto mining is the high energy needs that the mining process requires. For instance, crypto mining requires miners to purchase high-capacity computer networks, secure high-speed internet connection, and ensure 24 24-hour supply of electricity. These requirements can be taxing as far environment as well as the economy is concerned.
  • Crypto mining is a major cause of pollution because the hardware used can contribute to e-waste generation, which i very harmful to nature. These types of equipment can result in the emission of greenhouse gases, which are harmful to the environment.
  • Another major disadvantage of crypto mining is the lack of access to the process for ordinary citizens. The complex technical and mathematical processes involved in the mining of cryptocurrencies make it difficult for technologically illiterate people to indulge in the arena.
  • The profitability of cryptocurrency mining is also diminishing with time. There is a possibility of miners not getting enough money for the efforts that they put into the process. 
  • As cryptocurrency is a relatively emerging area in many countries, the taxation rules and formats are still complex and largely incomprehensible. This adds to the complexity of pursuing crypto mining.
  • There are many operational and financial risks associated with crypto mining. The hardware is prone to technical breakdown and can cause expensive maintenance and repair work. The processes can be expensive in places where the electricity costs are high. 
  • Other risks involved in crypto mining are fluctuations in the profit or costs of the process due to fluctuations in the market price of a certain crypto token.

Is Crypto Mining A Legally Valid Activity?

Crypto mining is legal in those countries that have actively adopted digital coins at par with fiat currencies as legal tender. However, the legality of the process in countries that are averse to the decentralized financial architecture is still a bone of contention. 

Many countries in the world view crypto mining as an illegal activity, simply because the whole process is decentralized and deregulated by any authorized entity. It is a parallel ecosystem where the participants coin the rules to promote their convenience and use cases. Even though each cryptocurrency platform aims to ensure high security and transparency, there is a high possibility that fraud can be initiated and executed without coming under the monitoring of a central authority. 

Countries like the US and Canada have definite rules and regulations about crypto mining whereas in India, there are no definitive rules to govern crypto mining. In Israel, on the contrary, crypto mining is seen as a business and is taxed.

The Taxability Of Crypto Mining

The taxability of crypto mining, i.e., whether the income attained through crypto mining is taxable under the income tax rules of a certain country is also debatable. In countries that have not legalized crypto mining, there are no definite laws regarding the same. In crypto-friendly nations such as the US, The income obtained by crypto mining is taxed according to the fair market value of the coin at that time. 

If the miner has registered the business as a means of self-employment, the tokens will be categorized under income earned through self-employment and will be taxed accordingly. 

The laws concerning the taxation of income received in cryptocurrency and the percentage of the income to be levied depend on individual rules and regulations of a country.

Also, Read: Crypto Tax-Free Countries

The Bottom Line

Crypto mining is a new age activity for the technically informed people to earn great. Professional miners must keep updating their skills and expertise to solve the various codes and puzzles to get their verification requests approved and the blocks added to the chain. 

The concerns related to the high use of energy and the impact of crypto mining on the environment are often raised from various parts of the world. Cryptocurrency platforms are on a relentless search for sustainable methods to make crypto mining more environmentally friendly. 

Fotis Dixon

Fotis Dixon is a business expert from the UK. He's written lots of articles about the newest market research and trends, especially on cryptocurrencies. Fotis is good at breaking down different topics to give useful information, helping readers stay updated on emerging trends.

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