Bitcoin 101: All You Need to Know  — Part 2

January 3, 2024
5 min read

In the first part of this article, we talked about the beginning of Bitcoin, the mystery surrounding its creator, and mentioned a few interesting facts about the most well-known cryptocurrency.

In addition, we also discussed how Bitcoin mining has evolved over the years.

Part 2 of "Bitcoin (BTC): All You Need to Know" focuses on Bitcoin mining, mentions some of its known issues, and speculates on what the future holds.

How does Bitcoin mining work?

a pick axe mining a bitcoin from within a rock
Bitcoin mining is the process of validating transactions, combining them into blocks, and adding them to the blockchain for a reward.

When the first block, also known as the genesis block, was created on the Bitcoin blockchain, there was no reward since there was no previous block to refer to. From then on, each new block refers to or links to the previous one, and that’s how the blockchain is created. As new blocks are added to the network, the miner who completes the process first is rewarded with new BTCs.

Here is how it works in a few steps:

  1. Gathering transactions on the network: Miners gather transactions from the Bitcoin network and verify them by checking if the sender has enough Bitcoin to complete the transaction, confirming its authenticity, and making sure it follows the network’s rules.
  2. Collecting transactions into blocks: Miners collect the verified transactions into blocks. The number of transactions one block can include varies from hundreds to thousands, depending on the transaction size. The smaller the size of the transactions, the larger their number within a block.
  3. Creating a new block: At this stage, miners compete to solve a complex mathematical problem. The goal is to find a specific value and produce a hash that meets certain criteria set by the network. This process is known as Proof of Work.
  4. Broadcasting, validation, and reward: Once a miner solves the puzzle, they broadcast the new block to the network, and if the majority of the network validates it, it’s added to the blockchain. The miner receives their reward — some new bitcoins and transaction fees.

What is Proof of Work?

Proof of Work (PoW) is the consensus mechanism that lies at the core of the Bitcoin blockchain. Consensus mechanisms, as the name suggests, are protocols or algorithms used to achieve agreement between all network participants about the validity and authenticity of transactions and the state of the network and its blocks.

In the case of the Bitcoin blockchain, we speak of a Proof of Work type mechanism because miners, using their equipment, do computational work to find a hash that meets specific criteria and that, when successful, allows them to add a block to the blockchain. The work is complex, time-consuming, and requires a lot of resources.

There are other types of consensus mechanisms that different blockchains utilize:

Proof of Stake (PoS): Validators are chosen to create and validate blocks based on the number of coins they hold and are willing to “stake” or put up as collateral. The larger the stake, the bigger the chances to validate the block and get additional cryptocurrency as a reward. Staking their own coins guarantees that validators are genuinely interested in maintaining the integrity of the network because they stand to lose their stake if they act against its rules. In contrast to the Bitcoin blockchain, Ethereum, the second best-known cryptocurrency, uses the Proof of Stake consensus mechanism to validate transactions on its blockchain.

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Other less popular consensus mechanisms that some blockchains use include:

Proof of Burn (PoB): Participants in the network send coins to an unspendable address, proving they have “burned” them in exchange for the right to mine or validate blocks and earn rewards once they add them to the blockchain.

Proof of Space/Time (PoST): Participants allocate disk space to the network, proving they have reserved some space for a certain amount of time for mining.

Known challenges and the future

Two of the biggest challenges that Bitcoin faces are scalability and energy consumption. As can be seen above, because different blockchains use different consensus mechanisms, their impact on energy consumption and scalability can vary greatly.

By design, the more Bitcoins we have in circulation, the more difficult it becomes to solve the mathematical problems and mint (create) new Bitcoins. And because Bitcoin mining is about who gets there first, to be successful, one needs powerful equipment to do the job. That, however, leads to high energy consumption — one of the main issues surrounding Bitcoin.

According to the Cambridge Bitcoin Electricity Consumption Index, the total Bitcoin energy consumption has been on the rise in recent years.

There is also the problem of scalability or, in other words, the ineffectiveness of the Bitcoin blockchain network when working with transactions on a larger scale. The network can only handle a certain number of transactions per second, causing delays during high-demand periods. In addition, transaction fees can also be quite volatile, which makes micro-transactions less practical.

The Lightning Network

Efforts have been taken to address both issues mentioned above. For example, the Lightning Network — a layer-2 solution built on top of Bitcoin blockchain — was created to improve the speed and lower the costs of Bitcoin transactions. The Lightning Network creates a secondary layer on top of the Bitcoin blockchain where users have payment channels directly between themselves, make numerous transactions within these channels, and only settle the final balance on the Bitcoin blockchain. The goal is to facilitate faster and cheaper transactions and potentially allow millions of transactions per second, instantly, and with minimal fees. While it does help with scalability, it’s important to note that the Lightning Network is still a developing technology.

Electricity consumption

As for the electricity consumption of Bitcoin mining, while different reports use different methodologies to estimate what percentage of the mining operations are carbon-free, with numbers ranging from 30 to over 50%, it is worth mentioning that efforts to greenify cryptocurrencies and make Bitcoin more eco-friendly are ongoing.

According to a report published by the Massachusetts Institute of Technology (MIT), Bitcoin miners are constantly looking for alternative forms of energy to power their machines and lower their expenses.

The future

With the number of people who own cryptocurrencies constantly increasing and Bitcoin being the most popular cryptocurrency, it is safe to say that interest in it will continue to grow. In addition, as governments continue to look for ways to regulate the crypto market to make it more secure, safe, and transparent, it can be expected that cryptocurrencies will see more widespread adoption in the future by businesses, institutions, and the general public, too.

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