What is Bitcoin Mining Actually Doing?

What is the point of Bitcoin mining? What is the value of the process?



What is Bitcoin Mining Actually Doing?The
answer to these questions lies the one thing that most of those who are quick to dismiss cryptocurrencies often miss or choose to ignore conveniently. And it is also the one thing that makes Bitcoin a disruptive innovation.

It is through understanding the process of Bitcoin mining that one comes to appreciate the real value of Bitcoin and how it is not only a unique technology but also one that has the potential to transform human society in ways we’ve not even begun to comprehend.

When Bitcoin mining is mentioned, what comes to the minds of many is an opportunity to earn digital coins by connecting powerful computers to the Bitcoin network. And indeed, over time, many have participated in Bitcoin mining without ever knowing its actual primary purpose. Their main focus in these cases is to get the mining reward, convert to fiat currency, and increase personal gain.

Designed to self-sustain

There is nothing wrong going into Bitcoin mining with earning the reward and increasing the personal worth as all that concerns you. This only illustrates the genius in Satoshi Nakamoto, the founder of Bitcoin.

Satoshi wrote a powerful piece of software to implement a truly decentralized electronic cash. But more importantly, the inventor designed a game theory that incentivizes self-seeking stakeholders to play by the rules to maintain the system. By trying to maximize their gain, stakeholders on the network end up effectively supporting the system.

So what is bitcoin mining actually doing?

The primary purpose of Bitcoin mining is to facilitate consensus on the status of a shared ledger on the network. This input is particularly important because the Bitcoin network is decentralized (peer-to-peer). It is composed of independent nodes (computers) with no central arbiter, but they all have to agree on what transactions are valid and who owns what at what time.

To understand the Bitcoin mining process, it is crucial to first acknowledge the critical role of a ledger in an electronic payment system. The term ‘blockchain,’ used to describe the underlying cryptocurrency technology, denotes a distributed ledger.

There is no electronic payment system that doesn’t have a ledger, a record of transactions. It is through the ledger that we get to know who owns what at what time. In centralized payment systems, there is an authority that maintains the payment ledger.

In a commercial bank, for example, the ledger is stored on the company’s servers. The process of assigning the rights of writing on the ledger is a straightforward one. A chain of command at the institution authorizes the bank teller (human or machine) to make changes on the ledger on behalf of the customer.

To maintain the integrity of the ledger, administrators hired by management strictly control and monitor access to writing privileges and rights.  

Bitcoin too has a ledger where records of who owns what at what time are kept. How the ledger is stored and updated is very different though.

Where is the Bitcoin ledger stored?

Before looking at how this ledger is maintained, it is important first to explain where it resides because that has a bearing on you understanding how and why mining is essential.

On a centralized payment system, like the one that a commercial bank maintains, the ledger is residing on servers. On the Bitcoin network, however, there is no server on which to store the ledger. Instead, each full node on the network keeps a duplicate copy of the ledger.

Also, unlike a commercial bank, Bitcoin does not have a central authority to assign the rights and privileges of writing on the ledger. Nevertheless, the need to update the ledger as users execute new transactions exists. And it is adequately and securely met.

When new transactions have to be added to the ledger, every one of the nodes on the network updates and synchronizes their copy with the rest. What Bitcoin mining does actually is to guide the process by independent nodes on the Bitcoin peer-to-peer network to update and synchronize their copies of the ledger. This is often described as finding a consensus on the status of the shared ledger.  

The protocol that guides the Bitcoin mining process is the first ever to facilitate peers on a public network to agree on the status of a ledger of payments. Up until 2009, all electronic payment ledgers were all maintained by centralized entities like banks.

What most of those who dismiss Bitcoin often miss is that with the launch of Bitcoin, for the first time people on a peer-to-peer network who do not know nor trust one another were able to agree on a single truth. They were able to accurately and securely maintain a ledger of transactions without the help of a central arbiter.

What is consensus on the Bitcoin network?

However, like most other terms in the blockchain space, the term ‘consensus’ as used to describe what Bitcoin mining achieves is a slight misnomer. It just happens to be one that explains what is closest to what actually happens.

What occurs during the Bitcoin mining process is that the computers on the network compete in some form of a lottery. The winning machine gets the rights and privileges to write the next block of transactions on the shared ledger for approximately 10 minutes.

The set of self-executing rules that guide the lottery are written in the core software that a computer has to install and run to communicate with others and be part of the Bitcoin network.

It is the set of self-executing rules that is known as a consensus algorithm or protocol. The rules can only be changed through an elaborate process, and all must agree to update their core software to a version that has new rules. This process is not easy to achieve, and that is the primary reason people trust the viability and longevity of Bitcoin.

How does the Bitcoin network achieve consensus

Here is a high-level presentation as to how a cycle of Bitcoin mining happens:

Each of the special nodes on the network known as miners collects the transactions users submit for confirmation. Each puts the transactions together into a batch known as a block.

The computers then compete in computing the data of the block into value and shape that is prescribed by the protocol. This process is known as hashing as it uses a mathematical hash function, which you could interpret as a mathematical multiplier. The Bitcoin network uses the SH256 hash function.

The mathematical computation process consumes a lot of energy. It also requires high computing power, and that is why today you can only join the Bitcoin mining process with application-specific integrated circuits (ASIC) powered hardware. This is powerful enough to do computation at the rate that is acceptable on the network.

The first miner to find the value, their block automatically joins the shared ledger as the next block. All the other miners update their copies of the ledger with the new block. While it takes time, computer power, and electricity to hash transaction data into a given value and structure, it is very easy for others on the network to prove that work was put into the process.

The miner whose block is recognized as the next official block of the shared ledger gets to keep the newly minted coin in that block. This is referred to as the reward, and its value halves every four years. Besides, the winning miner gets to keep the fees those sending bitcoins attach on their transactions.

These earnings are meant to compensate the miner for their time, investment in the mining hardware, and the electricity bill.

The process then starts all over again.

It is important to point out that even though a miner gets to write the next block of transactions on the shared ledger, they have to follow script rules. Otherwise, the network will ignore their block and add the next that follows all the rules.

Different types of blockchain consensus protocols

The electricity consuming consensus protocol that the Bitcoin network uses is referred to as the Proof of Work (PoW) algorithm. With the success of Bitcoin, other cryptocurrencies have been built. According to the digital asset tracking website CoinMarketCap, there are slightly over 2000 cryptocurrencies in circulation.

The increased number of cryptocurrencies has also seen an increased number of mining algorithms. Indeed, there are now over 20 consensus algorithms that have joined Bitcoin’s Proof of Work. Another most used consensus protocol is Proof of Stake (PoS) where a miner that writes the next block is chosen depending on native coins they hold.

The ultimate goal of all the consensus protocols used by blockchain network is the same; to help a peer-to-peer network pick the node that gets to write the next block of transactions on the shared ledger.  

 

A Blockchain Identity Solution Set to Change the Internet

Microsoft, IBM, Accenture and more than 70 other technology companies are working on a blockchain identity project set refurbish the Internet for the 21st century.

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Blockchain Identity Solutions
Image by Gerd Altmann from Pixabay

The way people, devices, applications, websites and even email addresses are identified on the Internet is on the verge of being disrupted in a significant way.

You could say the biggest ever change to the architecture of the World Wide Web is about to happen, and it is all thanks to Bitcoin.

In May 2017 Decentralized Identity Foundation (DIF), a consortium to explore ways of using blockchain for identity management on the Internet was founded. The membership has since grown to over 70 technology companies and startups. Some of the most active members include Microsoft, IBM, Accenture, Hyperledger and MasterCard.

For the last two years, a DIF technical team has been working on a protocol dubbed Sidetree, a second layer scaling solution on the Bitcoin network. When implemented, this protocol will enable Internet users to create decentralized identifiers (DID) on the Bitcoin blockchain with little technical hindrance or transaction throughput limitations.

This is turning out to be the most ambitious of the blockchain identity projects. Indeed, several startups that have been working on blockchain identity solutions of their own such as Civic, Identos and DIID are members of the consortium.

On May 13, 2019, the team made a major announcement concerning the development of the protocol. Stakeholders, as well as other interested parties, now have access to the early preview of the Identity Overlay Network (ION), a critical protocol interface between DID and the Bitcoin network.

“We’re announcing an early preview of a Sidetree-based DID network, called ION (Identity Overlay Network) which runs atop the Bitcoin blockchain ……. This approach greatly improves the throughput of DID systems to achieve tens-of-thousands of operations per second.”

But why is this a significant development?

At the moment, almost all identity management systems on the Internet, such as domain name and email address registries, are centralized. This goes against the spirit of Internet decentralization.

Identities are assigned, stored and updated on servers and data centers owned and controlled by mostly private companies and organizations. When you create a website, its ID is registered and accessed on domain nameserver, a database that a centralized third party maintains.

These entities, while striving to do a great job, are major single points of weaknesses.

The risk of massive data theft always exists as all it often takes to get control of the identity details of millions of users is to compromise single access points. With centralized data points, it is easier to carry out targeted sabotage attacks.

Indeed, the current architecture is designed in a way that the security of the system depends on being successful at blocking bad actors from accessing it.

What are the advantages of using blockchain for identity management?

Meanwhile, using blockchain for identity what Decentralized Identity Foundation is offering are identities that are not only secure, verifiable and censorship-resistant but also self-sovereign. What that means is that the identity can stand by itself with no need of it being referenced on a centralized registry, but even more, the user can carry it across platforms without the need to get permission from anyone.

The technology offers true ownership of identity on the Internet. Through public-private key cryptography, users have full control and can decide who to share details of their identities with.

The technology offers true ownership of identity on the Internet. Through public-private key cryptography, users have full control and can decide who to share details of their identities with.

In addition to a user not needing permission to create, update, share or move an identity, no one has the power to take it away from them. The current identity systems, it is possible to arbitrary remove users from registries, and that opens a window for censorship if the authorities in charge feel compelled to.

The security of each identity on the bitcoin network supported identity management systems is achieved through high-level cryptography. While it is possible to compromise access to a particular identity primarily through phishing, an attacker has to attempt a single identity at a time. There are no admin credentials one can steal to get access to multiple accounts or massive user data like it is the case with centralized systems.   

The Bitcoin network will provide the decentralized identity system with a ledger on which to create and secure user identity. It will also make the data related to identities immutable through the mining process or timestamping.

This is a powerful feature as even if users have full control of their identities, they are not able to go back in history to arbitrary make changes to suit particular current contexts. In other words, identity on the blockchain becomes verifiable even when it is the owner who controls its accessibility.

What this means for the Bitcoin network

With the decentralized identifiers system on top of its network, the value of Bitcoin is going to increase significantly, and I mean more than in terms of the price of its native coin (bitcoins) at the marketplace. The decentralized identity system is going to make Bitcoin even more powerful and useful.

In the previous post, we looked at how Bitcoin gets its value. Perhaps the most important takeaway from it is that the value of anything is considered to come from its usefulness in satisfying our needs.

And that is according to Carl Menger, who was a professor of political economy at the University of Vienna in the late 19th century and the founder of the Austrian School of economics.

If you haven’t read the post, take a moment to go through it.

After its launch, for a while, the general understanding was that Bitcoin’s best application is online money to be used in the place of fiat currencies like the US dollar. In particular, the kind that those who have something to hide can use to escape surveillance.

It turns out Bitcoin and the technology that powers it can do more than a digital currency for the dark web. Every sector you look at right now there is a startup building a robust and needed solution using the technology behind Bitcoin.

Why the Bitcoin blockchain?

With that said, there has been another misconception. And that is while the blockchain technology that Bitcoin introduced to the world can be applied in multiple use-cases, Bitcoin itself is rigid, and little innovation can be done on it to support more applications.

The Bitcoin network is now considered the world’s most powerful computer. In fact, it is more powerful than the world’s top 500 supercomputers.

The most cited weakness is its low transaction throughput. It is the reason the likes of Ethereum, NEO and EOS blockchains came into being. They were meant to overcome the shortcomings of the Bitcoin blockchain and make more decentralized applications possible.

However, Bitcoin remains the most secure blockchain owing to the amount of hashing (computer) power its network provides. The Bitcoin network is now considered the world’s most powerful computer. In fact, it is more powerful than the world’s top 500 supercomputers.

It is probably with this particular reason that the Decentralized Identity Foundation choose to use it instead of the others or to build a completely new one. The Identity Overlay Network that is out for early preview is meant to overcome the challenges of capacity and interoperability of the Bitcoin network.  

 

How Does Bitcoin have Value?

Courtesy of Flickr

The price of Bitcoin is always swinging high and low. In December 2017, we witnessed an all-time high of close to US$20,000 per Bitcoin, and a market capitalization of slightly over US$300 billion.   

Then the market went bearish in the following months as the crypto winter set in. The price rolled down, and it reached slightly above US$3,000 in December 2018. The market capitalization bled to under US$100 billion.

Right now we seem to be on the edge of another rally that could take us to new all-time highs in price and market capitalization.

The cycle of low and high has become part of Bitcoin. However, the general trend is the increase in its value.

But even with this volatility, how exactly does Bitcoin have value?

Is it the energy it consumes?

An argument those who don’t think Bitcoin is a good idea often make against it is that it lacks intrinsic or inherent value. Ironically, many in this school of thought hold the view that fiat currencies like the dollar have some intrinsic value. And that it comes from the backing by the state through central banking.

An argument those who don’t think Bitcoin is a good idea often make against it is that it lacks intrinsic or inherent value.

In response, Bitcoin enthusiasts have explained that the value of a bitcoin comes from the amount of energy the Bitcoin network consumes to mine it. According to a study by Crescent Electric Supply Company, a US-based electric hardware supplier, it costs US$4,675 to mine a bitcoin in the US. In China, the cost is US$3,172, South Korea $26,170 and Venezuela$531. The variation is brought about by how much electricity costs in different countries.

This explanation of how Bitcoin gets its value has its shortcomings. First, it is hard to reconcile the different costs of mining in different countries. Secondly, it means any amount on the price of Bitcoin above the cost of mining can never be justified.  

The question of what constitutes value is one that economists have sought to answer for decades.

Renowned economist has a better theory

Carl Menger was a professor of political economy at the University of Vienna in the late 19th century and he is regarded as the founder of the Austrian School of economics. In his book Principles of Economics, he explains that what constitutes the value of an item is its utility.

He states that ‘value is…nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being.’

‘Value is…nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being.’

In other words, value is the usefulness of something in satisfying our needs. This way of looking at value can be a great foundation in understanding the value of Bitcoin. The value of Bitcoin comes from its usefulness as a digital ledger that is immutable, tamperproof and decentralized.

Bitcoins also have value because of its usefulness as money that is durable, portable, fungible, scarce, divisible, and recognizable. Most importantly, Bitcoin is valuable because it is a less costly, fast and reliable mode of payment across international borders.

This usefulness of Bitcoin in meeting our needs translates to the demand of its units at the marketplace and corresponding prices. If there are more people finding it useful its price will keep going up. The value is further increased by the fact that Bitcoin is a deflationary currency; there will only be 21 million bitcoins.

The Bitcoin protocol is set in such a way that about every ten minutes new bitcoins come into circulation. However, the rate halves every four years so that around the year 2140 the release of new bitcoins will stop. By then all bitcoins ever mined will total 21 million.

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