Bitcoin mining is the process by which transactions on the Bitcoin Network are verified and recorded. Bitcoin miners are paid for their work in new bitcoins. Mining is the only way that new bitcoins can be created.
Bitcoin mining operates on the basis of what is known as a “proof of work” (POW) system.
The POW algorithm uses computationally intensive puzzles in order to validate transactions and create new blocks. Miners serve as nodes and are rewarded based on being the first to solve the aptly named “proof of work” mathematical problem. Solving the problem is not easy, and becomes increasingly difficult as the blockchain lengthens and additional miners join the distributed network, forcing miners to apply more and more computing power to reach each subsequent solution.
Using computing power to generate these rewards requires vast amounts of electricity, and the most discussed downside to the POW approach is the massive energy requirements. There has been regular political and economic debate about whether the use of this electricity for mining is a benefit to the global society.
Recently, subsequent to its shut down of cryptocurrency exchanges, China has implemented a strict enforcement approach to blockchain mining businesses, calling on regional authorities to strictly enforce existing policies that could make mining uneconomic or impossible. How this will play out is to be determined, but China accounts for more than half of the world’s Bitcoin mining power, and a shutdown of the related nodes could decrease the hashpower of the network, decreasing the difficulty of the blockchain algorithm, and increasing the economic upside for the remaining miners.
An alternative to POW is what is known as “proof of stake” (POS).
In a POS system, the person who is the successful creator of the next block (and, therefore, entitled to be compensated) is selected through the application of various combinations of random “stake” factors such as, for example, how much of the relevant cryptocurrency the person holds or how long the units of cryptocurrency have been held.
The equivalent of a miner in a POW system is referred to as a “validator” in a POS system. The pre-determined mechanic to calculate each validator’s stake is part of the algorithm, and all validators can see the rules. There is no reward for the first validator to complete a block in the blockchain. Successful validators receive transaction fees instead. The greater a validator’s stake in the relevant cryptocurrency, the greater the transaction fee it receives, and this fee is paid in the underlying cryptocurrency.
Because POS does not require continual and increasing computing power to solve mathematical problems, validators use less electricity, and do not need factory-scale computing operations. Another potential advantage is that, unlike POW systems in which miners are not required to own any of the relevant cryptocurrency, the validators must hold a stake, forcing an investment by those validating transactions, and potentially stabilizing the value.
Ethereum, probably the most well-known blockchain platform after the Bitcoin Network, has announced a consensus-based decision to move from a POW mining model to a POS model. Supporters and critics are debating security, value, and whether there will be any significant reduction in the energy required to support the Ethereum ecosystem.
A transition from POW to POS mining represents substantial development of the industry, and we see this as evidence that blockchain technology is robust, adapting, and here to stay.
Our Blog Series
We are excited to bring you a weekly blog series on blockchain, cryptocurrency, coins, tokens, capital market regulations, and legal approaches to this new industry. This is our seventh post, and you can expect to see at least one each week over the next few months.
Read our previous blog post, “Blockchain Mining 101.”
Subscribe now to receive each installment of the Blockchain Insights series, delivered to your inbox weekly.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.