Crypto 101-Part III-Mining a Crypto

For those new to this post refer to Part I and Part II

A short summary from part I

A blockchain is like a passbook to keep track of the information.

Now imagine this passbook holds details of millions of people and the information is held on thousands of computers.

Each computer will need to verify the transaction and once it is verified, it is like recording it on the physical passbook in permanent ink.

Crypto Mining

Mining is the process through which the blockchain is created.

Today we will focus on understanding the basics of 2 distinct methods being used-one which is the current standard and the other which is the challenger.

Proof of Work

This is a consensus mechanism that allows network nodes (various computers on the network) to agree on the transaction and authorize the same.

Each time the transaction is so authorized a blockchain is created with a reward for the miner in terms of crypto (bitcoin, Ethereum) etc.,

There are 2 types of transactions happening here-

  • One creating a new crypto and,
  • The other is verifying transfer transactions.

Both have rewards for miners who confirm the transactions.

Proof-of-work is the underlying algorithm that sets the difficulty and rules for the work miners do. Mining is the “work” itself.

It’s the act of adding valid blocks to the chain. This is important because the chain’s length helps the network spot the valid chain.

Transactions are processed into blocks. Each block has a:

block difficulty – for example: 3,324,092,183,262,715

mixHash-Forexample: 0x44bca881b07a6a09f83b130798072441705d9a665c5ac8bdf2f39a3cdf3bee29

nonce(number only used once) – for example: 0xd3ee432b4fb3d26b

This block data is directly related to PoW.

The proof-of-work protocol requires miners to go through an intense race of trial and error to find the nonce for a block. Only blocks with a valid nonce can be added to the chain.

When racing to create a block, a miner will repeatedly put a dataset, that you can only get from downloading and running the full chain (as a miner does), through a mathematical function.

This is to generate a mixHash that is below a target nonce, as dictated by the block difficulty. The best way to do this is through trial and error.

The objective of PoW is to extend the chain. The longest chain is most believable as the valid one because it’s had the most computational work done on it.

Within PoW system it’s nearly impossible to create new blocks that erase transactions or create fake ones or maintain a second chain. That’s because a malicious miner would need to always be solving the block nonce faster than everyone else.

PoW is also responsible for issuing new currency into the system and incentivising miners to do the work.

Miners who successfully create a block are rewarded in freshly minted crypto and all the transaction fees within the block. 

Challenges of Proof of Work

Security and integrity of the blockchain is the biggest advantage of a decentralized system.

However, there are 3 challenges

Accessibility– The barriers to entry to becoming a PoW miner are high. It requires a substantial amount of investment in hardware to run a rig and also access to low cost electricity. Hence being in a location with lower cost and also set-up a corporate entity to avail lower cost electricity increases entry barrier.

Centralization-high cost has led to mining getting concentrated in the hands of mining pools.

Scalability-As each block is mined consecutively and it is constrained by its size, sometimes miners have to wait for hours in the que.

One of the reasons such high amount of energy is being used in mining is the competition to be the first one to solve the puzzle.

This means the one with better computational power wins the race and that results into abnormal amount of energy usage

Ethereum is trying to change the mining protocol from “proof of Work” to “Proof of Stake”

Proof of Stake

Instead of miners a “proof of stake” will have validators.

The validators will have to stake their own cyrpto to be authorized as validators.

As a transaction is created validators will be chosen on random to mine them leading to reduction in competition and hence the resultant use of energy.

Once the transaction is created, more validators will be called upon the attest the transaction ultimately leading to its addition to the blockchain.

Proof of Stake will also try to enable scalability by breaking the blockchain into 64 smaller components called “shards” that will break the network into smaller partitions, with each partition having its own data separate from other shards.

This will distribute the blockchain into multiple partitions being processed separately thereby improving the efficacy of the overall network.

There are other elements to mining which I shall cover in the next part so that you can digest this post meanwhile. Will also try to break down the proof-of-work protocol further to make it easier to understand.

For guidance contact on manish.verma@manishverma.co.in or 9920741569

Follow my twitter handle irreverentinvestor@manver1974 for more such shares

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