Decrypting the Mining Mechanism of Crypto Assets: From Principles to Practice

Core Points Overview

• Mining is a key process in blockchain networks for validating transactions and creating new coins.
• Miners compete to solve complex puzzles through computational power to earn block rewards.
• Mining equipment has evolved from CPU to GPU and then to ASIC, continuously improving efficiency.
• Electricity costs, hardware expenses, price fluctuations of coins, and changes in protocols all affect mining profits.
• Mining pools and cloud mining provide opportunities for small-scale miners to participate.

Understanding Mining from Scratch

Imagine a globally distributed ledger that records every cryptocurrency transaction. This ledger requires someone to maintain and verify it—this is the core mission of mining.

Miners use specialized computing equipment to solve cryptographic puzzles (essentially repeatedly guessing numbers) to organize and confirm pending transactions. Whoever solves the problem first is rewarded with cryptocurrency. This mechanism may seem simple, but it carries the important responsibility of protecting the security of the entire network.

Why is mining so important?

Mining secures the safety of cryptocurrencies like Bitcoin. Through this process, user transactions are verified and added to a public blockchain ledger. Mining is the cornerstone of maintaining the decentralized operation of the Bitcoin network—without a central authority, the entire system operates efficiently.

At the same time, mining is also responsible for injecting new coins into circulation. While it sounds like “printing money,” cryptocurrency mining is subject to strict regulatory constraints. These rules are written into the underlying protocol and enforced by a distributed network of nodes, preventing arbitrary issuance of new coins. Miners solve puzzles by consuming computational resources and receive newly generated tokens as rewards—this is a costly “creation” rather than a free “issuance.”

The Specific Process of Mining

simplified version

Step 1: Transaction Packaging When users send or receive cryptocurrency, all pending transactions are collected into a “block” waiting for confirmation.

Step 2: Solve the Puzzle Miners continuously use computers to try to find a special number (called a nonce). When this number is combined with the block data, it generates a result that is less than the target value—just like participating in a digital lottery with a password.

Step 3: Block on Chain The first miner to solve the puzzle gains the right to add their block to the blockchain. Other nodes validate the validity of the block.

Step Four: Collect Rewards Winning miners receive two parts of the earnings: newly generated cryptocurrency + all transaction fees included in the block.

In-depth Analysis

All new transactions first enter a pending area called the “mempool”. Validation nodes check the authenticity of these transactions. The miners' task is to extract transactions from the mempool and organize them into candidate blocks.

It is worth noting that not all miners run validating nodes—although some miners serve both roles, mining nodes and validating nodes are technically different.

A block can be understood as a page of the blockchain ledger, recording multiple transactions and other data. Specifically, mining nodes collect unconfirmed transactions and combine them into candidate blocks. Subsequently, miners attempt to convert the candidate block into a confirmed block, which requires solving a complex mathematical problem, consuming a large amount of computational power. For each successfully created block, miners will receive a block reward – including newly minted tokens and transaction fees.

Technical Details: Five Key Steps

Step 1: Transaction Hashing

The first stage of mining is to obtain transactions from the memory pool and process them one by one through a hash function. When the data is hashed, the miner receives a fixed-size result - the hash value. In the context of mining, the hash of each transaction is an identifier made up of a string of numbers and letters.

In addition to hashing and confirming individual transactions, miners also add a special transaction to send the block reward to themselves. This transaction is called a coinbase transaction, and it creates new coins. Typically, the coinbase transaction is added to the new block first, followed by the queue of unconfirmed transactions.

Step 2: Construct the Merkle Tree

After the transaction hash is completed, these hash values are organized into a structure known as a Merkle tree (or hash tree). The Merkle tree is formed by pairing and rehashing the transaction hashes. The newly generated hashes are paired and hashed again. This process is repeated until only one hash remains — the root hash (or Merkle root). This root hash encompasses all the previous hashes that were used to create it.

Step 3: Find a valid block header

The block header serves as a unique identifier for each block. When creating a new block, miners combine the hash of the previous block with the root hash of the candidate block to obtain a new block hash. At the same time, a random number (nonce) is added. To validate the candidate block, miners must hash the combination of the root hash, the previous block hash, and the nonce value. This process continues until a valid hash is found.

Due to the immutability of the root hash and the previous block hash, miners can only change the nonce value until they find a valid hash that meets the criteria. This hash must be less than the target value specified by the protocol. In the Bitcoin network, the block hash needs to start with a specific number of zeros—this target value is known as mining difficulty.

Step Four: Broadcast Block

Miners repeatedly perform hash calculations on the block header with different nonce values until they find a valid block hash. After discovering a valid hash, the miner broadcasts the block to the network. All other nodes verify the validity of the block, and if it passes, they add it to their own copy of the blockchain. At this point, the candidate block becomes the confirmed block, and all miners turn to mining the next block. Miners who fail to find a valid hash will discard their candidate block and restart a new mining cycle.

The Situation of Dual Blocks Appearing Simultaneously

Sometimes two miners broadcast valid blocks almost simultaneously, leading to the emergence of two competing blocks in the network. Users begin mining on the block they received first. This temporarily splits the network into two versions of the blockchain. The competition continues until the next block is mined and surpasses all competing blocks. Once the new block is produced, the previous block of the winning miner is recognized as the victor. The abandoned block of the other miner is referred to as an orphan block or detached block. The miner who chose that block then switches to the winning block, based on its continued mining.

Dynamic Adjustment of Mining Difficulty

The mining difficulty is continuously adjusted by the protocol to ensure that new blocks are generated at a stable pace, thereby achieving predictable issuance of new coins. The difficulty fluctuates with changes in the total computing power of the network (hash rate).

When new miners join the network and competition intensifies, the hash difficulty increases to prevent the block generation time from shortening. Conversely, if a large number of miners leave the network, the hash difficulty will decrease, making it relatively easier to create new blocks. This automatic adjustment mechanism maintains the stability of block generation time, regardless of changes in the total computing power of the network.

Various Ways of Mining

The equipment and processes for cryptocurrency mining are continuously updated with the evolution of new technologies and consensus algorithms. Miners typically use specialized computing devices to solve complex cryptographic equations. Here are some of the most common methods:

CPU mining

Central Processing Unit (CPU) mining involves using a computer's CPU to perform hashing operations under the Proof of Work (PoW) consensus model. In the early days of Bitcoin, mining costs were low, and the entry barrier was also low, allowing ordinary computer CPUs to handle the challenges. At that time, anyone could attempt to mine.

However, as the number of miners increases and the network hash rate rises, the difficulty of profitable mining also increases. The emergence of specialized equipment, which has computing power far exceeding that of consumer-grade processors, has caused CPU mining to gradually lose its competitiveness. Today, CPU mining is no longer realistic, as the vast majority of miners have switched to specialized equipment.

GPU mining

Graphics Processing Units (GPUs) are designed to handle a large number of operations simultaneously. While commonly used for video games or graphic rendering, GPUs can also be used for mining. GPUs are relatively inexpensive, and unlike specialized mining equipment, they can perform a variety of tasks. GPUs can also be used for mining certain altcoins, but efficiency depends on the specific algorithm and mining difficulty.

ASIC mining

Application-Specific Integrated Circuits (ASICs) are designed for a single specific purpose. In the cryptocurrency field, ASIC refers to hardware specifically developed for mining. ASIC mining is highly efficient but requires a relatively large initial investment. Because ASICs are at the forefront of mining technology, these devices cost far more than CPUs or GPUs. Additionally, ASICs undergo continuous upgrades and iterations, leading to rapid obsolescence of previous generations. For this reason, ASIC mining is one of the most costly methods, but when operated on a large scale, it offers the highest efficiency and profit potential.

mining pool

As block rewards are only given to the first successful miner, the probability of an individual miner mining a block is extremely low. Miners with limited computing power have almost no chance of finding the next block on their own. To solve this dilemma, mining pools have emerged.

A mining pool is a collective of miners who combine computational resources (hash power) to increase the probability of finding blocks and share rewards. When a mining pool successfully finds a block, the rewards are distributed according to the proportion of work done by each miner. Mining pools are attractive to independent miners because they reduce hardware and electricity costs. However, these pools also increase the risk of centralization and the potential threat of a 51% attack.

Cloud Mining

Cloud mining allows miners to lease computing power from cloud mining service providers instead of purchasing equipment. This is a relatively easy way to start mining, but it comes with the risks of fraud and declining profits. If you plan to try cloud mining, you should choose reputable service providers.

The Uniqueness of Bitcoin Mining

Bitcoin is the most well-known time-tested cryptocurrency. Bitcoin mining is based on the Proof of Work (PoW) consensus algorithm. PoW is a blockchain consensus mechanism created by Satoshi Nakamoto and proposed in the Bitcoin whitepaper in 2008. PoW determines how the blockchain network reaches consensus among all distributed participants without the need for a third-party intermediary.

Malicious actors find it difficult to manipulate such networks, as they require a huge investment in electricity and computational resource costs. As mentioned earlier, in PoW networks, pending transactions are organized by miners and added to blocks. Miners race to solve problems using specialized equipment. The first miner to find the solution gains the right to add their block to the blockchain. If the validating nodes accept the block, the miner receives a block reward.

The specific amount of cryptocurrency rewards depends on the blockchain used. For example, in the Bitcoin blockchain (as of December 2024), miners receive a reward of 3.125 BTC for each block.

Bitcoin adopts a halving mechanism, reducing the BTC reward by 50% every 210,000 blocks (approximately every four years). This design ensures the predictability and scarcity of the total supply of Bitcoin.

Profitability Analysis of Mining

It is possible to earn income through mining, but it requires a deep understanding of the processes, risk management, and thorough research. Investors should be cautious about investing their funds and consider hardware costs, cryptocurrency price fluctuations, and the possibility of protocol changes. Users should take risk management measures and assess the potential costs and benefits of mining.

The profitability of mining depends on several factors, among which the fluctuation of cryptocurrency prices is key. When prices rise, the fiat value of mining rewards also increases. Conversely, a price drop reduces profitability.

The efficiency of mining equipment is a core factor in determining profits. The cost of mining hardware is high, and miners must weigh the investment in equipment against potential returns. Electricity costs are another important variable. Excessively high electricity costs may exceed revenues, making mining unprofitable.

In addition, mining equipment needs to be updated regularly, as it quickly becomes outdated. New models have stronger performance, and miners who do not have enough funds to upgrade will lose their competitiveness.

Significant changes at the protocol level cannot be ignored. Bitcoin halving affects mining rewards as it reduces the block reward by half. In certain cases, mining may be replaced by other validation mechanisms. Taking Ethereum as an example, it switched from a PoW consensus mechanism to Proof of Stake (PoS) in September 2022, completely ending mining activities on the network.

Summary

Cryptocurrency mining is a key component of Bitcoin and other PoW blockchains, laying the foundation for the security of these networks and the issuance of stablecoins. Mining has both advantages and disadvantages. The most obvious advantage is the potential to profit from block rewards. However, mining earnings are affected by various factors, including electricity costs and market conditions.

If you are interested in cryptocurrency mining, you should first conduct personal research, fully assess potential risks and opportunities, act within your means, and avoid blindly chasing trends.