What Is Bitcoin Mining?
Chances are you hear the phrase “bitcoin mining” and your mind begins to wander to the Western fantasy of pickaxes, dirt and striking it rich. As it turns out, that analogy isn’t too far off.
Bitcoin mining is performed by high-powered computers that solve complex computational math problems; these problems are so complex that they cannot be solved by hand and are complicated enough to tax even incredibly powerful computers.
The result of bitcoin mining is twofold. First, when computers solve these complex math problems on the bitcoin network, they produce new bitcoin (not unlike when a mining operation extracts gold from the ground). And second, by solving computational math problems, bitcoin miners make the bitcoin payment network trustworthy and secure by verifying its transaction information.
When someone sends bitcoin anywhere, it's called a transaction. Transactions made in-store or online are documented by banks, point-of-sale systems, and physical receipts. Bitcoin miners achieve the same thing by clumping transactions together in “blocks” and adding them to a public record called the “blockchain.” Nodes then maintain records of those blocks so that they can be verified into the future.
When bitcoin miners add a new block of transactions to the blockchain, part of their job is to make sure that those transactions are accurate. In particular, bitcoin miners make sure that bitcoin is not being duplicated, a unique quirk of digital currencies called “double-spending.” With printed currencies, counterfeiting is always an issue. But generally, once you spend $20 at the store, that bill is in the clerk’s hands. With digital currency, however, it's a different story.
Digital information can be reproduced relatively easily, so with Bitcoin and other digital currencies, there is a risk that a spender can make a copy of their bitcoin and send it to another party while still holding onto the original.1
Verifying Bitcoin Transactions
In order for bitcoin miners to actually earn bitcoin from verifying transactions, two things have to occur. First, they must verify one megabyte (MB) worth of transactions, which can theoretically be as small as one transaction but are more often several thousand, depending on how much data each transaction stores.
Second, in order to add a block of transactions to the blockchain, miners must solve a complex computational math problem, also called a "proof of work." What they're actually doing is trying to come up with a 64-digit hexadecimal number, called a "hash," that is less than or equal to the target hash. Basically, a miner's computer spits out hashes at different rates—megahashes per second (MH/s), gigahashes per second (GH/s), or terahashes per second (TH/s)—depending on the unit, guessing all possible 64-digit numbers until they arrive at a solution. In other words, it's a gamble.
The difficulty level of the most recent block as of August 2020 is more than 16 trillion. That is, the chance of a computer producing a hash below the target is 1 in 16 trillion. To put that in perspective, you are about 44,500 times more likely to win the Powerball jackpot with a single lottery ticket than you are to pick the correct hash on a single try. Fortunately, mining computer systems spit out many hash possibilities. Nonetheless, mining for bitcoin requires massive amounts of energy and sophisticated computing operations.The difficulty level is adjusted every 2016 blocks, or roughly every 2 weeks, with the goal of keeping rates of mining constant.4 That is, the more miners there are competing for a solution, the more difficult the problem will become. The opposite is also true. If computational power is taken off of the network, the difficulty adjusts downward to make mining easier.
What is a crypto wallet?
Crypto wallets are an integral part of using Bitcoin and other cryptocurrencies. They are one of the basic pieces of infrastructure that make it possible to send and receive funds through blockchain networks. Each wallet type has its advantages and disadvantages, so it's crucial to understand how they work before moving your funds.
How do cryptocurrency wallets work?
Contrary to popular belief, crypto wallets don't truly store cryptocurrencies. Instead, they provide the tools required to interact with a blockchain. In other terms, these wallets can generate the necessary information to send and receive cryptocurrency via blockchain transactions. Among other things, such information consists of one or more pairs of public and private keys.
The wallet also includes an address, which is an alphanumeric identifier that is generated based on the public and private keys. Such an address is, in essence, a specific "location" on the blockchain to which coins can be sent to. This means you can share your address with others to receive funds, but you should never disclose your private key to anyone.
The private key gives access to your cryptocurrencies, regardless of which wallet you use. So even if your computer or smartphone gets compromised, you can still access your funds on another device – as long as you have the corresponding private key (or seed phrase). Note that the coins never truly leave the blockchain, they are just transferred from one address to another.
Hot vs. cold wallets
As mentioned, cryptocurrency wallets may also be defined as "hot" or "cold," according to the way they operate.
A hot wallet is any wallet that is connected somehow to the Internet. For example, when you create an account on Binance and send funds to your wallets, you are depositing into Binance's hot wallet. These wallets are quite easy to set up, and the funds are quickly accessible, making them convenient for traders and other frequent users.
Cold wallets, on the other hand, have no connection to the Internet. Instead, they use a physical medium to store the keys offline, making them resistant to online hacking attempts. As such, cold wallets tend to be a much safer alternative of "storing" your coins. This method is also known as cold storage and is particularly suitable for long-term investors or "HODLers."
As a way to protect users' funds, Binance only holds a small percentage of coins in its hot wallets. The remaining is kept in cold storage, disconnected from the Internet. Noteworthy, Binance DEX provides an alternative for users that prefer not to keep their funds in a centralized exchange. It's a decentralized trading platform that allows you to have total control of their private keys, while also being able to trade directly from their cold storage devices (hardware wallets).
Software wallets come in many different types, each with its own unique characteristics. Most of them are somehow connected to the Internet (hot wallets). The following are descriptions of some of the most common and important types: web, desktop, and mobile wallets.
You can use web wallets to access blockchains through a browser interface without having to download or install anything. This includes both exchange wallets and other browser-based wallet providers.
In most cases, you can create a new wallet and set a personal password to access it. However, some service providers hold and manage the private keys on your behalf. Although this may be more convenient for inexperienced users, it's a dangerous practice. If you don't hold your private keys, you're trusting your money to someone else. To address this problem, many web wallets now allow you to manage their keys, either entirely or through shared control (via multi-signatures). So it's important to check the technical approach of each wallet before choosing the most suitable for you.
When using cryptocurrency exchanges, you should consider making use of the protection tools available. The Binance Exchange offers several security features, such as device management, multi-factor authentication, anti-phishing code, and withdrawal address management.
As the name implies, a desktop wallet is a software you download and execute locally on your computer. Unlike some web-based versions, desktop wallets give you full control over your keys and funds. When you generate a new desktop wallet, a file called "wallet.dat" will be stored locally on your computer. This file contains the private key information used to access your cryptocurrency addresses so you should encrypt it with a personal password.
If you encrypt your desktop wallet, you will be required to provide your password every time you run the software so that it can read the wallet.dat file. If you lose this file or forget your password, you will most likely lose access to your funds.
Therefore, it's crucial to backup your wallet.dat file and keep it somewhere safe. Alternatively, you can export the corresponding private key or seed phrase. By doing so, you will be able to access your funds on other devices, in case your computer stops working or becomes inaccessible somehow.
In general, desktop wallets may be considered safer than most web versions, but it's crucial to make sure your computer is clean of viruses and malware before setting up and using a cryptocurrency wallet.
Trust Wallet is a prominent example of a mobile crypto wallet.
A paper wallet is a piece of paper on which a crypto address and its private key are physically printed out in the form of QR codes. These codes can then be scanned to execute cryptocurrency transactions.
Some paper wallet websites allow you to download their code to generate new addresses and keys while being offline. As such, these wallets are highly resistant to online hacking attacks and may be considered an alternative to cold storage.
Owing to the numerous flaws, however, the use of paper wallets is now considered dangerous and should be discouraged. If you still want to use it, it's essential to understand the risks. A major flaw of paper wallets is that they aren't suitable for sending funds partially, but only its entire balance at once.
For example, imagine that you generated a paper wallet and sent multiple transactions to fund it, summing a total of 10 BTC. If you decide to spend 2 BTC, you should first send all 10 coins to another type of wallet (e.g., desktop wallet), and only then spend part of the funds (2 BTC). You can later return the 8 BTC to a new paper wallet, though a hardware or software wallet would be a better choice.
Technically, if you import your paper wallet private key into a desktop wallet and spend just part of the funds, the remaining coins will be sent to a "change address" that is automatically generated by the Bitcoin protocol. If you don't manually set the change address to one that you control, you will likely lose your funds.
Most software wallets today will handle the change for you, sending the remaining coins to an address that is part of your wallet. But the important thing to remember is that your paper wallet will be empty after sending its first transaction out – regardless of the amount. So don't expect to reuse it later.
The importance of backups
Losing access to your cryptocurrency wallets can be quite costly. So it's important to back up them regularly. In many cases, this is achieved by simply backing up wallet.dat files or seed phrases. Essentially, a seed phrase works like a root key that generates and gives access to all keys and addresses in a crypto wallet. Also, if you opted for password encryption, remember to back up your password as well.