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What is mining and what alternatives are there?

Simply put, mining is the system by which new coins are generated on the blockchain and transactions with existing coins are validated.


Miners are computer owners who provide the computing power with their computers to a cryptocurrency's network, which operates on a "proof-of-work" protocol. The first person to verify a new block is rewarded with newly generated units of cryptocurrencies. This reward is called a "block reward". The computers then mine in a race. Find out in detail how mining works, what it has to do with cryptocurrencies and what energy-saving alternatives there are.


Cointract Crypto Trading App Education: What is Mining? What is proof of work?
Photo by Pierre Borthiry - Peiobty

Basics

First of all, let’s get a brief fresh-up on what the blockchain is: The blockchain consists of several blocks. Each block represents a transaction, for example a transfer of a coin from person A to person B. The blocks are digitally linked together as a chain in order to guarantee traceability and security against manipulation.

Cointract Crypto Trading App: Visualization of how a blockchain works as a graphic

Mining as a validation process

So what does it mean "to mine"? The analogy comes from "gold mining" and stands for the system used to generate new coins on the blockchain and validate transactions with existing coins. You can picture it as follows:


If you buy a bitcoin, this transaction must first be verified and then added to the blockchain. In contrary to the purchase of FIAT currencies, where the financial institution is in control, the verification is done in a decentralised way, by solving a complex calculation problem. A large number of miners (computers or full nodes) compete to solve the task as quickly as possible. The winner adds the validated transaction to the blockchain and receives a reward in the form of cryptocurrencies. This consensus mechanism is called Proof of Work and many cryptocurrencies, such as Bitcoin, Dodgecoin or Litecoin, rely on this system.

Cointract Crypto Trading App: Graphic explanation of what mining is and how the process works

1) Person A sends person B 0.025 BTC.

2) The transaction is created.

3) The transaction is handed over to the miners for verification.

4) The miners validate the transaction. The fastest miner wins.

5) The transaction is added to the blockchain.

6) Person B receives 0.025 BTC from person A.



Criticism towards mining

Bitcoin and Co. face criticism in terms of environment and sustainability as mining consumes a lot of energy. The fact that many computers solve the same puzzle at the same time and under time pressure consumes a large amount of electricity. From 2009 to 2019, the computing power needed to mine a bitcoin increased by a factor of 12 trillion (!). Increasingly, this deficiency of the Proof of Work method for validating transactions on the blockchain is being replaced by the Proof of Stake approach.


Mining alternative: Proof of Stake

An alternative way to validate transactions is available: PoS (Proof of Stake) or also known as forging. Forging is a more advanced version of the PoW (Proof of Work) consensus mechanism.

With Proof of Stake, the full nodes (validators) wishing to confirm the transaction must participate in form of capital. This means that the validators (instead of miners) participate in a kind of lottery. The more capital is invested, the higher the probability of winning the selection process. The stake is the number of tokens that the validator owns.


You can compare it to traditional shares: The larger your stake in a company, the more voting rights you have. The important thing here is that the "losers" of the lottery get their invested capital credited back.


Proof of Stake brings a number of improvements:


  • Better energy efficiency - you don't need as much energy for proof of stake calculations because the validating party is participating. The validation of the transaction does not start until the contract is granted.

  • Low barriers to enter, reduced hardware requirements - no elite hardware is required to have a chance of creating new blocks.

  • Fewer commissions required for a transaction due to low electricity requirements.

  • More security through economic penalties for misconduct


The Ethereum Blockchain, for example, relies on this consensus mechanism and recently switched the entire blockchain to it in September 2022. Ethereum promises itself a more future-oriented, secure and sustainable solution for trading cryptocurrencies.


We hope this article was helpful to you and that you now have an initial understanding of mining.


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