The Bitcoin Blockchain

The Bitcoin blockchain is a database of transactions secured by encryption and validated by peers. The blockchain is not stored in one place; it is distributed and stored across multiple computers and systems within the network. These systems are called nodes. Every node has a copy of the blockchain, and every copy is updated whenever there is a validated change to the blockchain.

The blockchain consists of files (called blocks), which store data regarding transactions, previous blocks, addresses, and the code that executes the transactions and runs the blockchain. So, to understand the blockchain, it's important first to understand blocks.

Blocks

Each block in the blockchain is a digital container that permanently stores transaction data for the network. When new transactions occur, they are processed and bundled into a block. Once the network validates these transactions, the block is sealed and linked cryptographically to previous blocks. This creates a chain where each block's contents can't be altered without affecting the others.

How a Block in Blockchain Works

Active blockchain networks are continuously processing new transactions. These are grouped into blocks, which serve as the foundational units of the blockchain network. Each block is designed to store information while remaining secure.

There are two main ways blocks get approved and added to the chain:

  • Proof-of-Work (PoW)
  • Proof-of-Stake (PoS)

When a block in blockchain is opened (created), the blockchain creates the block hash, a 256-bit number that encodes the following information:

  • The current software version: This refers to the specific version of the software that the Bitcoin network is using at the time the block is created. It ensures that all participants (miners and nodes) are using the same version of Bitcoin’s rules.
  • The previous block's hash: Every Bitcoin block contains a unique identifier called a "hash," which is like a digital fingerprint of the block's contents. The "previous block's hash" is the hash of the block that came right before the current one.
  • The coinbase transaction: This is the first transaction in a Bitcoin block, where new Bitcoins are created (or "minted"). The reward for miners, which is the new Bitcoin issued for solving a block, is given through this transaction.
  • Timestamp: This is the exact time and date when the block is created (opened) on the Bitcoin network.
  • The target in bits: This is a number that determines how difficult it is to mine a new block. It defines the "target" that the block's hash must be below for the block to be accepted by the network.
  • The nonce: A "nonce" is a 32-bit number that miners change in an attempt to find a valid block hash that meets the target in bits. Miners keep changing the nonce and recalculating the block’s hash until they find one that fits the target.

Bitcoin Mining

Mining is a process of validating transactions and creating new blocks on the blockchain. Mining is conducted through software applications that run on computers or specially designed systems for mining called Application-Specific Integrated Circuits (ASIC).

Application-Specific Integrated Circuits (ASIC)

An ASIC is an integrated circuit chip designed specifically for mining. An ASIC miner is a device designed for the specific purpose of mining a specific digital currency based on the hashing algorithm they use.

Cryptocurrency mining is required by a Proof of Work (PoW) blockchain like Bitcoin to carry out its operations. The mining process involves solving cryptographic puzzles by generating a hash until finding one with a value equal to or below the target difficulty number's value. The first miner to find the solution to the puzzle has their block added to the blockchain. Each winner in the Bitcoin mining competition receives a reward (a specific amount of Bitcoin) along with the transaction fees for the transactions in that block.

Mining Difficulty and Halving

Bitcoin's mining difficulty adjustments will require a longer or shorter string of zeroes, depending on the number of miners on the network. The difficulty is adjusted every 2,016 blocks to hit a rate of about one new block every 10 minutes. The difficulty—or the average number of tries per second to solve the cryptographic puzzle—has been increasing since Bitcoin was introduced, reaching tens of trillions of average attempts to solve the hash.

There is also a very important concept in Bitcoin mining called halving. This concept states that every 4 years or 210,000 blocks, the mining reward or the amount of Bitcoin received when a new block is created (mined) will be cut in half.

Example: At first, the mining reward was 50 Bitcoins, but after 210,000 blocks, it was cut to 25 Bitcoins. In 2012, it was cut to 12.5, in 2020 it was cut to 6.25, and the last halving occurred in 2024, cutting the reward to 3.125 Bitcoins.

It is suspected that before 2023, the block reward will be 1 Bitcoin, after which the block reward will be handed in Satoshis (sats). Satoshis are the smallest monetary units of Bitcoin. Named after the creator of Bitcoin, Satoshi Nakamoto, a Satoshi represents one hundred millionth of a Bitcoin (0.00000001 BTC).

Mineable and Non-Mineable Coins

Mineable Coins: Mineable coins are any cryptocurrencies that one can mine through the process of crypto mining. In general, cryptocurrencies that follow the Proof of Work (PoW) mechanism are mineable—for example, Bitcoin, Litecoin, Dogecoin, etc. On the other hand, cryptocurrencies that follow Proof of Stake (PoS) are not mineable—for example, Ethereum.

Non-Mineable Coins: Non-mineable coins are cryptocurrencies that cannot be mined through crypto mining. These are the coins that follow Proof of Stake (PoS). Often, non-mineable coins are already in excess in circulation. Users can get these coins from crypto exchanges or by participating in events like Initial Coin Offerings (ICO).

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Consensus Mechanisms

Consensus mechanism is the core set of rules followed by nodes, which determines various important characteristics of blockchain such as security, scalability, and decentralization.

Proof of Work (PoW)

Proof of Work (PoW) was the first widely used blockchain consensus mechanism. It requires users to solve complex computational puzzles, known as mining, before submitting new transactions to the network. This expenditure of time, computing power, and energy aims to make the cost of fraudulent actions higher than the potential rewards. This means if a person tries to cheat or manipulate the blockchain by changing past transactions or adding fake transactions, the entire cost of the process of solving the puzzle and adding a new block is greater than the reward price.

Proof of Stake (PoS)

Proof of Stake (PoS) is a different approach to validating transactions and achieving consensus in a blockchain network. Unlike PoW, which relies on mining, PoS allows users with a small amount of cryptocurrency to participate in staking. In PoS, the more cryptocurrency a user holds and is willing to 'stake' for the network's security, the higher the chances of being chosen to validate transactions.

Staking: Staking lets you earn crypto rewards while supporting blockchain security. You retain full ownership of your crypto and can unstake it at any time. When you stake your ETH, it will start earning rewards after the staking wait time, which is determined by the ETH protocol.

PoW vs PoS

The main difference between PoW and PoS lies in the process of validating transactions and adding new blocks to the blockchain. PoW involves users solving complex puzzles, while PoS depends on the staking of coins.

In PoW, the first miner to solve the puzzle gets the reward, which can lead to a competitive environment and significant energy consumption. On the other hand, PoS is less energy-intensive and allows for more participation as it doesn't require specialized hardware.

Mining Algorithms

Cryptocurrency mining algorithms are a set of cryptographic instructions for the verification of transactions and maintaining the security of blockchain networks. These algorithms decide how new blocks are added to the blockchain and how miners compete to solve complex mathematical problems. The main function of mining algorithms is to keep the blockchain decentralized and secure while preventing any single entity from controlling the network.

Popular Cryptocurrency Mining Algorithms

  • SHA-256 (Bitcoin): SHA-256, or Secure Hash Algorithm 256-bit, is the cryptographic hash function used by Bitcoin. This algorithm is one of the most famous and widely used mining algorithms in the cryptocurrency world, mainly for its strong security and ability to resist attacks. Bitcoin miners use this algorithm to solve complex math problems and add new blocks to the blockchain. They earn the reward (some part of Bitcoin) along with the transaction fee for creating a new block.
  • Scrypt (Litecoin, Dogecoin): Scrypt is a hashing algorithm used on certain Proof of Work blockchains. Scrypt is a password-based key derivation function (KDF) hash algorithm that is designed to lower the dominance of ASIC miners as it relies upon a hash algorithm that creates keys based upon some secret key number. Scrypt is mainly developed to improvise the SHA-256 hash algorithm.
  • Ethash (Ethereum): Ethash is a proof-of-work algorithm used by Ethereum that is ASIC-resistant. It lets users hash a large data set called DAG (Directed Acyclic Graph) that changes regularly.
  • X11 (Dash): X11 is a hashing algorithm that combines the hashing algorithm of 11 different cryptographic functions to boost security. Its multi-stage design makes it more secure against attacks and more energy-efficient than some other algorithms. X11 is mainly used for Dash and can be mined using GPUs or special X11 ASICs.
  • Equihash (Zcash): Equihash is a memory-hard proof-of-work algorithm that is designed to resist ASICs and support decentralized mining. It needs a lot of memory resources, which makes it hard for ASICs to surpass GPU miners. Equihash is used by privacy-focused cryptocurrencies like Zcash and is usually mined with GPUs because it can handle its memory requirements.

Note: Resisting ASICs refers to the idea of making it difficult for Application-Specific Integrated Circuits (ASICs) to outperform General Purpose Computing Units (like GPUs) in mining a particular cryptocurrency.

Cloud Mining

Cloud mining is a technology where users use rented cloud computing power without installing and directly running hardware. Cloud mining firms allow users to open an account remotely and participate in the mining pool.

Cloud miners can be part of a mining pool and purchase some hash power for a certain fee. All participants earn some share of profit from successful mining based on the hash power rented.

Payout Methods in Mining Pools

  • Pay-Per-Share (PPS): In this payout method, miners are paid a fixed amount for each valid share they submit, regardless of whether the pool actually mines a block or not.

    Example: Let’s consider that a miner contributes 1,000 shares. Since the pool pays a fixed 0.0001 BTC per share, Miner A will earn 0.0001 BTC * 1,000 shares = 0.1 BTC.

  • Full-Pay-Per-Share (FPPS): This payout method is an extension of the pay-per-share method. In addition to paying miners for each valid share, miners are also paid a portion of the transaction fees earned from the blocks the pool mines.

    Example: • Miner A gets paid a fixed amount for each share, say 0.0001 BTC per share. So, for 1,000 shares, Miner A gets 0.1 BTC. • Plus, Miner A also gets a portion of the 0.5 BTC in transaction fees. If Miner A contributed 1,000 shares out of 100,000 shares, they get 0.005 BTC from the transaction fees. So, Miner’s total payment is 0.1 BTC from the block reward + 0.005 BTC from transaction fees = 0.105 BTC.

  • Pay-Per-Share-Plus (PPS+): This method combines the pay-per-share model with a share of the block rewards and transaction fees. Miners are paid per share like in pay-per-share, but the pool also distributes a percentage of the block rewards (including transaction fees) to miners, which can be added to the payout.

    Example: Miners get a fixed payment per share, just like PPS, but they also get an additional payout from the block reward and transaction fees the pool earns when it mines a block. This makes PPS+ more rewarding than just regular PPS.

  • Pay-Per-Last-N-Share (PPLNS): PPLNS (Pay-Per-Last-N-Shares) is a payout method where miners are not paid immediately for each share they submit. Instead, they are paid based on the total number of shares submitted by everyone in the pool during the last "N" shares. The more shares a miner submits relative to the total, the bigger their payout when the pool finds a block.

    Example: PPLNS (Pay-Per-Last-N-Shares) is a payout method where miners are not paid immediately for each share they submit. Instead, they are paid based on the total number of shares submitted by everyone in the pool during the last "N" shares. The more shares a miner submits relative to the total, the bigger their payout when the pool finds a block.