Fully understand how to mine digital currencies such as Bitcoin, Litecoin, Dogecoin, the recommended hardware and the expected Return on Investment (ROI). Could mining cryptocurrencies be the next evolutionary step to traditional trading?
Understanding the Digital Currency
Digital currencies act as an alternative to current global currencies such as Euro’s and US Dollars. It is not controlled by central banks or governments. Its core value is determined by its users and is bulletproof to any type of economic figures such as employment and housing data. No commissions, fees or third parties are required (such as a clearing house) for the transaction to take place. The attractive characteristics of paying for services via a digital currency is its anonymity. No one can identify the person behind the wallet. This however does not disrupt the elegant design of the electronic system. We explain how to protect your digital currency address here.
The anonymity, unfortunately, paved the way for illegal activities, take Silk Road as an example. Governments issued multiple warnings concerning digital currencies, emphasizing it is an unregulated market and each individual should be aware of the risks involved such as the fact that digital currencies transactions are irreversible in any circumstances. We cannot deny the risk of course but we do sense an element of fear in these warnings. If individuals will turn into digital currencies and depart the traditional banking system it could very well restructure the face of our capital markets forever. A new age in the history of mankind.
Bitcoin is currently the most popular cryptocurrency so we will use it as an example. Bitcoin is a digital file. The network is based on peer to peer technology where all transactions are recorded in a place called the ‘ledger.’ Every computer in the network has a copy of the ledger in their system. When you wish to transfer Bitcoins from one account to another, let’s say 5 Bitcoins (BTC) you notify the network to add 5BTC to the account you wish to receive the Bitcoins and deduct 5BTC from your account. The information is passed along the network where each computer updates the ledger in their system and pass it thorough the network. To ensure the transaction is real and not forged, a digital signature (referred to as a private key) is applied for each transaction to reassure its authenticity. Only the owner of the Bitcoin address you are sending the funds to can access and claim the sent Bitcoins.
The order of the transactions, dated all the way back to the very first Bitcoin transaction are listed in a ‘block.’ Transactions listed in a block are said to have been placed at the same time. Each block includes a reference number to the previous block to the first very first Bitcoin trade. There are approximately 300 transactions in one block. The order of the blocks is referred to as the ‘block chain.’ When thousands of transactions are transmitted through the system, they will be categorized as ‘unconfirmed orders,’ meaning, these orders are not categorized by date and time in a block. This is where the miners come in.
The miners duty in the electronic system is to solve a block for the unconfirmed (not verified) orders. A mathematical proof of work (referred to as the ‘Hashcash’) must be submitted for the new block to be inline with previous blocks. The difficulty for validating new blocks increases in accordance to the amount of miners in the network to ensure the average time to validate a new block is around ten minutes.To sum up, mining Bitcoins means validating the transactions that take place in the system. Validating transactions is essential to eliminate ‘double spending.’ This is where I sent X amount of Bitcoins to George and then using the exact sent Bitcoins for John. It is strongly recommended if you have received Bitcoins for a certain service to wait 60 minutes before supplying the promised service to ensure the transaction is deep in the block chain.
How to Solve a Bitcoin Block?
We will try to simplify the mathematical puzzle that must be solved by miners in order to be rewarded. It
In order to create a new block a mathematical problem must be solved. Bitcoin uses Secure Hash Algorithm 256-bit (SHA256, developed originally by the NSA) as its fixed hash function. Miners first verify the transactions a number of times (approximately 18 times) before adding the transactions to the memory people. The miners next task is to hash each transaction via SHA256 in order to create the block. The hashes are then placed in what is referred to as ‘Merkel Tree.’ The previous block’s hash, merkel root and nonce are all placed in the block’s header (referred to as the hash header). The block header is then hashed via SHA256 to generate the output that will identify the block.
Let the Mining Begin
After obtaining the above output it is important to note that a target value is set by the Bitcoin protocol. In simple words, this means that the block header must begin with a certain number of zero’s. The hush must be smaller or equal to the target value in order to be accepted by the Bitcoin network. For example, the target value for mining Bitcoins was recently changed (difficulty increased) from 0000000000000000692842000000000000000000000000000000000000000000 to 00000000000000005D859A000000000000000000000000000000000000000000. The smaller the target the more difficult it will be to obtain the required hash. There is a reason why the system made it more difficult to solve a block, we will cover it shortly.
If the generated output does not begin with target value number of zeros it will be rejected. This is where the nonce comes into play. The nonce, a random number, is added to other header in order to produce a valid hush for the block in accordance to the target value. One is added to the nonce and the header is rehashed. The header will be hashed repeatedly until a valid hash is generated. The miner then updates the hash into the system. The network peers confirm the hash has been found, add it to the block chain and begin working on the next block. The miner earns new 25BTC (the new Bitcoins are referred to as a coinbase transaction) for his contribution for maintaining the system, which is valued at $15,950 (1 BTC = $638). Every four years (every 210,000 blocks) the rewarded Bitcoins will be halved until all Bitcoins were mined (the limit is 21mln). At the time of this writing there are approximately 12,852,000 in circulation.
The target value is what sets the difficulty for mining Bitcoins. It is updated every 20,016 blocks. The ‘Bitcoin Difficulty’ is a simple indicator that measures the difficulty of achieving the correct hash for the block header. The Bitcoin system operates in a way that it will take on average 10 minutes to solve a block. If there are more miners in the system and blocks are solved in 5 minutes for example, after 20,016 blocks the system will make it more difficult to find the correct hash to ensure it will take approximately 10 minutes to solve a block.
To summarize, miners verify Bitcoin transactions and place them in a block. To solve the hash for header, the nonce is constantly varied to result in a hash that is equal or less to the target value set by the Bitcoin protocol. You are not manually attempting to guess the hash as proof of work must be submitted. Your computer (CPU, GPU or ASIC) will run multiple combinations using the nonce in order to solve the block. The first one to obtain the hash submits it to the network for verification, earns new 25 Bitcoins. The peers will then begin working on solving the next block.
CPU, GPU, FPGA and ASIC
Due to the immense amount of Bitcoin miners, if your hash rate is too slow your chance of solving a block is slim, unfortunately. Several years ago, Central Processing Unit (CPU) was used to mine Bitcoins. To simplify, a CPU is using your computer’s (organic) processing power to discover the correct hash. With the difficulty so high, if there are other peers that have a faster hash rate your chance of success is limited. In theory, you could beat the other peers in the system but the odds of earning the fresh Bitcoins is almost like winning the national lottery.
When you install the mining software to your computer it will show your hardware hash rate. Here is a quick guide to hash rates per second:
KH/s means 1,000 hashes per second
MH/s means 1,000,000 hashes per second
GH/s means 1,000,000,000 hashes per second
TH/s means 1,000,000,000,000 hashes per second
PH/s means 1,000,000,000,000,000 hashes per second
If your CPU can only produce 15KH/s do not expect to make any money from mining Bitcoins. Here is a great reference to see how your software hash rate, click here.
GPU stands for Graphics Processing Power. It is commonly used for 3D images and other visual effects. Using GPU for mining Bitoins will provide you with a significantly higher hash rate per second, which ultimately increase the odds of obtaining the required hash for the block. However, temperature is a major factor in GPU mining. Mining via GPU means a lot of heat will be generated. A cooling system must be acquired to ensure the GPU will not overheat. The optimal temperature varies but below 80 celius degrees is optimal. Miners often use multiple GPU’s simultaneously to achieve a greater hash rate per second.
FPGA stands for a Field-Programmable Gateway Array (FPGA). Using the integrated chip for mining digital currencies will require a small power consumption than GPU while striving to achieve the same performance (hash rate per second) of a GPU. if Bitcoin’s value decreases the power costs of maintaining GPU (and ASIC, discussed soon) will chip into your profit and could very well result in a loss. Although the hash rate per second of FPGA does not match ASIC, some miners will be more fond of FPGA chips then GPU’s. Naturally, it is entirely your decision which hardware to acquire.
ASICS stands for Application Specific Integrated Circuit (ASIC). GPU were not initially designed for mining. ASIC has been specifically crafted for mining digital currencies. Using ASIC technology can significantly increase the hash rate to over 1 TH/s. The downside od ASIC is its price and power consumption. It is seen as a long term investment and greatly depending on the digital currency price. If you wish to mine digital currencies without joining a pool (explained later) we believe it is essential you are equipped with the latest gear in order to succeed. Our suggestion would be 2 x Titanium Bitcoin miner that can achieve an incredible hash rate of 6TH/s.
When purchasing a hardware it is important to highlight that Bitcoin uses SHA256 while some digital currencies (such as Litecoin) are using scrypt, hence the scrypt mining reference. Scrypt is a different type of algorithm, simpler than SHA256 used by Bitcoin. If you considered mining digital currencies as an investment do make a note of the algorithm behind the currency. Below are a number of digital currencies and the algorithm used for mining. Please note that there many other currencies that can be mined that are not listed in our brief summary:
|Bitcoin (BTC)||SHA256||21,000,000 max coins|
|Quark (QRK)||SHA256||247,000,000 max coins|
|Terracoin (TRC)||SHA256||42,000,000 max coins|
|Mazacoin (MZC)||SHA256||2.4192 billion max coins|
|Peercoin (PPC)||SHA256||20,500,000 max coins|
|Litecoin (LTC)||Scrypt||84,000,000 max coins|
|Fastcoin (FST)||Scrypt||165,888,000 max coins|
|Reddcoin (RDD)||Scrypt||109 billion max coins|
|Feathercoin (FTC)||Scrypt||336,000,000 max coins|
|Dogecoin (DOGE)||Scrypt||10 billion max coins|
At the time of this writing, the majority of the digital currencies are using Scrypt. It is entirely your decision which hardware to purchase and which currencies to mine. For security measures, it is essential that you do not download any software for the computer that is used for mining. In fact, it may be wiser to dedicate a new computer for mining. To achieve maximum results, the computer must be left running 24 hours a day. As mentioned earlier, cooling software is extremely important.
Ready to Mine
To begin mining once you have acquired the necessary hardware you need to open a Bitcoin wallet (the wallet contains your private keys, addresses). There are two types of wallets, an online wallet and a local wallet. For security reasons some may deter from online wallets and prefer the local option. It is your decision which type of wallet you wish to create. We provide two links where you may receive more information on creating your very first Bitcoin wallet:
Security is essential. Make sure your backup your entire wallet and not just the private key. If you have decided to create an online wallet it is important to encrypt the online backup to prevent any security breaches. Likewise, encrypting your wallet means a password will be required for any withdraw. Do print copies of your Bitcoin wallet and have it stored safely. We strongly suggest these steps to protect your investment.
When you set a password you must acknowledge there will be no possibilities to retrieve it if it is lost. Memorize your password and/or make sure you have it saved in a safe place such as on paper or CD. We do not recommend storing it on your computer. Do ensure to use numbers, capital letters, small letters and punctuation marks that are least 20 characters long.
Offline transactions can also be adopted for security measures, requiring two different computers. One computer must be disconnected to the network, hence the ‘offline’ reference. This computer has the entire wallet and is able to sign transactions. The second computer will be connected to the network but will be assigned as ‘watching wallet.’ To make Bitcoin transactions there is a public key and a private key. The public key is used to view the account’s (biotin address) balance and past transactions but no new transactions can be made without the private key. As discussed earlier, the private key is the digital signature that is used to affirm the transactions, meaning, proving you are the owner of the account and not a bogus transaction. The computer that is connected to the network will not include the private key (just the public) while the other computer that is not connected to the internet will hold the private key.
Make a transaction from the computer that is connected to the network. Save it on a diskonkey, sign the transaction with the private key with the computer that is not connected to the internet (offline) and then send the transaction via the computer that is connected to the network (online). There is a software called ‘Armory’ that is designed for offline transaction. Click here for further details.
Although at the time of this writing it is unavailable, hardware wallets will soon enter productions. These are small devices where the private key is stored. When you wish to make a transaction connect the device via USB and it will sign the transaction for you using your private key. Read more about TREZOR
When you have created your wallet, have the mining gear, it is time to begin mining. There are multiple mining software you may use. Each software is designed to work on different hardware (CPU, GPU, FPGA and ASIC). You may view a complete list of the Bitcoin software by clicking here. We would suggest CGMiner as it functions using either GPU, FPGA and ASIC. It is important to double-check the mining software supports the desired algorithm for your digital currency, SHA256 or Scrypt.
Joining a Mining Pool
Now that we clarified how to mine digital currencies, let’s discuss the option of joining mining pools. Using CPU or low hash rate for solving blocks may result in a low compensation. If other miners have a faster hash rate your odds of earning Bitcoins are minimal. A mining pool is where a group of miners join forces and combine their hashing power together to solve blocks. The earned Bitcoins are shared amongst the miners in accordance to their hash contribution to the pool. Each pool has a different structure for rewarding its miners. To be completely transparent, please follow the link to observe the leading mining pools in the market (click here).
Traditional Trading Vs. Mining
Although alternative currencies can be traded from various exchanges, we believe MTGox reflects the online threats that exist in these digital markets. In order to evaluate mining vs. traditional trading, we do need to answer the following question. Miners are rewarded with new Bitcoins for solving blocks, so what happens when all Bitcoins are in circulation? At the time of this writing sending Bitcoins is free of charge. Once all the coins are mined it is believed a transaction fee will be applied for sending Bitcoins. Miners in return for solving a block will earn the transaction fee.
After an extensive research we believe there is a great potential for mining currencies. In order to succeed, you must begin mining a currency that you believe will rise in the medium to long term. It is best to select a currency where you will have minimal competition (less miners) and a strong hash rate per second. We will provide fundamental and technical outlooks on various digital currencies and Altcoins for the benefit of global traders and miners to assist you with succeeding in these digital markets.
We have concentrated for you some great tools for mining Bitcoins: