Mining Explained: A Detailed Guide on How Cryptocurrency Mining Works

In its heyday, cryptocurrency mining was an arms race that led to increased demand for graphics processing units (GPUs). In fact, Advanced Micro Devices, a GPU manufacturer, posted impressive financial results as demand for the company’s shares soared and shares traded at their highest level in a decade.

Despite the surge in demand for gpus, the crypto mining gold rush quickly came to an end as the difficulty of mining major cryptocurrencies like bitcoin increased just as quickly.

Reading: What do i need to mine bitcoin

However, cryptocurrency mining can still be profitable. So what is crypto mining, is it legal and how can you get started? this article takes a closer look at these questions.

For more information and topics, visit our freeman law blockchain and cryptocurrency resource page.

what is crypto mining?

Most people think of crypto mining simply as a way to create new coins. however, crypto mining also involves validating cryptocurrency transactions on a blockchain network and adding them to a distributed ledger. More importantly, crypto mining prevents double spending of digital currency on a distributed network.

Like physical currencies, when a member spends crypto, the digital ledger must be updated by debiting one account and crediting the other. however, the challenge of a digital currency is that digital platforms are easily manipulated. The bitcoin distributed ledger therefore only allows verified miners to update transactions on the digital ledger. this gives miners the added responsibility of protecting the network against double spending.

Meanwhile, new coins are generated to reward miners for their work on network security. Since distributed ledgers lack centralized authority, the mining process is crucial to validating transactions. therefore, miners are incentivized to secure the network by participating in the transaction validation process which increases their chances of earning newly minted coins.

To ensure that only verified crypto miners can mine and validate transactions, a proof-of-work (pow) consensus protocol has been implemented. pow also protects the network from any external attack.

proof of work

Crypto mining is somewhat similar to precious metal mining. while precious metal miners will unearth gold, silver or diamonds, crypto miners will trigger the release of new coins into circulation. for miners to be rewarded with new coins, they need to implement machines that solve complex mathematical equations in the form of cryptographic hashes. a hash is a truncated digital signature of a piece of data. hashes are generated to protect data transferred on a public network. miners compete with their peers to zero in on a hash value generated by a crypto currency transaction, with the first miner to crack the code adding the block to the ledger and receiving the reward.

Each block uses a hash function to refer to the previous block, forming an unbroken chain of blocks that leads back to the first block. for this reason, peers on the network can easily check if certain blocks are valid and if the miners who validated each block correctly resolved the hash to receive the reward.

Over time, as miners implement more advanced machines to solve pow, the difficulty of the equations on the network increases. at the same time, competition among miners increases, increasing the scarcity of the cryptocurrency as a result.

how to start mining cryptocurrencies

Cryptocurrency mining requires computers with special software specifically designed to solve complicated cryptographic mathematical equations. In the early days of technology, cryptocurrencies like Bitcoin could be mined with a simple CPU chip in a home computer. however, over the years cpu chips have become impractical for mining most cryptocurrencies due to increasing levels of difficulty.

Cryptocurrency mining today requires a specialized gpu or application specific integrated circuit (asic) miner. Additionally, the GPU on the mining rig must be connected to a reliable internet connection at all times. each crypto miner is also required to be a member of an online crypto mining pool.

different cryptocurrency mining methods

Different cryptocurrency mining methods require different amounts of time. In the early days of technology, for example, CPU mining was the go-to option for most miners. However, cpu mining is considered by many to be too slow and impractical today because it takes months to accumulate even a small amount of profit, given the high electricity and cooling costs and increased difficulty across the board.

GPU mining is another method of mining cryptocurrencies. maximizes computational power by pooling a pool of gpu on a mining rig. for gpu mining, a motherboard and rig cooling system is required.

Likewise, asic mining is yet another method of mining cryptocurrencies. Unlike GPU miners, ASIC miners are specifically designed to mine cryptocurrencies, so they produce more units of cryptocurrency than GPUs. however, they are expensive, which means that as mining difficulty increases, they quickly become obsolete.

Given the increasing costs of gpu and asic mining, cloud mining is becoming more and more popular. Cloud mining allows individual miners to harness the power of large corporations and dedicated crypto mining facilities.

See also: What is Bitcoin? 1 Simple Explanation for Kids & Beginners

Individual crypto miners can identify free and paid cloud mining hosts online and rent a mining rig for a specified period of time. this method is the most hands-free way to mine cryptocurrencies.

mining pools

Mining pools allow miners to pool their computational resources to increase their chances of finding and mining blocks on a blockchain. if a mining pool is successful, the reward is distributed across the mining pool, in proportion to the amount of resources each miner contributed to the pool.

Most crypto mining apps come with a mining pool; however, crypto enthusiasts are now banding together online to create their own mining pools as well. Because some pools get more rewards than others, miners can switch pools whenever they need to.

Official crypto mining pools are found by miners to be more trustworthy as they receive frequent updates from their host companies as well as regular technical support. the best place to find mining pools is cryptocompare, where miners can compare different mining pools based on their reliability, profitability, and the currency they want to mine.

Is crypto mining worth it?

Determining whether crypto mining is worth it depends on several factors. Whether a prospective miner chooses a CPU, GPU, ASIC miner, or cloud mining, the most important factors to consider are the mining rig’s hash rate, electrical power consumption, and overall costs. In general, crypto mining machines consume a considerable amount of electricity and emit a significant amount of heat.

for example, the average asic miner will use about 72 terawatts of energy to create a bitcoin in about ten minutes. these numbers continue to change as technology advances and mining difficulty increases.

although the price of the machine is important, it is just as important to consider the electricity consumption, electricity costs in the area and cooling costs, especially with gpu and asic mining equipment.

It is also important to consider the difficulty level of the cryptocurrency an individual wants to mine, to determine if the operation would be profitable.

the tax implications of crypto mining

taxation of crypto mining remains an important consideration.

Cryptominers will generally face tax consequences (1) when they are rewarded with cryptocurrency for mining and (2) when they sell or trade the reward tokens. Regarding (1), the irs issued notice 2014-21 which directly addresses the tax implications of crypto mining. According to the notice, a miner will recognize gross revenue upon receipt of reward tokens in an amount equal to the fair market value of the coins at the time of receipt. furthermore, if a taxpayer’s mining activities constitute a trade or business, or if the taxpayer conducts such activities as an independent contractor, reward token/virtual currency payments are considered self-employment income and are subject to to taxes on self-employment. Similarly, if a taxpayer mines as an employee, payments made in cryptocurrencies are treated as wages subject to federal social security/medicare income tax withholding and unemployment taxes.

For a more detailed discussion of the tax implications of crypto mining, see the taxation of crypto mining. For cryptocurrency tax planning resources, see Charitable Remnant Unit Trusts (“CRUTS”) and Cryptocurrencies, Cryptocurrency Margin Trading Taxation, and Estate Planning and Cryptocurrencies. And for the latest on IRS voluntary disclosures for previously unreported cryptocurrency gains, see the IRS Voluntary Disclosure Practice.

is crypto mining legal?

Most jurisdictions and authorities have yet to enact laws governing cryptocurrencies, which means that for most countries, the legality of crypto mining remains unclear.

according to the financial crime control network (fincen), crypto miners are considered money transmitters, so they may be subject to the laws that govern that activity. In Israel, for example, crypto mining is treated as a business and is subject to corporate income tax. In India and elsewhere, regulatory uncertainty remains, although Canada and the United States appear friendly to crypto mining.

However, aside from jurisdictions that have specifically prohibited cryptocurrency-related activities, very few countries ban crypto mining.

Our freeman law cryptocurrency law resource page provides a summary of the legal status of cryptocurrencies for every country in the world with legal or regulatory provisions governing cryptocurrencies.

The globe below provides links to country-by-country summaries:

See also: Can Dogecoin Reach 100? Or Even 1? 10? 1,000? | SoFi

See also: Bitcoins bid to become the one chain to rule them all – TechCrunch

See also: Can Dogecoin Reach 100? Or Even 1? 10? 1,000? | SoFi

See also: Bitcoins bid to become the one chain to rule them all – TechCrunch

Also, check out our state-by-state freeman law resources:

state-by-state digital currency laws and regulations

digital currency transmission laws, state by state

conclusion: the sustainability of crypto mining

For aspiring crypto miners, curiosity and a strong desire to learn are simply a must. The crypto mining space is constantly changing as new technologies emerge. professional miners who receive the best rewards are constantly studying the space and optimizing their mining strategies to improve their performance.

On the other hand, climate change advocates are becoming increasingly concerned as more and more fossil fuels are burned to power the mining process.

These concerns have led cryptocurrency communities like ethereum to consider switching from pow frameworks to more sustainable frameworks such as proof-of-stake frameworks.

See also: Can Dogecoin Reach 100? Or Even 1? 10? 1,000? | SoFi

See also: Bitcoins bid to become the one chain to rule them all – TechCrunch

For more information on related topics, see:

blockchain and cryptocurrency

the Computer Fraud and Abuse Act (CFAA)

bitcoin and beyond: the reality of taxing and regulating virtual currency

The Build Back Better Act: Tax Implications for Cryptocurrencies

fincen intends to amend fbar regulations to include virtual currency

Can you go to jail for failing to disclose virtual currency on a tax return or as part of a billing alternative offer?

charitable remainder unit trusts (“cruts”) and cryptocurrencies

See also: Can Dogecoin Reach 100? Or Even 1? 10? 1,000? | SoFi

See also: Bitcoins bid to become the one chain to rule them all – TechCrunch

See also: Can Dogecoin Reach 100? Or Even 1? 10? 1,000? | SoFi

See also: Bitcoins bid to become the one chain to rule them all – TechCrunch


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