What is Crypto Mining & How Does it Work?

What is Crypto Mining & How Does it Work?

What is Crypto Mining & How Does it Work?

What is Crypto Mining & How Does it Work?

Our goal here is, at a high level, to understand the basics of crypto's blockchain technology and to learn just enough to spark a curiosity to explore this new frontier of innovation further.

What is Crypto Mining?

Crypto mining (cryptocurrency mining), is a process used to validate that a transaction between two wallets are authentic. The term "mining" was adopted as a metaphor because the process for creating bitcoin is a lot like mining for gold. It takes "physical" effort to mine for gold whereas it takes "computational" effort to mine crypto. For all the computational effort required to validate the blockchain network, a crypto miner will receive a "block reward".

Incentives for Mining Crypto

Block Rewards & Transaction Fees

Earning a block reward is the primary incentive for crypto miners to continue investing resources in maintaining and validating the blockchain network. Currently, the two most widely adopted consensus mechanism to secure the blockchain are proof-of-stake (PoS) and proof-of-work (PoW).

Mining crypto is a race to see which miner successfully validates the next block first. For winning the race, the crypto miner gets a prize known as a "block reward". The block reward is the primary incentive for mining crypto. For some cryptocurrencies, collecting transaction fees can also be considered a worthwhile incentive.

Crypto Economics


Each cryptocurrency has its own supply and demand side characteristics which play an important role in how crypto miners dispose of their coins. There are really only two choices, one either chooses to sell their coins or not. The determining factor comes down to the owners assessment of future supply and demand of the coin they possess.

Bitcoin is largest cryptocurrency by market capitalization traded on public exchanges. It was created by Satoshi Nakamoto as an open source software in 2008 and began use in 2009. bitcoin is a peer-to-peer digital currency secured by cryptography and validated by a network of nodes called the blockchain.

bitcoin and Ethereum are two interesting examples to explore because the supply and demand side properties are quite different.

Bitcoin's Supply Side Cryptonomics:

  • Bitcoin has a hard cap of 21 Million which is a predetermined core feature of bitcoin's core protocol.

    Satoshi Nakamoto, the founder of bitcoin, meant for bitcoin to offer people a means of storing wealth without being exposed to the whims of centralized organizations and institutions (banks) or governing bodies (Federal Reserve).
  • Mechanisms to regulate the rate of difficulty and distribution over time such as the quadrennial "halvening" event which cuts the block reward in half and the "network difficulty adjustment" which occurs every 2,016 blocks.

Bitcoin's Demand Side Cryptonomics:

  • Bitcoin's fixed supply properties are currently its most attractive feature and responsible in large part of its characterization as a store-of-wealth asset.
  • Its potential to be an uncorrelated asset, inflation hedge, and wealth preservation asset much like Gold. Some would call it Gold 2.0.
  • There is also a small but potentially meaningful value from the network effect of bitcoin's actual function of facilitating decentralized payments. Companies like PayPal, Square, and Strike are all working to build bitcoins' core infrastructure and hopefully enhance its utility value over time.


Ethereum (ETH), is the second largest cryptocurrency by market capitalization on publicly traded exchanges and second only to bitcoin.

The ETH protocol is very different than bitcoin in that it is used to facilitating the development of decentralized software such as smart contracts and distributed apps (dApps). Ethereum's value is largely derived by its utility value.

Ethereum Supply Side Cryptonymic

  • Ethereum currently has no supply cap. That will change with the roll out of Ethereum 2.0.
  • Miners use the same proof-of-work validation protocol as bitcoin and receive 2 ETH plus a transaction feel commonly known as a "gas fee".
  • Ethereum is currently working on an upgrade, EIP-1559, that will fundamentally change its supply side economics by creating a method for destroying (burning) coins in the validation process.

Ethereum Demand Side Cryptonomics

  • Ethereum was mainly designed to support the development of decentralized applications (dApps) where users can interact with applications by supporting the development innovations such as smart contracts.
  • Financial institutions would largely benefit from the use of smart contracts because they are a secure peer-to-peer method of consummating a transaction where to parties agree on a set of terms and can ensure each party satisfy the terms of the agreement.
  • The crypto community has attributed the development of decentralized finance (DeFi) to ETH's adoption as the crypto of choice to facilitate the trading non-fungible tokens (NFT) and many other financial instruments.

Crypto's Blockchain Trilemma

What is the Blockchain Trilemma?

The blockchain trilemma is concept coined by Vitalik Buterin, one of the co-founders of Ethereum, that proposes three main issues inherit to all public blockchain networks. The concept basically states that there are three main issues that are at play when building a blockchain:

  • Decentralization, as a concept in the trilemma, is thought of governance over how the network is maintained. In terms of bitcoin, the governance structure of its decentralized network cuts both ways. Each each individual mining node gets a vote when an improvement proposals (PIP) is submitted.

    If the PIP is submitted and gains enough support by the community and manages to get a 95% approval of votes in favor, the core developers of bitcoin begin the process of upgrading the Bitcoin's core software.

    If the PIP ultimately turns out to be a poor upgrade, a carefully balanced blockchain ecosystem could be compromised in the long-run.
  • Security - to improve the network's defense from malicious takeovers, a protocol can determine the level of consensus necessary to validate a block being added to the blockchain ledger.
  • Scalability - transactions are central to payments and in the payments world, transactions per second (TIPs) is a very important metric which measures the speed and scalability of a network. Bitcoin aims to validate a block in 10 minutes whereas Ethereum validates a block around 10-15 seconds.  

Finding the Perfect Balance for Users

The trilemma for developers is finding the right balance for the crypto utility and ensuring that balance meets the needs of its end users. Typically, one of these considerations must be sacrificed in order to strengthen the other two.

This dilemma is very similar to what photographers go through when setting up a shot. Photographers must balance ISO, aperture, and shutter speed to capture the desired effect of the photo they are trying to take.

Innovation & Outlook of Crypto

Both proof-of-work and proof-of-stake are maintained by a very different balance set of strengths and weakness as referenced above in the section on the blockchain trilemma. For the blockchain ecosystem to grow and innovate, it's simply a fact that innovation must play a role in improving the governance, security, and scalability of each crypto's network.

Here are some examples of how continued innovation may improve the chances of PoW consensus mechanisms in crypto may evolve in the future

Proof-of-Work's Potential Future

As bitcoin's adoption scales and the technology matures, it is expected that its store-of-wealth value should naturally increase as less bitcoin become available on exchanges. The expectation from long-term investors is to see bitcoin's utility become a greater component of its net value proposition.

In order to reach those goals, developers will need to continue to innovating on top of bitcoin's blockchain network and find ways to improve on scalability.

Strike is a layer-2 (L2) payments app which uses the Lightning Network built on top of the bitcoin's base layer blockchain. Layer-2 transactions are not validated the same way as transaction on the base layer.

A transaction on the Lightning Network is more like opening a temporary peer-to-peer payment channel with the ability to almost instantaneously send and receive an unlimited number of transactions. Once the channel is closed, all the transaction data is consolidated into one transaction and then that transaction is queued to be added to the base layer via bitcoin's primary validation consensus protocol.

The Lightning Network is a great example of how innovation is leading to scaling solutions that will improve the utility value of bitcoin over time.

Bitcoin Mining Innovation & Immersion Cooling

Proof-of-Work validation is resource intensive, as a result, bitcoin and other PoW crypto success will likely require more efficient means of hash per second. Hash rate is simply a metric for how fast a processing unit can solve for PoW crypto algorithm during the block validation process.

Moore's law states that the number of transistors in integrated circuits will double every two years. Empirical observation has actually been remarkably accurate over the decades. However, as we continue progressing it is becoming harder and harder to keep up with that rate of growth.

Immersion Cooling Technology

Miners that utilize a proof-of-work validation consensus protocol are incentivised to find ways of reducing the variable costs (energy) necessary to mine crypto. Managing heat that radiates from circuits on ASIC's as they try validate a block are a major source of energy consumption.

Immersion cooling technology has recently been gaining favor as a potential innovative step towards optimizing resource consumption in the mining process. The idea behind immersion cooling is ASICs are bathed dielectric (electrically non-conductive) liquid instead of on traditional server racks which require constant airflow to moderate radiating heat.

The cooling properties of liquid are far superior to air-cooled systems. The primary concern here is the process requires much less energy and maintenance over time ultimately lower the net cost of mining bitcoin.

In May of 2022, Argo Blockchain (NASDAQ: ARBK, LSE: ARB) energized the Helios facility in West Texas which is officially the largest bitcoin mining facility built on immersion cooling technology. Riot Blockchain (NASDAQ: RIOT), has also experimented with immersion cooling at their Whinstone facility in Rockdale, Texas as well.

Dynamic Throttling Technology

Miners are collecting an incredible amount of real-time data on the performance of their ASIC's. Another way of maximizing performance is throttling up during favorable conditions or throttling down when the risk of overclocking outweighs the benefits of running the machines.

Overall, miners are incentivized to find optimize net hash per second and net return on investment of each ASIC. This includes maximizing the longevity and performance of the machine itself.

About Author:
Michael is a market research analyst who's been working on bitcoin and blockchain research since 2018. He currently consults for Argo Blockchain and works for a bitcoin & crypto marketing agency based out of Los Angeles.