Cryptocurrency mining 101
3 factors beginners overlook before they start mining crypto
With cryptocurrency mining profitability on the rise, it has become an excellent source of passive income. However, there are some basic crypto variables involved that every single miner has to face.
The basics of crypto mining
Cryptocurrency mining is an energy-intensive activity. Miners use considerable power to make guesses and find a block’s hash, thus recording that block in the ledger.
Then, it’s not surprising that the highest cost of running a mining operation is the electricity bill. Additionally, you may have additional expenses, like purchasing mining equipment, cooling systems, component replacement, and many others. Naturally, you’d pay most — if not all — of these in your local fiat currency.
Knowing an estimate of your costs beforehand, you could calculate how much of your mined coins — whichever they are — you’d have to sell to cover your expenses. The remaining coins would be your net mining profits.
However, other factors may affect your mining operation, impacting your profitability. These risks are unavoidable, as they’re inherent to how cryptocurrency and mining work. For that same reason, you should be aware of them and know how to reduce their impact on your revenue as much as possible.
Let’s dive into them.
Volatility and price action
The first aspect of cryptocurrency that could harm your mining operation’s performance is, of course, the price of the coin you’re mining.
As we’ve said, you will pay for your expenses in fiat currency but earn in crypto. So if the price of the specific coin you’re mining goes down against fiat, you’ll have to sell more of your earnings to cover your expenses.
Volatility is a double-edged sword, though, as the price could also shoot up, affecting your profitability positively.
Naturally, this phenomenon will affect those with higher costs the most, as miners with higher profit margins can tolerate low prices for longer before they lose profitability.
However, during multiple-year bear markets, many miners have to shut down their machines, as they consume more electricity than they can afford.
Network hashrate and difficulty
As you may already know, proof-of-work blockchain networks automatically can change how hard it is to mine a block. Difficulty adjustments are programmed onto the blockchain’s code and happen automatically after an N number of blocks — for example, in Bitcoin, it’s 2016; in Monero, it’s 1.
Through these automatic adjustments, proof-of-work networks reduce or increase the mining difficulty — or how hard it is to find a block — to keep the protocol secure and make it costly to attempt an attack. Furthermore, they also help maintain block time standards, ensure performance, and keep mining competitive.
How does this all affect profitability, then? The more hashpower is mining, the harder it will become to find a block, and thus, the more power miners need to earn block rewards.
Additionally, mining pools distribute payments among their contributing miners according to their shares, which are often proportional to their hashrate. If you were mining against a pool and hashrate increased, but yours stayed the same, you’d receive a smaller part of the payments, as your output now represents a smaller percentage of the pool’s total hashrate.
If you want to learn more about mining pools, you can read our article below.
Like volatility, difficulty can work as a blessing or a curse. If a large portion of the miners goes offline, those remaining will enjoy an unusual high-profitability mining season.
Time until next halving
Like difficulty adjustments, halvings reduce the emission of new coins by half. They are programmed to happen every N block — N varies depending on the network, although not all of them have halvings.
Do you want to learn more about halvings? Check out our article below.
It’s essential to consider halvings because, in most proof-of-work networks, miner rewards have two different components:
- The fees paid for all the transactions included in a block.
- A block subsidy, which is the amount of new bitcoin created after every block is found.
Interested in how miners make money? Learn more about mining revenue in our article below.
Now, historically, these events have also had a positive outcome. The decrease in inflation significantly reduces the available supply, driving an increase in bitcoin’s price.
However, this appreciation doesn’t happen instantly. In past opportunities, it has taken weeks or even months for prices to catch up. During that period, mining profitability may be significantly affected.
Before starting your mining operation, it is fundamental to consider how far away we are from the next halving and calculate how long you can remain profitable at reduced rewards. That way, you’ll know for how long you can keep mining if the price were to lag.
Final thoughts
Crypto mining is an excellent way to earn passive income and turn your electricity into profits. But that doesn’t mean it’s easy.
Setting up a mining operation takes considerable planning and preparation, and even then, your profits could take a hit due to unpredictable factors. You could have acquired the best miners and convenient electricity prices and still take a hit from a drop in price.
Make sure you consider all the possibilities and are aware of the risks. That way you’ll be prepared and know how to react to unpredictable and adverse conditions.
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