Of all the ways how to buy bitcoins, cloud mining may be the most unusual.
With Bitcoin cloud mining, you don't buy bitcoins or the actual hardware used to "mine" it.
You buy a contract for a certain amount of mining power, known as "hashing power," for a certain period of time. You then earn a portion of bitcoin every day for the duration of the contract.
This is a twist on conventional Bitcoin mining (see sidebar). Today Bitcoin mining involves the purchase of one or more dedicated mining machines (essentially computers designed specifically to mine Bitcoin). Small-time miners run their machines in their homes, but large operators will have many mining rigs running in their own building or buildings.
That's where Bitcoin cloud mining enters the picture. A few of the large operators sell a portion of their massive hashing power to folks who like the idea of mining Bitcoin but would rather not buy and run the rigs themselves. (The rigs consume a lot of electricity and generate a lot of heat. Plus, to get a decent return, they need to run 24/7.)
Many people just learning about Bitcoin (a January Coin Center study showed 65% of the U.S. population had never heard of it) become fascinated by the mining aspect of it. You can actually create money with a computer!
Mining is how bitcoins are created. People running specially designed computers (miners) are all trying to solve the same mathematical riddle. More hashing power increases a miner's chances of doing so.
Whoever solves it first creates a block that gets added to the Bitcoin blockchain. But the winning miner also gets a reward of 25 new bitcoins.
The network is designed to create one new block every 10 minutes. If increasing hashing power causes the blocks to be solved more frequently, the Bitcoin network raises the difficulty level. Eventually 21 million bitcoins will be created, with the last one expected around 2140.
Each block contains the transactions made on the network since the previous block was discovered. Other miners and nodes on the network then verify that block (and its transactions).
Without the miners, the Bitcoin could not function.
That was one of my first thoughts when I discovered Bitcoin in 2011. Back then the difficulty was low enough that you could mine Bitcoin on a personal computer.
I invested $300 in a graphics card - the mining rig of its day - and managed to generate about 20 bitcoins in six months before the card burned out. The Bitcoin price slumped to under $5 in the meantime, so my mining experiment looked like a big money loser at the time. (Luckily I kept my bitcoins.)
Mining today is no less risky. Even cloud mining is an unusually involved and time-consuming way of how to buy bitcoins.
Yet Bitcoin mining has a certain romantic appeal, particularly for those who love tech. And many Bitcoin fans also like the idea of being an active participant in the network that supports the digital currency.
So here's how it works - and a look at the pros and cons...
For individuals who just can't resist Bitcoin mining, cloud mining makes the most sense.
Some still do mine Bitcoin themselves. But the cost of the rigs, which run from several hundred dollars to several thousand, and the cost of electricity to run them, are big deterrents.
With cloud mining, the operator worries about buying and maintaining the rigs. And they can set up their mining farms in places with the cheapest electricity.
Germany-based Genesis Mining, for example, has Bitcoin mining operations in China, Iceland, and Canada. Genesis is one of the top cloud miners.
To start, you just go to the website of one of the cloud miners. I went through the process at Genesis Mining, which I will use as an example here.
The first thing you do is pick a contract. Genesis offers contracts for as little as $22.49, which buys you a "lifetime contract" of 50 gigahashes.
You can spend thousands of dollars if you like and get thousands of gigahashes. The more hashing power you buy, the more Bitcoin you'll earn.
"Lifetime" doesn't mean forever, by the way. Each contract only lasts as long as the hashing power you've purchased produces enough Bitcoin to be profitable. After 20 consecutive days with zero profits, the contract is terminated.
Once you've paid for your contract, you need to provide a Bitcoin address on the Wallets page so you can get your Bitcoin. Most cloud miners make daily payouts.
One caveat I discovered at Genesis: If you pay with a credit card, Genesis holds your daily earnings in escrow for the first 30 days. If you pay in Bitcoin, you start getting the daily payouts immediately. This was disconcerting as it appeared I had no earnings until I found the running tally on the "My Orders" page.
But in nearly three weeks of mining, my total has steadily increased.
This is a great question, except that it's impossible to answer. Whenever the Bitcoin price spikes, it attracts more miners and more hashing power. Since your hashing power stays the same, you earn less Bitcoin. If the Bitcoin price should fall, and more miners shut off their unprofitable rigs, you'll earn more.
Once you've earned some Bitcoin, its value versus the U.S. dollar will fluctuate. Some miners sell their bitcoins as they go along; others hold under the assumption the Bitcoin price will rise over time.
The simplest way to determine your "break-even" point, though, is to look at the amount of Bitcoin used to buy the contract (or convert the U.S. dollar amount you spent to the Bitcoin equivalent).
In my case, I bought 250 gigahashes for $112.50. For that money, I could have bought 0.45 BTC. That makes 0.45 BTC my break-even. Everything after that will be profit.
As of today I have 0.01726243 BTC in my Genesis account. At this rate, assuming the network difficulty remains relatively stable, I will reach 0.45 BTC in about a year and a half. But like most types of investing, it's a risk. I could end up in the red or in the black.
One thing potential cloud miners need to know is that the reward per block will drop from 25 bitcoins to 12.5 bitcoins at some point in 2016. That will significantly reduce payouts unless half of the mining power goes offline.
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On the other hand, any mined Bitcoin could greatly appreciate versus the dollar in years to come. If Bitcoin goes back to $1,000, a total of 0.45 BTC would be worth $450 - a return four times the initial investment.
Remember, I invested $300 to mine 20 bitcoins in 2011 that at one point were worth less than $100. Today they're worth just under $5,000.
But cloud mining carries another risk that calls for particular caution...
Unfortunately, Bitcoin cloud mining is a business easily replicated by the unscrupulous to create Ponzi schemes.
It's a huge problem for Bitcoin cloud mining.
"I'm really concerned about this," Genesis Mining CEO Marco Streng told Money Morning. By his reckoning, 29 of the 38 current cloud mining operations are some form of Ponzi scheme.
They're not easy to distinguish from legitimate operations. But some red flags include unusually high payouts and other perks to lure in customers until the day the scheme collapses. Streng also says people should look for transparency and proof that the company actually owns mining rigs.
"If someone is new to Bitcoin, and new to mining, they need to educate themselves," Streng said.
Those with an interest in Bitcoin cloud mining should check out the reviews on Cloudminingdirectory.com. Also worth looking at is a thread on Bitcointalk.org that has sought to track all the Ponzi schemes.
Follow me on Twitter @DavidGZeiler.
More Ways to Buy Bitcoins: While you can buy bitcoins from Bitcoin ATMs or Bitcoin exchanges, ways to buy the digital currency keep expanding. In some countries you can buy bitcoins at convenience stores, and others are upgrading bank ATMs for use with Bitcoin. The biggest developments are in Asia and Europe, but this is happening in the United States as well...
