Cryptocurrency mining is a term synonymous with Proof-of-Work (PoW) blockchains. The process involves the maintenance of the blockchain by validating and confirming transactions for rewards, hence, mining new blocks.
The mining process rewards the first miner for solving a block with a new cryptocurrency. For example, the Bitcoin blockchain rewards miners who solve a block with 6.25 BTC. The rewards used to be much more; however, with the growing popularity and usage of the Bitcoin network, the rewards are periodically halved for economic reasons.
How Did Mining Pools Come into Existence?
Initially, when Bitcoin was new, the network was lightweight, and mining was done individually, i.e., several miners competed to be the first to solve a block and get rewards. In fact, they did all these without the very sophisticated equipment currently used.
However, as Bitcoin became more popular and the network became overloaded with more users, nodes, and miners, competition increased; hence, each miner needed to improve their equipment to be ahead of others. Nevertheless, this wasn’t enough, the competition got even fiercer, and it became almost impossible for an individual to solve the block and earn rewards.
Consequently, several discussions arose in the BitcoinTalk forum, where Slush, a Czechian, suggested that it would be good for miners to create several pools where they can join resources to increase the chances of earning block rewards. As a result, he founded the famous “Slush Pool” in 2010.
Since then, other mining pools have become popular, and even other Proof-of-Work blockchains have adopted mining pools.
What is A Mining Pool?
A mining pool involves the collaboration of hundreds or thousands of interdependent miners running the same mining software (client). Since they have cumulatively invested their resources towards mining, they will stand a better chance of earning mining rewards. The software (client) distributes the rewards across all miners in the pool according to a pre-agreed sharing formula.
Classifications of Mining Pools
Mining pools can be classified based on how they carry out mining activity or by their reward-sharing formula.
There are two basic ways in which mining pools carry out their activities; these include:
- Cloud-based pools: Cloud-based mining pools enable miners from different locations to independently mine and connect to a pool via the cloud.
- Mining Farms: Mining farms are physical locations where miners are present, working on mining cryptocurrency by working together in close proximity.
Classification of Mining Pools Based on Reward-Sharing Formula
As there are several mining pools, each has its set rules and sharing formulas; hence, there are about a dozen sharing formulas. However, we will highlight the most common ones.
- Pay-Per-Share (PPS): In a PPS reward system, miners will receive rewards for every “share” contributed. This share is the computation done by each miner and is measured by pool metrics (not necessarily blockchain metrics). In a PPS system, miners will receive rewards regardless of whether they solved a block or not.
- Pay-Per-Last-N-Shares (PPLNS): In a PPLNS system, rewards are only shared after miners have successfully solved a block. Hence, individual miners will be rewarded according to the ratio of shares they contributed to mining. For example, if you contributed 1/100 shares, then in a block reward of 6.25 BTC, you will earn 0.00625 BTC.
- Full-Pay-Per-Shares (FPPS): In an FPPS system, miners earn rewards for every share contributed (as in PPS) and also earn a share of the transaction fees paid by users on the network. Hence, the miners can earn more rewards.
- Pay-Per-Share + (PPS+): The PPS+ sharing formula shares rewards to miners (as in PPS) regardless of whether a block was solved or not; however, transaction fees are distributed according to the number of shares contributed (according to PPLNS)
Problems with Mining Pools
Bitcoin’s founder, Satoshi Nakamoto, aimed for absolute decentralization. They wanted a world where no one held single control or power, especially in financial systems; hence, the initial goal for Bitcoin mining was never to be collaborative. However, in reality, it had become too expensive and nearly impossible for one individual to invest computing power into mining; hence, pools had become a necessity. Unfortunately, mining pools have become somewhat watered down Bitcoin’s decentralization.
Currently, it is rumored that the three biggest Bitcoin mining pools control about 46% of the Bitcoin network; this means that influential bad attackers from across the three pools can align to achieve malicious consensus via a 51% attack.
What is a 51% attack?
A 51% attack occurs against a blockchain when a malicious attacker gains over 50% of the blockchain’s mining capabilities, hence, compromising the network. Although it is probably improbable for each of the top mining pools to combine in malice, it is not entirely impossible, and the worry of centralization kicks in.
However, away from the cons, mining pools have a significant advantage: it helps to avoid miner capitulation.
What is Miner Capitulation?
Miner capitulation occurs when small-scale miners abandon their mining operations, particularly during a dip, because it is less lucrative to mine Bitcoin. Even worse, they may be running at a loss; hence, they shut out the lights and sell their equipment and coins, and as a result, fewer people will be available to secure the network.
First, the massive sell-off will cause the price to plummet further, and the market will move further downward. Secondly, a massive reduction in the number of miners reduces the network security, which causes further bearish signals.
In this case, an established blockchain would likely bounce back; but smaller blockchain networks can suffer and find it hard to recover.
However, with mining pools where thousands of miners pool resources, the network is at less risk of capitulation, even during heavy dips, because the collaborative resources of miners make it possible for individual miners to survive the losses.
The Devil or the Deep Blue Sea?
Amongst other mining advantages and disadvantages, these are the most prominent. Hence, it is worth considering which is the lesser evil.
It is often argued that miners are part of the network; hence, they are incentivized to keep it secure. After all, if the blockchain gets compromised, everyone will equally suffer the destruction of cryptocurrency, so it is unlikely for mining pools to come together to form a 51% attack. Conversely, it is argued that miner capitulation could lead to a massive crash that will burn a lot of investors; hence, it should be avoided.
Satoshi Nakamoto’s planned future for Bitcoin and the blockchain isn’t perfect; there are loopholes, and adjustments must be made. As a result, we would need to sacrifice the utopian dream of absolute decentralization if we genuinely want to see the success of blockchain technology.
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