Mining Pools Explained

Introduction

Mining is a crucial component of the security of proof-of-work blockchains. By having participants calculate hashes of specific properties, cryptocurrency networks can be secured without the need for a central authority. When Bitcoin was first introduced in 2009, anyone could compete with other miners using a regular computer to calculate the hash of the next valid block. At that time, mining difficulty was low, and the overall network hash rate was not high, allowing users to add new blocks to the blockchain without specialized hardware.

As a result, the most powerful computers could mine more blocks, leading to significant changes in the ecosystem. Miners began to continuously seek various ways to gain a competitive advantage.

After experimenting with various hardware such as CPUs, GPUs, and FPGAs, Bitcoin miners ultimately opted for Application-Specific Integrated Circuits (ASICs). On these mining devices, you cannot browse Binance Academy or log onto Twitter to post pictures of cats. As the name suggests, ASICs are designed to perform a single task: calculating hashes. These devices are purpose-built and extremely powerful, gradually replacing other types of Bitcoin mining hardware.

What Is a Mining Pool?

Despite the impressive hardware capabilities, they do not solve all problems. Even with multiple high-performance ASIC devices, a miner still represents only a "drop in the bucket" in the Bitcoin mining landscape. Even with significant investments in hardware and substantial electricity consumption, the probability of mining a new block remains low, and it is unpredictable when one might receive block rewards, potentially resulting in no returns at all. If you are looking for consistent income, joining a mining pool may be a more promising option.

Suppose you and nine other participants collectively control 0.1% of the network's hash rate. This means you have a chance of mining one block out of every 1,000 blocks. Given that an estimated 144 blocks are mined daily, you would approximately mine one block per week. Depending on your financial situation and investment in hardware and electricity, this "solo mining" method might be feasible.

However, what if the income is insufficient for profitability? You could collaborate with those nine other miners. By pooling everyone's hash power, the total hash rate would reach 1% of the network. This would improve the chances of mining a new block to "one in a hundred," potentially yielding one to two new blocks per day, with rewards shared among the participants. In short, this is the concept of a "mining pool." Mining pools provide miners with relatively stable income and have been widely adopted.

How Mining Pools Operate

Mining pools are typically organized by a coordinator who oversees the miners' activities. The coordinator monitors miners as they seek random numbers and ensures that hash power is not wasted on creating identical blocks. Additionally, the coordinator is responsible for distributing rewards and paying fees to participating miners. Currently, there are various methods used by mining pools to calculate a miner's contribution and corresponding rewards.

Pay-Per-Share (PPS) Pools

Pay-Per-Share (PPS) is a common reward distribution mechanism. Under this system, each "share" submitted by a miner corresponds to a fixed amount of reward. These "shares" are used to record the hash power contributed by the miner. The reward for each "share" is relatively low but increases over time. It is important to note that these "shares" are not valid hashes on the network, but rather hashes that meet the pool's specified conditions.

In a PPS mechanism, miners receive rewards regardless of whether the pool successfully mines a block. However, pool operators must assume some risk and therefore charge a corresponding fee. This fee can be collected upfront when miners join or deducted from future block rewards.

Pay-Per-Last-N-Shares (PPLNS) Pools

Pay-Per-Last-N-Shares (PPLNS) is another popular distribution mechanism. Unlike PPS, PPLNS only rewards miners when the pool successfully mines a new block. After the pool mines a new block, this mechanism verifies the N value of the previously submitted "shares" (the N value varies depending on the pool). The miner's contribution of "shares" is divided by N, multiplied by the block reward, and then the pool operator's share is deducted to determine the miner's reward.

For instance, if the current block reward is 12.5 bitcoins (assuming no transaction fees) and the operator charges a 20% service fee, the miner would ultimately receive a reward of 10 bitcoins. If N is 1 million and the miner contributed 50,000 "shares," the miner's reward would be 5% of the block reward (i.e., 0.5 bitcoin).

While various similar mechanisms exist in the market, the above two are the most common. It is worth noting that although we are discussing Bitcoin, many popular proof-of-work cryptocurrencies also have mining pools, such as Zcash, Monero, Grin, and Ravencoin.

Do Mining Pools Pose a Threat to Decentralization?

At this point, you might have some questions. The strength of Bitcoin lies in the fact that no single entity can easily control the blockchain. What happens if a single entity controls the majority of the hash rate?

These questions merit deeper exploration. If an entity controls 51% of the hash rate, it can launch a 51% attack. If successful, the attacker could delete transactions and reverse completed transactions, causing significant harm to the cryptocurrency ecosystem.

Do mining pools increase the risk of a 51% attack? The answer is: possibly, but the probability is relatively low.

Theoretically, the top four mining pools could collude to hijack the network. However, doing so would not be very meaningful. If the attack were successful, the price of Bitcoin would plummet due to the system's compromise, ultimately devaluing the tokens mined by the pools.

Moreover, mining pools do not necessarily come equipped with mining devices. Entities can point their devices at the coordinator's server, which can easily migrate to other pools. For miners and pool operators, maintaining the decentralization of the ecosystem is crucial. Only by ensuring mining remains profitable can everyone share in the rewards.

In some cases, the growth of mining pools is indeed concerning, but mining pools and their participating miners typically take measures to mitigate hash rate concentration.

Conclusion

The emergence of the first mining pool fundamentally changed the landscape of the cryptocurrency mining market, benefiting miners looking for long-term stable income. With the continuous introduction of new mechanisms, everyone can find the mining method that best suits them.

Ideally, the level of decentralization in Bitcoin mining should continue to deepen. The current level of decentralization can only be described as "sufficiently decentralized." Regardless, no one can consistently obtain the majority of the hash rate from a single pool over the long term. Participants should remain vigilant about this potential threat, as Bitcoin is maintained collectively by users, not solely controlled by miners.

Risk Warning

While the cryptocurrency market offers significant growth potential and innovation opportunities, it also carries a high level of market risk and price volatility. The value of crypto assets can fluctuate dramatically in a short period, potentially leading to substantial financial losses for investors. Additionally, the cryptocurrency market faces multiple risk factors, including technical risks, legal and regulatory uncertainties, cybersecurity threats, and market manipulation. We strongly advise users to conduct thorough research and due diligence before making any investment decisions and to consult professional financial advisors. All investment decisions are made at the user’s own risk. Thank you for your trust and support of Venkate!

Building The Future of Crypto Exchange

Where Meet a Confluence of Inspiration and Innovation

Venkate Exchange is an innovative cryptocurrency trading platform, drawing its name and inspiration from Venkateswara—a deity symbolizing wealth and prosperity in Indian mythology.