Mining is integral to the security of Proof of Work blockchains. By computing hashes with certain properties, participants are able to secure cryptocurrency networks without the need for a central authority.
When Bitcoin first launched in 2009, anyone with a regular PC could compete with other miners to guess a valid hash for the next block. That’s because the mining difficulty was low. There wasn’t much hash rate on the network. As such, you didn’t need specialized hardware to add new blocks to the blockchain.
It stands to reason that the computers that could compute the most hashes per second would find more blocks. And this caused a major shift in the ecosystem. Miners engaged in something of an arms race as they scrambled to gain a competitive edge.
After iterating through different kinds of hardware (CPUs, GPUs, FPGAs), Bitcoin miners settled on ASICs – Application-Specific Integrated Circuits. These mining devices won’t allow you to browse Binance Academy or to tweet out pictures of cats.
As the name suggests, ASICs are built to perform a single task: compute hashes. But since they’re designed specifically for this purpose, they do it incredibly well. So well, in fact, that using other types of hardware for Bitcoin mining has become quite uncommon.
What is a mining pool?
Good hardware only takes you so far. You could be running several high-powered ASICs, and you’d still be just a drop in the Bitcoin mining ocean. The chances of you actually mining a block are pretty slim, even though you’ve spent a lot of money on your hardware and the electricity required to run it.
You don’t have a guarantee on when you’ll get paid with a block reward, or even if you’ll get paid at all. If consistent revenue is what you’re after, you’ll have much greater luck in a mining pool.
Let’s say that you and nine other participants own 0.1% of the network’s total hashing power each. That means that, on average, you would expect to find one in every thousand blocks. With an estimated 144 blocks mined a day, you’d probably find one block a week. Depending on your cash flow and investment into hardware and electricity, this “solo mining” approach could be a feasible strategy.
However, what if this revenue won’t be enough to turn a profit? Well, you could join forces with the other nine participants we mentioned. If all of you combine your hashing power, you’d have 1% of the network’s hash rate. This means you’d find one in every hundred blocks on average, which works out at one to two blocks a day. Then, you could just split up the reward and share it amongst all the involved miners.
In a nutshell, we’ve just described a mining pool. They’re widely used nowadays since they guarantee a more steady stream of revenue to members.
How do mining pools work?
Typically, a mining pool places a coordinator in charge of organizing the miners. They’ll make sure the miners are using different values for the nonce so that they’re not wasting hash power by trying to create the same blocks. These coordinators will also be responsible for splitting the rewards and paying them out to the participants. There are several different methods used to calculate the work done by each miner and to reward them accordingly.
Pay-Per-Share (PPS) mining pools
One of the more common payout schemes is Pay-Per-Share (PPS). In this system, you’ll receive a fixed amount for every “share” that you’ve submitted.
A share is a hash used to keep track of the work of each miner. The amount paid out for each share is nominal, but it adds up over time. Note that a share is not a valid hash within the network. It’s simply one that matches conditions set out by the mining pool.
In PPS, you’re rewarded whether or not your pool solves a block. The pool operator takes on the risk, so they’ll probably charge a sizable fee – either upfront from the users or from the eventual block reward.
Full Pay-Per-Share (FPPS)
The FPPS model uses the PPS system, but pool participants also get a share of transaction fees. FPPS calculates this by taking an average for a standard network transaction over a recent period and distributing this based on shares submitted.
Pay-Per-Last-N-Shares (PPLNS) mining pools
Another popular scheme is Pay-Per-Last-N-Shares (PPLNS). Unlike PPS, PPLNS only rewards miners when the pool successfully mines a block. When the pool finds a block, it checks the last N amount of shares submitted (N varies depending on the pool). To get your payout, it divides the number of shares you’ve submitted by N, then multiplies the result by the block reward (minus the operator’s cut).
Let’s give an example. If the current block reward is 12.5 BTC (assume no transaction fees) and the operator’s fee is 20%, the available reward for miners is 10 BTC. If N was 1,000,000 and you provided 50,000 shares, you’d receive 5% of the available reward (or 0.5 BTC).
You can find several variations of these two schemes, but they’re the ones you’ll hear of most often. Note that while we’re talking about Bitcoin, most popular PoW cryptocurrencies have mining pools as well. Some examples include Zcash, Monero, Grin, and Ravencoin.
Are mining pools a threat to decentralization?
Alarm bells might be going off in your head as you read this article. Isn’t the whole reason that Bitcoin is so powerful because no single entity controls the blockchain? What happens if someone gets the majority of the hashing power?
These are very valid questions. If a single entity can acquire 51% of the network’s hash power, they can launch a 51% attack. That would allow them to censor transactions and to reverse old ones. Such an attack can cause massive damage to a cryptocurrency ecosystem.
Do mining pools increase the risk of a 51% attack? The answer is: maybe, but it isn’t likely.
24-hour breakdown of hash rate by pool on April 16 2020. Source: coindance.com
In theory, the top four pools could collude to hijack the network. That wouldn’t make much sense, though. Even if they did manage to pull off an attack, the price of Bitcoin would probably plummet as their actions would undermine the system. As a result, any coins they’ve acquired would lose value.
What’s more, pools don’t necessarily own the mining equipment. Entities point their machines towards the coordinator’s server, but they’re free to migrate to other pools. It’s in the best interest of both the participants and the pool operators to keep the ecosystem decentralized. After all, they only make money if mining remains profitable.
There have been a few occasions where pools have grown to what might be considered a worrying size. Generally, the pool (and its miners) take steps to reduce the hash rate.
The cryptocurrency mining landscape was forever changed with the introduction of the first mining pool. They can be highly beneficial for miners that wish to get a more consistent payout. With many different schemes available, they’re bound to find one that best suits their needs.
In an ideal world, Bitcoin mining would be much more decentralized. For the time being, however, it’s what we might call “sufficiently decentralized.” In any case, nobody benefits from any single pool gaining the majority of the hash rate in the long run. Participants would likely prevent it from happening – after all, Bitcoin is not run by the miners, but the users.