Introduction

Mining is fundamental to the security of Proof of Work blockchains. By processing specific hashes, participants are able to ensure the security of cryptocurrency networks without the need for a central authority.

When Bitcoin was first released in 2009, anyone with a regular computer could compete with other miners to guess a valid hash for the next block. This was possible because the mining difficulty was low. There wasn't much hash rate on the network. Therefore, users did not need specialized hardware to add new blocks to the blockchain.

It stands to reason that computers with a greater capacity to calculate hashes per second would find more blocks. This caused a huge change in the ecosystem. Miners engaged in a race of sorts, trying to gain an advantage in the mining competition.

After iterating with different types of hardware (CPUs, GPUs, FPGAs), Bitcoin miners ended up adopting ASICs – Application-Specific Integrated Circuits. These mining devices do not allow you to browse the Binance Academy page or post photos of your cat on Tweeter.

As the name suggests, ASICs are created to perform a single task: calculating hashes. But because they were designed specifically for this purpose, they do it incredibly well. So well, that using other types of hardware for Bitcoin mining has become very uncommon.

What is a mining pool?

Good hardware can only help you to a certain extent. You could run several high-powered ASICs and it would still be just a drop in the ocean of Bitcoin mining. The chances of you mining a valid block are very small, even if you have invested a lot of money in hardware and the huge amount of electricity required for mining.

You have no guarantee when you will receive a block reward, or if you will at all. If you are looking for a consistent source of income, you will have much better luck in a mining pool.

Let's assume that you and nine other participants own 0.1% of all hash power on the network. This means that, on average, you would find one valid block for every thousand blocks. With an estimated 144 blocks mined per day, you would probably find one valid block per week. Depending on your cash flow and investment in hardware and electricity, the “individual mining” approach may be a viable strategy.

But what if this income is not enough to generate profit? You can join forces with the other nine participants we mentioned. If you all combine hash power, you will have 1% of the network's hash rate. In other words, you would find, on average, one valid block for every hundred, which represents one or two blocks per day. Then, you would split the rewards among all miners involved.

We have just briefly described a mining pool. They are widely used nowadays, as they guarantee a more consistent source of income for members.

How do mining pools work?

Typically, a mining pool has a coordinator responsible for organizing the miners. They ensure that miners use different values ​​for the nonce, avoiding wasting hash power trying to create the same blocks. These coordinators are also responsible for dividing the rewards and paying them out to participants. There are several methods used to calculate the work done by each miner and distribute rewards accordingly.

Pay-Per-Share (PPS) Mining Pools

One of the most common payment methods is Pay-Per-Share (PPS). In this system, you will receive a fixed amount for each “share” you send.

A share is a hash used to record each miner's work. The amount paid for each share is nominal, but increases over time. Note that a share is not a valid hash on the network. It is simply a hash that matches the conditions set by the mining pool.

In PPS, you are rewarded even if your pool does not find a valid block. The pool operator assumes the risks, so a fee will likely be charged – either in advance or after the eventual reward received for a valid block.

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

Another popular system 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 number of shares sent (N varies depending on the pool). To distribute the payment, it divides the number of shares sent by N and multiplies the result by the block reward (subtracting the fee charged by the operator).

Let's take an example. If the current block reward is 12.5 BTC (disregard the transaction fee) and the operator fee is 20%, the reward available to miners will be 10 BTC. If N is 1,000,000 and you provide 50,000 shares, you will receive 5% of the available reward (0.5 BTC).

There are several variations of these two systems, but they are the most common. While we'll talk more about Bitcoin, other popular PoW cryptocurrencies also have mining pools. Some examples include Zcash, Monero, Grin and Ravencoin.

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Do mining pools pose a threat to decentralization?

As you read this article, alarm bells may be going off in your head. Isn't it precisely the fact that no single entity controls the blockchain that makes Bitcoin so powerful? What happens if someone is able to get most of the hash power?

These questions make perfect sense. If a single entity is able to obtain 51% of the network's hashing power, it can launch a 51% attack. This would allow you to reverse previous transactions or censor them. This type of attack can cause enormous damage to a cryptocurrency ecosystem.

Do mining pools increase the risk of attacks by 51%? The answer is: maybe, but it's not likely.

Hash rates by pool over a 24-hour period, as of April 16, 2020. Source: coindance.com

Theoretically, the four main pools could band together to gain control of the network. But that wouldn't make much sense. Even if they managed to carry out an attack, the price of Bitcoin would likely plummet as these actions would harm the entire system. In other words, all coins acquired after the attack would lose value.

Furthermore, pools do not always have the necessary mining equipment. Participants point their machines to the coordinator's server, but can freely migrate to other pools. It is interesting for pool participants and operators to keep the ecosystem decentralized. After all, they only make money if the mining process can remain profitable.

There have already been some cases of pools in which they grew to reach a size considered worrying. In cases like this, the pool (and member miners) usually take action to reduce the hash rate.

Final considerations

The introduction of the first pool changed the cryptocurrency mining landscape forever. They can be very beneficial for miners looking for a more consistent income. With several possible schemes available, miners can find one that best suits their needs.

In an ideal scenario, Bitcoin mining would be much more decentralized. For now, however, this is what we can call “sufficiently decentralized”. Either way, in the long run, no one benefits from a single pool getting the majority of the hash rate. Participants would probably prevent this from happening – after all, the Bitcoin network is not managed by miners but by users.