What are Bitcoin Mining Pools?
One of the first things people want to understand when they start learning about bitcoin is how the currency is created and how a digital currency derives its value. To understand this, we need to know that the bitcoin protocol is based on a system known as proof-of-work (POW).
What is bitcoin mining?
POW is what is known as a consensus algorithm. Put more simply, it is a way of ensuring that the computers in the network (known as nodes) agree on a common version of what has happened. POW has two functions: to add new blocks (groups of transactions) to the blockchain and to confirm that the transactions have genuinely taken place. The transaction confirmation is critical because in a decentralized network there is no third party like a bank or credit card company in the middle to carry out this process.
This proof of work ‘mining’ is the means by which new bitcoins are created. In order to create new ‘coins’ (which are simply digital representations of value and have no physical form), computers must race to solve mathematical problems of increasing levels of difficulty. The first one to win that race and find the answer is rewarded for being correct by receiving a payment known as a block reward, which is a payment of a certain number of bitcoins that are kept by the winning miner. The blocks are linked together consecutively because the hash of each block contains the hash of the previous block, which increases security and means that there is no possibility to go back and change the blockchain history at a later date. This is why you may sometimes hear blockchain referred to as ‘the trust layer of the internet’.
Bitcoin mining pools
Mining pools are groups of miners who agree to share the block rewards in proportion to their contributed computing power. While mining pools can be an attractive proposition for miners to join as they can smooth out rewards over time and make them more predictable, they can also concentrate power on the pool’s owners. However, miners can also choose to redirect their hashing power to a different mining pool at any time.
When bitcoin was first invented, anyone could mine bitcoin on their home computers by simply downloading some software and leaving it running on their machine. This is equivalent to being on Level One of a computer game, if you like, where it is easy to complete the first set of challenges and move onto level two. However, as the problems get increasingly difficult over time (and we are now 11 years on since the Bitcoin white paper was published), the chances of being the first to solve the puzzle require large amounts of computing power and therefore access to cheap electricity. By late 2011, the economics of bitcoin mining evolved to the point where more industrial solutions such as specialized hardware chips and use of mining pools became the most viable solution.
Influence of China
Many, if not most, mining pools are now based in China as access to electricity is very cheap. Mining also now requires highly specialized computer hardware to run complicated algorithms. Mining centralization in China has become a controversial facet of Bitcoin and could possibly be a risk to the future of the Bitcoin blockchain because of what is known as the risk of a 51% attack.
A 51% attack means that a user or a group of users now control the majority of mining power. The attackers have enough power to control most events in the network such as having a monopoly on generating new blocks and being the only ones receiving rewards as they would be able to prevent other miners from completing blocks. You can think of it as a bit like owning 51% of a company’s shares. They also have the potential to act maliciously and re-order transactions in order to spend the same money twice.
Risks of mining centralization
Since there are now about 20 major mining pools — of which Chinese pools are estimated to control around 81% of the network hash rate — the risk of mining pools colluding to pull off a 51% attack is certainly possible. Nevertheless, bitcoin developers and experts say that were it to happen, various emergency technical and governance changes could be introduced to prevent this from happening.
Gavin Andresen, who is the former chief scientist at the Bitcoin Foundation and was handed the reins as the lead developer of the bitcoin core protocol by Satoshi Nakamoto him or herself wrote a blog post back in 2012 where he argued that miners would “quickly figure out a rule or rules to reject” a majority attack. He claimed that a simple line of code could be added to Bitcoin’s core protocol that would stop an attack in its tracks. This would then require the attacker to not only have a majority of mining power, but also a majority of high-priority transactions happening on the network. A 51% attack would also undermine confidence in the entire Bitcoin network which would be potentially counter-productive for companies who have invested heavily in mining overheads.
Do any other cryptocurrencies use Proof of Work mining?
Other cryptocurrencies like Bitcoin Cash and Litecoin are also based on Proof-of-Work but since this algorithm is energy-intensive, developers have also created different types of consensus mechanisms — such as Proof of Stake (POS) — that may work faster, partly in order to build blockchain-based solutions that can handle more transactions and potentially be more enterprise-friendly.
The Future?
As for the future of mining pools, bitcoin developers and miners outside of mining pools are highly conscious of the risks of greater centralization and are working on solutions to take back power over the ordering of transactions. But whatever happens, bitcoin mining pools remain a powerful and influential force to be reckoned with in the world of blockchain.
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