How Miners Make Money + MEV Factor

This article will help you understand why the transfer of mining capacities from China affects the network and fees.

Mining stands at the heart of the crypto industry’s roots, making up the process that started the extraction of the first-ever cryptocurrency — Bitcoin. As per the concept of the Bitcoin network, miners who run the Proof-Of-Work consensus algorithm-based network need an incentive to maintain the process of adding new transactions to the blockchain. The incentive is a necessary measure to make sure that there is an intrinsic side to the entire concept of blockchain maintenance and the turnover of liquidity is assured.

However, mining is far from simply setting up a mining rig, powering up the cooling equipment, and watching the money tickle onto a digital wallet. The calculations that miners have to consider within the process of their operations include more than just the market rates, but also other factors that affect the profitability of mining as a whole.

How Miners Earn Profits

All miners who are engaged in the extraction of coins within PoW networks make their profits in two major ways — on transaction fees, and on mining subsidy.

If combined, the two means of payouts produce a simple formula that adds up to the total reward accrued and granted to a miner for a block successfully added to the network chain:

Transaction fees + Mining subsidy = Block reward

Transaction fees are the commissions that miners are paid for placing transactions into the blockchain. Each time a coin is transferred from a wallet to another, the record of such asset movements must be hashed. The miners receive rewards for collecting the many various transactions on the network and placing them into blocks. For instance, in the Bitcoin network, a new block is mined almost every 10 minutes, meaning that the fees from all the transactions paid for that particular block are awarded to the miner who extracted it.

As for Mining subsidies, these are predetermined fees that are set for each block and awarded to the miner who becomes the first to successfully mine it and add the next block to the blockchain network’s records. Mining subsidy fees are halved every four years in the Bitcoin network as computational complexities increase.

Before being included in any block, all transactions up for routing are placed into a dedicated environment called a memory pool, or mempool for short. The miners view these mempools and select the transactions they are willing to include in the block they will be mining next. The higher the fee set for the transaction by the sender, the higher the chance that it will be selected from the mempool and rushed into the next block. At peak transaction times when the market is highly active, fees increase and this results in higher earnings for the miners.

All miners are paid their rewards via a special transaction called a coinbase. The coinbase is always the first transaction to be included in a new block added to the blockchain, and it is used by miners to accrue the transactions in the block, as well as the reward per block.

MEV

MEV, or Miner Extractable Value, also known as Maximal Extractable Value, is another important trick that miners have up their sleeves to increase their profits per block. The basic concept foresees the ability of miners to sequence transactions in the queue to be added to the block, thus making the transaction setters increase the fee to have their transaction placed up the queue.

Since transaction placement and speed play a crucial role in trading, MEV takes on a variety of tactics that mimic front running on Wall Street, sandwiching practices, backrunning, and so forth. The given type of practice is mostly found on blockchains like Ethereum, where smart contracts play a crucial role in transaction processing. Bitcoin has no MEV so far, but the introduction of the Lightning Network could make such practices common there as well.

How Mining Difficulty Affects Transaction Fees

The difficulty of mining refers to the complexity of the calculations involved in the process of mining a cryptocurrency as the number of miners increases. Difficulty increases and decreases over time to adjust to the average time needed to produce a block — 10 minutes on average in the Bitcoin network.

As more miners connect to the network, the hash rate, or the overall computing power of the network, increases, which leads to an automatic increase in mining difficulty. In the Bitcoin network, the difficulty level is adjusted automatically every time 2,016 new blocks have been added to the network.

There is an inverse relationship between mining difficulty, hash rates, and profitability. As hash rates fell, as was witnessed in early April 2021, when China cracked down on miners, the profitability values soared, as the number of transactions increased and transaction fees went up. With the drop in hash rates, the difficulty of mining dropped, as the number of miners supporting the network also decreased.

In essence, it is becoming more profitable to mine Bitcoin as hash rates fall and mining difficulty drops.

Mining Farms Hubs And Threats Of Centralization

Starting from April 2021, China has begun a major crackdown on mining sites, which had previously been responsible for over 65% of all Bitcoin mining worldwide. The intent of the authorities extends to shutting down as much as 90% of all Bitcoin mining facilities.

Such harsh measures have had an immediate impact on the distribution of mining capacities and have led to a sharp drop in hash rates. Miners are now being forced to either sell off their mining rigs altogether at dumping prices or migrate their facilities overseas to continue operations. Among the major centers that are becoming havens for crypto miners are Iran, which has leveled crypto mining to entrepreneurial industrial activity, and Inner Mongolia that currently stands for almost 8% of all mining worldwide. Kazakhstan is also becoming a major mining hub with almost 6% of all hash rates migrating to the country, which has ample space for mining facilities, plenty of cheap electricity, and a favorable regulatory framework to match.

With 65% of all mining being concentrated in China had led numerous experts to believe that a threat of network centralization is looming. Considering that most miners are Chinese nationals, it was possible to envision a scenario in which like-minded miners could theoretically band together to form a consortium via common communication channels and start dictating network terms. However, the crackdown in the middle of 2021 has dissipated such hypothetical fears.

How Pools Work

With mining rigs becoming outlawed in China, one of the major means of mining that miners are turning their attention to is pool mining. The given concept has been around for years and involves the pooling of mining capacities into a single facility to evenly distribute mining rewards among all participants. The pools can either act as intermediaries for managing the contributing miners, or they can act as parties that distribute the rewards in equal measure.

Another method that is just as popular and affordable is cloud mining, which involves random users willing to engage in mining who rent mining equipment for a period of time on a contract basis with a set profitability level. This type of remote participation in mining is ideal for those who do not want to maintain their own mining rigs but wish to receive cryptocurrency rewards.

New Farming Methods

The excessive amount of energy needed for mining is one of the reasons why it is being frowned upon. This downside has led to the emergence of new types of mining, such as cold staking and Proof of Space.

Under the innovative cold staking mechanism, holders of the Callisto currency keep their assets on cold wallets disconnected from the internet, essentially guaranteeing that they are not being traded. The concept of granting cold stakes to operating nodes is more eco-friendly than mining Bitcoin.

Another innovative concept is Proof-of-Space employed by the Chia coin, which essentially requires transaction processors to prove that they are allocating unused hard drive space for storage that is used by the Chia network via a connection to average computers, negating the need for powerful mining rigs. As another “eco-friendly” mining method, Chia has already gained considerable success on the market and has led to a spike in demand for hard drives.

To Sum It All Up

A large number of popular cryptocurrencies are mined. Given the negative impact on the environment, many developers and foundations are thinking about switching to less hazardous ways of working.

However, mining new coins like Bitcoin makes the network more stable. And the miners themselves earn cryptocurrency in exchange for providing production capacities. And then, they can exchange it for stablecoins or traditional assets.

Originally published at https://blog.mercuryo.io.