A cryptocurrency enthusiast willing to reap profits through the standard mining process either goes solo using his/her own mining devices, or joins a mining pool where his/her mining resources are clubbed with those of other pool miners to improve the mining output with enhanced processing. This article discusses how mining pools work.
The world’s oldest currency, physical gold, is dug out of the earth through the process of gold mining. It discovers hidden gold that is not yet available. Successful mining allows the individual digger or the mining company to own the gold.
Cryptocurrency mining works similarly, as virtual coins can be discovered digitally using computer programs. The bitcoin system has set a limit of total 21 million bitcoins.
All these bitcoins are lying within the blockchain system. Most are already dug out or “mined,” and owned by different participants, while the rest are in the process of being mined and will eventually become available. (See more: Only 20 Percent Of Total Bitcoins Remain To Be Mined.)
Understanding the Mining Process
Cryptocurrency mining involves two functions – releasing new cryptocurrency into the system (similar to gold discovery), and verifying and adding transactions to the blockchain public ledger. It is performed using an internet-connected computer which is often equipped with special mining hardware devices and software programs to control and manage the mining process.
Crypto mining is a calculation-intensive, puzzle-solving-like computation process that requires high processing power along with high electricity consumption. The miner who first solves the puzzle gets to place the next block on the blockchain and claim the rewards. Rewards include the miner becoming the owner of the newly released bitcoin, or getting fees linked to the transactions performed in the block. (For more, see How Does Bitcoin Mining Work?)
The cryptocurrency discovery process is configured in such a way that if more miners are working, the difficulty level goes up, while a decline in the number of miners eases the difficulty level. The rewards make mining a lucrative activity for monetary gains. As more miners attempt to grab a piece of the pie, finding new blocks gets computationally more difficult, requiring more computing power. This is often impractical and too expensive for individual miners.
Pooling Resources: Let’s Mine Better, Together!
Enter the mining pool, which is a collection/group of miners working together to increase their chances of finding a block at the group level, compared to that at the individual level. Through such pools, miners combine their individual computational resources with those of the other members which enhances their joint processing power, and helps to achieve the desired output faster.
To draw an analogy, a gold digger having a capacity to dig 100 square meters of land in one day will take 100 days to explore one hectare of land for gold. Combining 100 gold diggers can complete the job in just 1 day. The discovered gold can be split among all 100 diggers evenly, assuming all have put in equal effort to explore their assigned portions of land.
Similarly, one can combine nine mining devices, each generating mining power of 335 megahashes per second (MH/s), to generate a combined output of around 3 gigahashes. The output is faster and has a better chance to discover bitcoins.
However, this pooled work with better output and higher chances, comes at a cost. The reward earned through combined mining is split among the various pool members, as compared to sole ownership on the reward earned through individual mining.
Functions of a Mining Pool
A mining pool essentially works as a coordinator for the pool members. The functions involve managing the pool members’ hashes, looking for rewards through pooled efforts of available processing power, recording work performed by each pool member, and assigning reward shares to each pool member in proportion to the work performed after suitable verification.
The pool may also charge a fee from each member miner.
Work to each pool member can be assigned in two ways. The traditional method involves assigning members a work unit comprised of a particular range of nonce, the number that blockchain miners are computing for. Once the pool member completes the work on the assigned range, he places a request for a new work unit to be assigned.
A second mining method allows pool members the liberty to pick and choose as much work as they like without any assignment coming from the pool. The methodology ensures that no two members take the same range, just like no two gold diggers should explore the same piece of land.
There can also be a pool of pools, to further enhance output.
How Do Mining Pools Share Rewards?
Successful identification of the block hash leads to reward for the pool, which is then shared based on the pool shares mechanism. Shares describe how much work a particular member’s computer is contributing to the mining pool.
There are two kinds of shares – accepted and rejected. Accepted shares indicate that work done by a pool member is contributing substantially towards discovering new cryptocoins, and these get rewarded.
Rejected shares represent work that does not contribute to a blockchain discovery, and hence are not paid for. Even if a member’s computer performs work successfully but submits it late for that particular block, it constitutes rejected work.
A pool member ideally wants that all his shares get accepted. However, rejected shares are inevitable as it is impossible that all the computations on a member’s computer will be useful in coin discovery, and will always be submitted on time.
Pool members are rewarded based on their accepted shares that helped in finding a new coin block. A share has no actual value, and it simply acts as an accounting method to keep the reward distribution fair.
Based on the accepted shares, members get rewarded using different methods, which include the following:
- Pay-per share (PPS): Allows instant payout solely based on accepted shares contributed by the pool member, who are allowed to withdraw their earnings instantly from the pool’s existing balance.
- Proportional (PROP): At the end of a mining round, a reward which is proportional to the number of the member’s shares with respect to total shares in the pool, is offered.
- Shared Maximum Pay Per Share (SMPPS): A method similar to PPS but limits the payout to the maximum that the pool has earned.
- Equalized Shared Maximum Pay Per Share (ESMPPS): A method similar to SMPPS, but distributes payments equally among all miners in the bitcoin mining pool.
Other variations include Double Geometric Method (DGM), Recent Shared Maximum Pay Per Share (RSMPPS), Capped Pay Per Share with Recent Backpay (CPPSRB), and Bitcoin Pooled Mining (BPM).
Before deciding to join a particular pool, miners should pay attention to how each pool shares its payments among members and what fees, if any, it charges. Typically, pools may charge between 1% and 3% as pool fees.
The Bottom Line
With mining becoming increasing popular aided by high-speed devices compatible with home computers, the chances of realistically profiting from individual mining are diminishing. Most individuals opt to join a mining pool which allows them high-probability limited profits, instead of low-probability high profits.
Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.