Are Large Mining Pools Bad for Cryptocurrencies?

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A central tenet of cryptocurrencies is the importance of decentralization. For proof-of-work blockchains like bitcoin and ethereum, anyone with a computer and an internet connection is theoretically free to mine cryptocurrency in exchange for supporting the network.

However, as the popularity and market for cryptocurrencies have evolved, that idea seems to have fallen by the wayside. Most cryptocurrencies are not minted at the home computers of crypto enthusiasts. They’re minted at large mining operations in data centers.

As of mid-2021, all of the top bitcoin mining pools were based in China, with the top five pools accounting for fully half of the processing power devoted to the cryptocurrency.

They may be elsewhere soon. China has been periodically cracking down on cryptocurrency mining pools, in part because they’re massive energy drains. The exodus from China was well underway in 2021.

The likely destination for much of the crypto mining industry: Texas.

  • Minting crypto coins was intended to be an egalitarian process shared by individual enthusiasts.
  • In reality, crypto mining is dominated by the operators of huge mining pools.
  • As the complexity of mining increases, individual operators have to sign up with a pool to compete.

Advantages of Mining Pools 

In crypto mining, the question of centralized or decentralized is hard to untangle. A mining pool can include many individual crypto enthusiasts who invest in “mining rigs” but sign up with one of a number of mining pools to harness its far superior processing power.

Still, the greatly increased complexity of crypto mining makes it a near-impossible mission for a single miner with a stack of equipment. Signing up with a big operator, and paying its fees, is the only alternative.

The increasing centralization of mining pools presents its own set of advantages and disadvantages.

Faster Processing

The first advantage is faster processing. In bitcoin mining, each node competes with the rest of the network to add to the overall blockchain. Blocks are found only when other nodes within the network agree to their discovery. Having multiple blocks within the same network can speed up the discovery process because it reduces latency or delays. 

The process also irons out discrepancies in Internet connections between nodes placed in different regions. In turn, more direct network connections between bitcoin nodes speed up the notification process. 

Large numbers of mining systems within the same network also make for an efficient mining process, reducing the number of so-called “orphan blocks,” or blocks that are not selected to be part of the blockchain. 

Pools also help bitcoin mining firms achieve economies of scale. The difficulty of problems that miners must solve in order to earn bitcoin has increased over time and can only increase as the rate of bitcoin production slows down.

From a technical standpoint, the introduction of more powerful machines might make the process more efficient. But bitcoin miners still have to contend with increased electricity costs, which represent 90% of the costs of such operations.

Governments and power companies have nudged bitcoin mining operations towards mining pools by offering subsidized electric rates. Like most industrial products, scale is useful to drive down costs. 

Texas

One preferred destination of the operators of the vast central data centers that dominate crypto mining, now that they’re unwelcome in China.

Disadvantages of Mining Pools

The shift from decentralized to concentrated mining pools has not occurred without controversy from the earliest days of bitcoin. 

For example, a 2013 paper by Ittay Eyal and Emin Gün Sirer, two Cornell academics, argued that “Bitcoin Is Broken” because it enables selfish mining. That is, a group of miners can join forces and “hide” their generated blocks from the main blockchain. This enables nodes within their network to discover the blocks and quickly generate additional blocks. The hidden blocks are revealed only after the hidden chain of blocks has reached a length equal to that of the new blockchain. The profits generated as a result of this type of mining provide incentives for small mining groups to join large ones.    

The launch of Bitcoin Cash, a cryptocurrency that was forked from bitcoin’s blockchain in August 2017, also generated discussion about the power of bitcoin miners.

Enter Bitcoin Cash

Jihan Wu, Bitmain’s CEO, threw the resources of his mining pools behind the cryptocurrency even as small and independent miners boycotted it. The result was a surge in its price resulting in a high of $3,706 in December 2017. As of Aug. 15, 2021, one Bitcoin Cash (BCH) was worth $705.30.

The other, more serious, allegation relates to the potential for manipulation of cryptocurrency prices by mining pools. Because they control the supply of coins to the market, centralized mining pools can control their prices by restricting the number of coins available for trading.

The Bottom Line 

Cryptocurrency mining has transitioned from an operation that was distributed over groups of individual computers to centralized mining pools involving big investments.

That change is primarily a result of the cryptocurrency’s popularity and increase in transaction volumes.

There are both benefits and drawbacks to the centralization of bitcoin mining pools. 

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. As of the date this article was written, the author owns small amounts of bitcoin.

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