Why Mining Pools?
Bitcoin miners are only compensated with a block reward when they guess the solution to a math puzzle faster than other miners. Bitcoin’s Proof-of-Work mechanism is based on the randomized SHA-256 hash function and consequently, miners could compete for lengthy time periods without knowing if they will find a block, or how near they are to finding one. An analogy is like buying a lottery ticket. The more computing power you have, the more lottery tickets you generate, but it is uncertain that any of them will be the winning ticket.
Large mining corporations are able to have more predictability due to the size of their operation and aggregate computing power. They generally maintain a consistent revenue stream and capital reserves can compensate for extended periods of time without receiving a block reward. This is like buying enough lottery tickets consistently such that the chances of winning become predictable.
Individual miners are unable to predict when they will find a new block and forecast revenue reliably. As a result, independent miners are exposed to extremely uneven and uncertain revenue. If they do find a block, the payout would be extraordinary (like buying one lottery ticket and it wins), but maintaining a small operation with high costs and zero revenue for months at a time is extremely difficult. However, independent miners can pool their resources and share the earned rewards to help smooth out revenue. An analogy is multiple people buying lottery tickets, pooling them together, and if anybody wins, the reward is split amongst everybody. Mining pools are based on this concept, and the first mining pool created was called SlushPool1.
How Mining Pools Work
Members of a mining pool contribute their processing power (measured in hash rate) to the effort of discovering a block. If a member of the pool earns a block reward, they pay that block reward to the mining pool coordinator who takes a small fee (typically 1%-3%) then splits the block reward to each member of the pool based on their hash rate contribution.
There are two main reward systems in mining pools: PPS (Pay per share) and PPLNS (Pay per last “n” shares).
PPS or FPPS (Pay Per Share or Full Pay Per Share)
Considering the lottery example, let’s assume it statistically takes 100,000 lottery tickets to win, and each ticket is generated via a certain amount of computing power. If you contribute computing power that generates 10,000 tickets or 10% of the tickets it takes to win, then you are paid 10% of the block reward up front (minus pool fees) for your contribution, regardless if you or anybody else contributed a winning lottery ticket. The pool operator tasks the risk of not collecting any winning lottery tickets, but can also benefit from collecting more than 1 winning lottery ticket in the statistical 1 in 100,000 wins. Payouts to miners under PPS are relatively stable and consistent. In FPPS (Full Pay Per Share), miners also receive transaction fees in addition to the block reward.
PPLNS (Pay Per Last n Shares)
Instead of being paid up front, like PPS, a miner is only paid proportionally (minus pool fees) for their contribution after a block reward is awarded. This results in a more variable payout, but potentially higher if multiple winning lottery tickets are contributed to the pool during the n timeframe it takes to earn a block reward.
There are other reward systems, but PPS and PPLNS are the two main ones and others are variants of being paid up front or paid after the reward is found.
Bitcoin mining pools can have different reward systems and fee structures. The larger the pool the more likely it will have a payout, but also the more miners it needs to split the payout with. When joining a pool, it is important to consider the pool’s reputation for paying out fairly and consistently, as well as the pool’s uptime.
Mining Pool Game Theory
In theory, Bitcoin mining pools could collude to launch a 51% attack on the network and steal or double spend coins. However if they did this, the value of Bitcoin would plummet thereby devaluing any advantage gained by having 51% of the network’s hashrate. Bitcoin pools also don’t directly own the computing power, so any miner could simply swap to other pools if they notice a pool is not acting in the best interest of the network.
Ultimately, Bitcoin mining pools encourage decentralization of the network’s computing power since it allows anybody to participate in Bitcoin mining and receive a payout. This helps the Bitcoin network remain resilient to any single point of failure.
Resources
Bitcoin Pool Distribution: https://btc.com/stats/pool
Bitcoin Mining Pool Stats: https://miningpoolstats.stream/bitcoin
Bitcoin and Cryptocurrency Technologies: https://www.coursera.org/lecture/cryptocurrency/mining-pools-iIRi2
Presented in the Bitcointalk forum on November 27, 2010 by the user Slush. https://bitcointalk.org/index.php?topic=1976.0