What is Digital Mining? – Behind the Distributed Ledger Curtain
Blockchain or distributed ledger technology is a shared ledger, duplicated across a network of computers or operators of “nodes” on the network, typically referred to as “Miners”. Blockchain secures the data using encryption and the decentralized manner of retaining individual records across a wide group of operators of nodes, so that no one Miner can gain control of the specific currency network.
Who Are Miners and Why Do They Do It?
Miners today can be anyone, from an individual operating their own equipment and data storage to pools of Miners operating from a shared platform to minimize costs. Miners choose the network they want to join and download/install the open source software to create a node, or place, on that network. Some networks/software are completely open, while others are “permissioned” and require a node applicant to demonstrate a “proof of work” that they have the capacity to compute the required calculations, before they can download the code. With a node created, they can then participate in the calculation “race” to create (or “mine”) new currency in that network; validate transactions; or, in the case of Ethereum, participate in other functions happening within that network (Smart Contracts, etc).
Miners act to either create a new currency (i.e. a new coin or token in the BitCoin network – hence the term “Miner”), or block on the chain to match and validate ongoing transactions. Each transaction record once verified, is known as a block, and as new blocks or transactions are verified, they are added to the “chain” and can never be changed or removed once they are created. For coin creation, the Miner must solve a complex mathematical puzzle to ultimately find a missing number that produces the winning result and a new coin. The winner is announced to all that are competing and is awarded some of the currency. Losers then continue to guess the next winning block. The difficulty of the puzzle depends upon the network and the number of nodes or participants. The Miner can also solve for blocks that match, validate and record ongoing transactions using existing currency, and also receive some token or fee for participating.
While the reward to create and validate coins may be significant, the costs to mine are high. The computing power required to handle the calculation and validation can be massive and varies across different types of currencies. Because of this, some new entrants have elected to join pools or platforms of Miners that provide technology or other support, but also share in the revenue.
There are new mining models called Point of Service (POS), where participants receive randomized rights to create or validate transactions, usually based on the amount of the cryptocurrency that they own. Instead of receiving an amount of the currency for creating new coins, Miners receive fees. These models do not require the same computing power to “discover” the key to the block and therefore have lower participation costs, but also yield lower revenues.
Broker and Investor Due Diligence
Several companies have begun creating gaming chips and hardware to service the cryptocurrency mining market and are being tracked by investors. Investors should be aware that the process of mining is always changing, and these new revenue sources may be short-lived as technology and processes change. Those interested in participating in the mining process should do their due diligence and ensure they are getting involved with a reputable network.
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Oyster helps firms view the opportunities and risks associated with cryptocurrencies from a strategic, operational, and compliance standpoint for the emerging cryptocurrency industry and for exchanges, broker-dealers, FCMs and RIAs.
Terry Schafer is a financial services executive, with 30 years of experience as a COO and CFO for investment banking capital markets, trading and derivative businesses in New York, London and Tokyo, as well as Fin-Tech start-ups, private funds, RIA’s and hybrid broker-dealer businesses. Terry’s expertise in business management, operations, compliance and technology allows her to translate business, legal and regulatory requirements into workable business and compliance policies, processes and technology solutions.