What is Digital “Mining?”
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 (e.g., a new coin or token in the BitCoin network) 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. Both concern for the environment and investor pressure are causing some Miners to look to power their computers with renewable energy or sign up with data centers that rely on alternative energy sources. Other entrants have elected to join pools or platforms of Miners that provide technology or other support, but also share in the revenue.
There are 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
Companies creating gaming chips and hardware to service the cryptocurrency mining market 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. You can learn more about digital assets by downloading our complimentary eBook Digital Assets in the Securities Industry.
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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.