What is mining?

Mining is the process of creating new bitcoins, which is based on computers solving complex mathematical problems. Mining is the only way to issue cryptocurrency. One of the translations of the word mining is “mining or development of deposits.” If we are talking about bitcoin, then we are dealing with the production of “virtual gold”.

Who is mining bitcoin?

The people who are mining are called miners. This word also means specialized devices for mining bitcoin and other cryptocurrencies.

What is it like?

In part, miners can be compared to participants in torrent trackers, which, by launching a special program, allow other users to download movies or music. In the case of Bitcoin, miners maintain the functioning of the payment system, confirm transactions, and maintain a consensus on a single and unchanging state of the entire network. They receive bitcoins as a reward.

How does the mining process take place?

The mining process consists in calculating the hash (output) of the block header in the blockchain. The block includes the previous block header hash, transaction hash and a random number. When a new block is formed, the miner receives a reward – a certain amount of bitcoins. Many miners are competing for the award at the same time. As a rule, transactions included in a block are considered confirmed after six blocks in a row have been calculated.

What does cryptocurrency mining look like?

Today, cryptocurrency mining most often occurs in specialized data centers, which are also called mining farms. A typical bitcoin mining farm is a room containing a number of ASICs (application-specific integrated circuit). In the room itself, the required temperature regime is maintained or other cooling methods are used.

Is mining profitable?

The economic feasibility of mining is determined by several factors at once: the cost of electricity, the performance of “hardware”, the current complexity, as well as the market rate of bitcoin in relation to other currencies. If at the very beginning of the existence of bitcoin its mining was quite possible at home, today it requires very large computing power. An increase in the number of miners and the appearance of more powerful devices lead to an increase in the complexity of mining, which negatively affects profitability.

What equipment do you need?

At the very beginning of bitcoin’s existence, it was possible to mine it even on ordinary computers with more or less powerful processors and video cards. Today it is no longer necessary to talk about it. Modern mining is the use of expensive specialized devices and chips, the production of which has already become a separate multi-million dollar industry.

It turns out that there is no point in doing this alone?

Most likely, yes, unless you have sufficient funds to acquire expensive equipment and be able to pay the costs associated with its maintenance. However, this does not mean that you have no chance of making money from mining. It is to involve ordinary users in the process that the so-called pools (associations) of miners exist. Pools can include hundreds and thousands of cryptocurrency miners who receive their reward shares in accordance with the size of the contribution. The network sees such a pool as one miner producing hundreds of gigahashes per second, although in fact it is one main server that distributes tasks to individual miners. This practice turns out to be more effective and brings rewards faster, although it does it in small portions.

What reward can I expect?

According to the original Bitcoin whitepaper written by Satoshi Nakamoto, the reward for finding a new block is halved every four years: at the beginning of 2013 it was 50 BTC, then dropped to 25 BTC, and in the summer of 2016 it dropped to 12.5 BTC. The next reduction (halving) of the award will take place in 2020.

If you are a member of a pool, you can count on a reward proportional to your mining capacity in the “common pot”. The difficulty of finding blocks changes every 2016 blocks or approximately every two weeks. As the power of the network increases, so does the complexity.

There are many services for calculating the current mining profitability on various algorithms and devices. One of the most popular of these is WhatToMine.

How to ensure confidentiality and security when mining bitcoin

In the early days, Bitcoin mining was truly open and accessible. Anyone could just download the free software to their computer and start making money.

However, such a low barrier to entry did not last long. By the end of 2010, CPU mining had lost its competitiveness due to the advent of GPUs. This trend led to the creation of the Slush Pool in November of the same year, which allowed the CPU miners to receive a steady income again.

When ASICs entered the market in 2013-2014, they quickly revolutionized the industry. The need for specialized mining hardware has raised the barriers to entry, and it remains high to this day. However, not all was lost.

At least if you were able to get your hands on a few SHA-256 ASICs and available electricity, nothing stopped you from mining. Unfortunately, now even this right may not remain for everyone.

As governments and regulators study Bitcoin, their attempts to regulate or even directly control mining seem inevitable.

What can be done to keep mining as accessible as possible?

Network security

Would you like your ISP to be aware of everything you do online? Most likely no. One of the ways internet users have partially restored privacy in recent years is by moving from HTTP to HTTPS. The latter is already the standard for all websites.

The “S” in HTTPS stands for Secure, short for Secure Socket Layer (SSL), which is a layer of secure sockets. Basically, this means that your ISP knows which websites you visit, but does not know what you are doing on them.

On websites without an SSL certificate, your ISP can track all of your activity, including usernames, passwords, and even payment details. Obviously, HTTPS is a more acceptable protocol for users.

Most bitcoin miners still use the HTTP equivalent of mining, Stratum V1. Miners and mining pools are constantly exchanging data in JSON (human readable format) and, unless additional precautions are taken, the ISP can see all the details of this data transfer.

In other words, ISPs can easily see that someone is mining bitcoin based on the data available to them. Worse, a malicious ISP employee can steal the hashrate (and thus the bitcoins) without your knowledge. Even your neighbor can carry out a hash hijacking attack if the ISP does not properly isolate clients from each other.

To prevent this, miners can use the industry equivalent of HTTPS: Stratum V2. While V1 data transfers are unencrypted and human-readable, Stratum V2 uses Authenticated Data-Attached Encryption (AEAD) to ensure the privacy of data transfers between miners and pools.

Switching from JSON to binary in Stratum V2 significantly reduces the size of the data transferred, so that encrypted messages in V2 are about 50% lighter than unencrypted messages in V1. Data download by miner will not increase after switching to V2.

Your ISP doesn’t have to know that you are mining bitcoin. Stratum V2 avoids this. But this is only part of the solution.

Complete confidentiality

Your ISP can still see which websites you visit. You can learn a lot about a person even from a list of URLs.

For normal web browsing, a VPN can come in handy. A VPN masks your public IP address so your ISP doesn’t know what you are doing on the Internet and doesn’t track your activities. Bitcoin miners can also use VPN services, but this leads to network latency, which can be quite costly in a business where every millisecond counts.

Bitcoin miners can achieve the same privacy improvement with DNS proxies without significantly increasing network latency.

This dnsscrypt-proxy provides a local service that can be used directly on the local resolver or as a DNS forwarder, encrypting and authenticating requests using the DNSCrypt protocol and forwarding them to an upstream server. The DNSCrypt protocol uses high-speed, high-security elliptic curve cryptography, which is similar to DNSCurve, but aims to secure communication between the client and its Layer 1 converter.

Information that is usually exposed is also encrypted through a DNS proxy server, which means that the ISP cannot determine which sites you visit.

Miners can use any DNS proxy that supports encrypted DNS protocols such as DNSCrypt v2 and DNS-over-HTTPS to achieve much more privacy. Combined with Stratum V2, this is the equivalent of browsing the web with a VPN and visiting only HTTPS domains.

Hiding your energy consumption is another problem

If you only use one or a few ASIC devices, these steps will help you keep mining confidential and safe. Large-scale mining leaves a thermodynamic footprint that is difficult to hide.

The best thing to do with software is to make sure no one, including your ISP, can eavesdrop on your mining or steal your hashrate.

How strongly Bitcoin miners influence the market

Analyst Karim Helmi and the Coin Metrics team have developed a new methodology for quantifying the assets held by bitcoin miners. Its peculiarity lies in the separation of the activity of miners and mining pools, which makes it possible to more accurately estimate the reserves of mined coins at their disposal.

Key points

  • Within the framework of the new methodology, addresses associated with miners and pools are analyzed separately, stocks and activity of market participants are estimated.
  • This method has advantages over previous approaches to analyzing miner’s costs. They focused on the activity of the pool operator, and not on the actions of the miners.
  • The supply of coins concentrated at miners is gradually decreasing, and net flows from their addresses are stabilizing. Over time, the influence exerted by miners on the market decreases, but it is still significant.

Miners and the market

In addition to securing the network, miners have a huge impact on market dynamics. By receiving freshly released bitcoins, rather than buying them, miners are the direct net sellers of the asset. This effect is exacerbated by the fact that the operating costs of miners, among which electricity and rent prevail, are denominated in fiat currency. In this case, the income is denominated in bitcoin.

The new approach, using previously unavailable information, analyzes the activity of miners and their motives, and also estimates the impact of their costs on the market.

On-chain data indicate a gradual decline in the influence of miners on the network. However, these market participants remain key players in the ecosystem with access to large amounts of funds.

Summing up the market supply of coins

To calculate the miner flows, let’s start by grouping all addresses that received payment directly from coinbase transactions. Let’s mark them as 0-hop addresses. The addresses that received payments from the 0-hop sample will be labeled 1-hop.

In a typical situation, pools first receive the block reward, then it is distributed among the miners. 0-hop addresses are usually associated with pools, 1-hop addresses are associated with miners. For this reason, existing systems trying to draw conclusions about the behavior of miners based on the analysis of flows from 0-hop addresses are theoretically untenable. They are not evaluating what they should be evaluating, focusing on the activity of the pool operator.

Of course, labeling miners and pools based on distance from a coinbase transaction is not a perfect method. Especially when applied to the early stages of the network’s development, when solo mining and alternative pool models were more popular.

Since the first mining pool, Slush Pool, mined the debut block in December 2010, observations prior to that date should only be used as a reference. In addition, addresses of miners who have not received funds from 0-hop addresses are not marked. Overall, however, such a heuristic represents a significant improvement over current approaches and is intended to more accurately reflect general trends.

Miners, especially active in the early years of the network, control a significant amount of bitcoins. The number of coins at 0-hop and 1-hop addresses has generally declined throughout the history of the first cryptocurrency. In the second half of 2019 and the first half of 2020, on the eve of halving, there was a significant change in trend.

Miners have accumulated an additional 383,000 BTC during this period. The effect was mostly limited to 1-hop addresses, and the supply concentrated in the 0-hop sample remained virtually unchanged.

Dynamics of Bitcoin stocks at 0-hop and 1-hop addresses. Source: Coin Metrics.

There are several spikes in the supply concentrated among miners. Such bursts are often associated with addresses with significant balances, mining their first block or making their first interaction with a 0-hop address.

The most notable of these leaps occurred on August 16, 2012, when the whale holding over half a million bitcoins received a portion of the coinbase reward for block # 194,256.

New entrants are also responsible for increasing miner-controlled supply ahead of the third halving.

The dynamics of the supply growth associated with new addresses of miners. Data: Coin Metrics.

ue to inflation, the gradual decline in miner-controlled reserves becomes more significant when viewed in the context of total emissions. This is in line with the trend towards a more even distribution of bitcoin supply.

This is also consistent with the widespread adoption of the pooling model. The latter implies a low probability that non-mining addresses will be mistakenly labeled 1-hop.

However, even today, miners and pools control a significant portion of the total Bitcoin supply.

The share of miners’ reserves in the total supply of bitcoin. Source: Coin Metrics.

Pools and payments

The inflow of funds to and from these two groups of addresses is another powerful on-chain signal. Since pools usually receive coinbase rewards immediately, 0-hop threads are a useful indicator of mining pool activity.

Since the early days of the Bitcoin network, inflows and outflows of funds from 0-hop addresses have been characterized by a downward trend. The exception is a few bursts of activity, the most notable of which is associated with the aforementioned whale.

Bitcoin streams associated with 0-hop addresses. Source: Coin Metrics.

Miner revenues or block reward receipts account for the bulk of the flow of funds to 0-hop addresses. Although miners’ income is volatile in the short term due to fluctuations in fees and blocks mined, it is relatively stable over the long term.

Bitcoin miner revenues and flows associated with 0-hop addresses. Source: Coin Metrics.

Inflows and outflows are closely correlated with each other. However, outflows are much more volatile, since miners can withdraw funds from mining pool wallets at any time. Consequences of halving 2016 and 2020

Bitcoin-denominated streams associated with 0-hop addresses. Source: Coin Metrics.

Miner funds

0-hop streams are useful for tracking payments from pool operators. In the context of today’s standard wallet architecture, they do not cover transactions carried out directly by miners.

In most cases, block rewards go to an address controlled by the pool operator. The latter stores these coins until miners receive regular payments or request a withdrawal of funds.

Bitcoin-denominated streams associated with 1-hop addresses. Source: Coin Metrics.

In the context of the pooling model, the 1-hop address movement of funds more accurately reflects the costs of miners. This report is one of the first attempts to analyze such flows. Due to the much larger number of matching addresses and the high velocity of money circulation, these flows are much larger and more volatile compared to 0-hop.

For analyzing the movement of funds in the early stages of network development (before pools became the most common method of mining), 0-hop streams may be a more suitable tool. However, even today, analysis of 1-hop streams only gives an approximate estimate of miner activity. This is due to differences in the wallet pool structures, which could cause exchange addresses to be mistakenly included in these flows. But in general, such a model gives a more holistic view of the costs of miners in modern conditions.

As with 0-hop, 1-hop inflows and outflows are closely related. Since block rewards represent only a small fraction of 1-hop proceeds, inflows and outflows are very volatile in this case. The influence of halving on this category of streams is less obvious.

Bitcoin-denominated streams associated with 1-hop addresses. Source: Coin Metrics.

Over the last year or so, miner-related flows have increased slightly, indicating increased activity. As net flows are relatively stable and become less volatile, the increased activity does not seem to be reflected in the increased impact on the network.

The close relationship between inflows and outflows indicates that most miners tend to immediately move coins in their possession. Given that derivatives exchanges and fiat lending services are primarily custodian platforms, miners can use financial instruments to hedge bitcoin price risks.

However, the results of a study by the Center for Alternative Finance at the University of Cambridge indicate that the adoption rate of such instruments is low – miners generally prefer to hold significant reserves in bitcoin. Significant amounts of turnover may indicate that miners are active market participants, selling most of the mined coins.

Through the prism of the dollar

Since the costs, profits and losses of miners are denominated in dollars, it is advisable to view their flows through the prism of the value denominated in US currency. Since 0-hop streams are mainly composed of block rewards, the dollar value graph is very similar to the miner’s revenue graph.

USD denominated flows associated with 0-hop addresses. Source: Coin Metrics.

The USD-denominated miner’s flow chart resembles the pool flow chart on a larger scale. This is due to their interdependence with the price of bitcoin. However, unlike pool threads, miner threads have an upward trend, which even briefly exceeded the 2017 high at the end of 2019. This indicates a lot of miner activity on the network.

Dollar-denominated flows associated with 1-hop addresses. Source: Coin Metrics.

Where are we now?

On-chain metrics measuring flows and stocks indicate a gradual decline in the influence of miners on the network. However, miner-related activity is still significant, with these market participants controlling a significant share of the Bitcoin market supply.

As the only direct recipients of the issue, miners and pools have an impact on the network that is not easy to quantify. The metrics in this article only give a superficial understanding of the behavior of miners.

In the future, we hope to analyze the flows from miners to exchanges, more accurately assessing their impact on the market. We also plan to explore an active offer focused on miner addresses, weeding out coins lost in the early stages of the network’s development, as well as taking into account the wallet structure of individual pools. This will allow for a more detailed analysis of the behavior of miners.

Coin Metrics has created a new methodology for assessing the activity of bitcoin miners

Coin Metrics analyst Karim Helmi has developed a new methodology for quantifying Bitcoin miners’ stocks that separates the activity of miners and mining pools. This allows them to more accurately estimate the stocks of mined coins at their disposal.

Helmi points out that his approach takes into account the additional 380,000 BTC accumulated ahead of the third halving in May this year. Previous methodologies that measure only the balances of addresses to which rewards for the found block go, these coins were not taken into account.

Исследователь собрал вce aдpeca, получившие oплaту напрямую с coinbase-тpaнзaкций бeз вxoдныx дaнныx, и пометил их как 0-hop (оператор майнинг-пула). Адреса мaйнepoв, пoлучaющиx выплaты с выборки 0-hop, получили маркировку 1-hop.

Helmi draws attention to the relative stability of inflows to 0-hop addresses, as they are generated through block generation rewards. He also points to the volatile nature of outflows, taking into account the past halvings.

The dynamics of inflows / outflows associated with 1-hop addresses is so changeable that it is not possible to clearly identify the moments of halving. Helmi adds that over time, the effect is to weaken their volatility.

According to the analyst’s observations, 2020 is out of the ordinary. Pure 0-hop flows have remained positive for the first time in a long period of time. This became more evident after the third halving.

Based on the gradual fading of net flows associated with 1-hop addresses, Helmi writes about the decline in the impact of Bitcoin miners on the market.

He supports his hypothesis with a graph that demonstrates a decrease in the share of the total supply of coins at the disposal of miners.

The new methodology is not without flaws, Helmi admits.

“Marking of miners and pools based on distance from coinbase-transaction is an incomplete method. Of course, if it is applied to the early state of the network, when solo-mining and alternative pool models were more popular, “the study says.

The analyst believes that his approach could prove useful in discovering partner and hidden mining pools.