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This is the second of a series from a study by Dr. Garrick Hileman & Michel Rauchs of the University of Cambridge – Judge Business School – Center for Alternative Finance. The first part of the series can be seen here: Lines Between Exchanges And Wallets Are Increasingly ‘Blurred’ 

Mining operations play an important role in the cryptocurrency system because it groups unconfirmed transactions into new blocks and adding them to the global ledger called the 'blockchain.'

The operation provides the needed computing power to safeguard blockchain by calculating tremendous numbers of hashes to find a legitimate block.

At the onset of Bitcoin, mining activity is done by hobbyists using ordinary PCs or laptops. But as the digital currency’s popularity explode, the cryptocurrency mining operation also rapidly evolved that it is now a capital-intensive industry utilizing superfast computer hardware.

This eventually led to more issues, the researcher said. As miners increase their computing powers, it also made it more difficult to solve the puzzle that allows them to earn rewards. The emergence of the first Bitcoin mining pool in 2010 also led to further increases in the difficulty of finding a block hash. Over the years, miners led an arms race to find cheaper energy and more powerful rigs to compete with the rising difficulty.

 “Today, mining has become a competitive and resource-intensive industry that features its own value chain,” the researchers noted.

Mining Governance and Operations

According to the study, a significant 82 percent of large miners perform multiple mining value chain activities, such as pool, operator, hardware manufacturing, cloud services, etc., to maximize profits. Another 27 percent of the large miners engage in three or more value chain activities, while all small miners specialize in a single activity.

Notably, nearly three-quarters of all major mining pools are based in just two countries. At least 58% of mining pools with greater than 1% of the total Bitcoin hash rate are based in China, followed by the US with 16%

Regulations

To date, there is no standard rule on cryptocurrency mining. This is good for miners as they are not concerned with legal and regulatory risk factors in their operations. However, regional differences can be observed with regards to how miners perceive the current regulatory environment.

For example, more than half of miners based in Asia-Pacific do not report any significant impact from regulation but would like to have more regulatory clarity, while the majority of North 

American and European miners seem to be satisfied with existing regulations (or the lack thereof).

A major concern amongst miners is the expected tighter regulation that is forthcoming that will create barriers, as well as increased taxation of mining profits. The mining sector wants the cryptocurrency to be exempted from the VAT and prefer the digital currencies to be treated as a commodity over currencies for tax purposes.

Risk Management and Challenges

Along with increased capitalization for faster hardware, small and individual miners are concerned that mining fees will not be enough to compensate for decreasing block rewards moving forward. Available data showed that the proportion of transaction fees as a percentage of total Bitcoin mining revenues have significantly increased in 2016, and are projected to reach 10% at the end of 2017.

“While this poses significant challenges to cryptocurrency payment companies and users who perform a considerable number of on-chain transactions, the emergence of a fee market might be necessary to maintain Bitcoin’s security model in the long run. As block rewards decrease miners will need to have economic incentives in order to continue providing hashing power to secure the system,” the researchers said.