It is similar to the concept of diversification in portfolio management, where holding ten diverse stocks is better than holding one.
If there are a 1000 tickets and you hold one of those tickets - the probability of you winning the lottery is one in a thousand. But if you hold 100 of the tickets - then your chances are 1 in 10 – so you can expect to win the lottery every 10 draws. With your one ticket, you would expect to win every 1000 lottery draws.
However, if you can’t afford 100 tickets you can band together with another 99 individuals to form a syndicate and split the reward every time you win. This means that your cash inflow will be less, but more frequent: the volatility of returns is lower.
Reducing Return Volatility with Mining Pools
The same thing is true for Bitcoin and cryptocurrency mining.
If you have a 1TH machine and the Bitcoin Network total hashpower is 1 PetaHash then you have a 1 in 1000 chance of solving the block every ten minutes. You might not solve it for long periods, but by joining together with other miners in a pool you can form a syndicate and work in concert - and split the returns according to what percentage of the hash power you contribute to the pool. So if you have 10 TH of a 100 TH mining pool and you win the block reward of 12.5 Bitcoins – you would receive 10% or 1.25 BTC.
With mining, it is important to understand the different types of blocks involved, because of the effect it can have on your expected income. This article provides a comprehensive insight into orphan, uncle & genesis blocks.
Mining pools are a good way of smoothing your returns, but there is a cost – usually 1-2% of your winnings. Instead of hooking up your Bitcoin miner that you have bought – you can outsource it further by buying a mining contract that gives you rights to a certain amount of hash power for a certain period of time. This is called cloud mining.
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