[Updated] Dogecoin decline and mining explained

To those following Dogecoin it probably hasn’t gone unnoticed that the price has experienced a constant decline in recent history. Although this may be interpreted as a decline in popularity of the young digital currency, it should be noted that the main cause is an unfortanate side effect of the design of Dogecoin, that is currently being worked on.

Mining rewards

Earlier we discussed how transactions are validated by so-called “miners”, who have to solve computational puzzles to this purpose. The set of the most recent transactions that haven’t yet been recorded previously are referred to as a “block.” Once a block is validated, it is added to the “block chain”, a public ledger of all transactions.

All the miners working on a block are in fact racing to solve the same puzzle. Once a solution has been found this will be rewarded with new coins and transaction fees paid by the users, before the miners continue to work on the next block. The difficulty of the puzzles to be solved is dependent on the total computational power in the network, which adjusts automatically to make sure the puzzles are solved at a steady pace.

Dogecoin rewards its miners with a random number of coins per block. The main issue for Dogecoin seems to be that its block rewards aren’t actually random, but can be predicted. This means that so called “multipools” can temporarily allocate their computational power to Dogecoin in an attempt to collect only the most profitable blocks.

Mining pools and multipools

Because the entire reward of a block is awarded to only a single miner, most miners are organized in “mining pools.” Basically, this allows miners to work together and fairly split the rewards according to “contributed processing power”. This is done to provide a steady flow of income, as a pool with 20% of the computational power in a network is expected to receive 20% of block rewards on average. A single miner would only get rewarded rarely and infrequently.

Next to mining pools that are dedicated to mining a single cryptocurrency, multipools came into existence. Multipools have a similar set up to normal pools, but derive their name from the fact that they switch between Bitcoin and alternative cryptocurrencies (altcoins). They try to mine the most profitable cryptocurrencies, always immediately selling their mined coins on the market, causing the price to drop.

Altcoins versus multipools

This can cause a problem for altcoins in general, as multipools are often big and therefore have a lot of computational power. If a multipool starts mining a small altcoin in terms of computational power in its network, then it can significantly raise this. The difficulty of the puzzles that the network has to solve adjusts to this new level (while the multipool takes advantage of the relatively low difficulty until this happens), but becomes a problem when the multipool switches to another coin. The difficulty doesn’t immediately adjust back, leaving dedicated miners with too difficult puzzles.

Dogecoin

The previous doesn’t affect Dogecoin that much because it is one of the bigger cryptocurrencies. But these multipools are now exploiting the fact that the thought to be random block rewards can be predicted. By dedicating their capacity to mining Dogecoin at the right time, they can make unintended large profits. As multipools sell their newly mined coins right away, it puts unusual selling pressure on the price of Dogecoin.

Temporary

The previous is acknowledged by the Dogecoin developers, who are currently working hard to change the block rewards to fixed amounts.  At the same time they are trying to correct the rate at which the difficulty adapts to a change in computational power of the network. After the fix is implemented, it can be expected that Dogecoin prices will stabilize again. Until then, some downward pressure will remain.

Update 12 March, 2014: Dogecoin v1.6 has been released today to address the issues highlighted in this article.