The cryptocurrency industry is increasingly becoming a source of side income for those who like to get their hands dirty in technological innovations. Since the invention of Bitcoin (BTC) and its widespread adoption as an investment instrument, validating transactions and offering certain services on the blockchain has turned into an industry in itself.
Operating a masternode is a very fruitful side hustle if you know your way around the cryptocurrency ecosystem. It allows you to arbitrage your holdings while contributing to the maintenance of the blockchain. Even better than directly mining cryptocurrencies, running a masternode pays much better with much less investment on expensive mining devices. After reading this article, you will know what a masternode is and if it’s something you want to dabble in.
All cryptocurrencies, be it a solid currency like Bitcoin (BTC) or Ethereum (ETH) or a lesser-known altcoin such as Signum (SIGNA) or a meme coin like Shiba Inu (SHIB), rely on blockchain technology to be mined, maintained, and carried forward. For this reason, before delving into what a masternode is, we’ll go over the basics of blockchain and cryptocurrency mining.
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Blockchain technology basically lets us keep track of all the transactions that are ever made using that particular cryptocurrency. You might think that blockchains are where coins live, but this alone would be an inadequate analogy. Rather, you can think of blockchains as the things that constitute the coins. They hold the information of which wallet keeps how much of the cryptocurrency and how those coins ended up in those wallets. Here is how it happens exactly.
Cryptocurrency mining is a metaphor for the computational work that nodes in the network undertake to be able to earn new tokens. It’s the process by which new virtual coins are created and added into circulation. It’s also the way that new transactions are validated. Thus, it’s a critical component of the maintenance and development of cryptocurrency technology.
Cryptocurrencies are mined using sophisticated equipment that is capable of solving extremely complex computational math problems. These problems depend on the coin and its consensus mechanism (PoW, PoS, PoC, etc.). Generally, the first device that finds the solution to the problem gets the block prize, which is a set of native cryptocurrencies of that blockchain.
The block prize that miners (or nodes) receive is an incentive to have miners keep assisting the blockchain through validating transactions by legitimizing and monitoring them. There are many miners on a given network spread around all over the globe, and all of them continuously check the validity of the transactions. This way, cryptocurrencies stay decentralized and transparent.
So, overall, nodes are entities that ensure the blockchain functions securely and correctly by solving complex math problems to validate and encrypt new transactions on the blockchain. But regular nodes are not the only type of nodes on the blockchain.
Types of Nodes
Nodes are computers and servers that support and maintain blockchain networks and they are the pillars of a decentralized network and the secure and transparent payment system that cryptocurrencies provide today.
There are several different types of nodes that you need to understand in order to understand how the blockchains of different currencies operate. These are light (regular) nodes, full nodes, and masternodes.
Each of these nodes has different responsibilities on the blockchain they support. Before we get into what masternodes are, let’s have a look at what the other types of nodes do for the blockchains.
A node (a regular node or a light node) is the most basic type of computing device on a blockchain. In rough terms, a decentralized blockchain network is composed of all the nodes that support it. In Proof of Work (PoW) based blockchains, those nodes are the miners. The PoW consensus mechanism allows the nodes to continuously check and come to an agreement regarding the validity of the transactions and the state of the whole blockchain.
When a new set of transactions are encrypted into a new block, it’s broadcasted to the entire network. To move forward, the block needs to be approved by all the other nodes on the network. When all the nodes validate and add that block into their copy of the blockchain, the network consensus is achieved, and the process is repeated again for the new transactions.
Usually, blockchains that operate using PoW are quite big. For instance, as of late 2021, the size of Bitcoin’s blockchain has hit around 360 gigabytes and is subject to exponential growth even today. Moreover, mining, what the nodes do by validating each block, is an extremely cumbersome task in terms of the computational workload.
For these reasons, light nodes want to keep their computational workload at a minimum, so they only download just enough blockchain data to process and verify new transactions. This way, light nodes can operate quickly without becoming overwhelmed by too much data.
Full nodes do everything light nodes do, plus a bit more. They contain the entire copy of the blockchain ledger, not only the minimum amount needed to verify the last transactions. Thanks to the full nodes, we can be sure that the blockchain hasn’t been tampered with. Plus, they constitute a reset point in case of an immense failure across the network.
Compared to light nodes, full nodes have more responsibility and authority on the network. But there is another type of node that is a bit more complex than the full nodes – the masternodes.
A Brief History of Masternodes
The origin of the masternode concept can be found in Dash coin. Dash, formerly Darkoin, was developed in 2012 by Evan Duffield, only one year after Bitcoin’s innovation, but it took another 2 years for the coin to be released to the market. Darkoin shared Bitcoin’s mission of offering a totally decentralized digital alternative to fiat money by providing major attributes: liquidity, quick transactions, and anonymity.
Dash offers two optional modules for instantaneous and anonymous transactions: PrivateSend and InstantSend. To allow these features, Dash relies on a network of dedicated servers which are called masternodes.
Understanding Master Nodes
A decentralized blockchain can consist of several types of nodes. Altogether, these nodes run the blockchain transparently and securely while maintaining the rules and functionalities of the blockchain. As we talked about in the previous sections, nodes are responsible for maintaining the massive public ledger by validating each transaction through validating blocks. But a masternode’s function is a bit different than a regular node’s.
A masternode is like a server with a privileged status on the blockchain. Unlike regular nodes, masternodes don’t compete to add blocks to the blockchain. Instead, they provide exclusive services such as validating instant transactions and taking a role in the governance of the blockchain by having voting rights on the decisions concerning the future of the blockchain. In return for these services, masternodes gain a reward, like a block reward in mining cryptocurrencies, but different. The reward mechanism in masternode services is through transaction fees, which puts the masternodes on a commission-like incentive structure.
To become a masternode, a node needs to lock up a certain amount of tokens. It’s just like staking your coins to gain the privilege of validating instant transactions and collecting the rewards later on. Each masternode has a different return on investment (ROI) that depends on the protocol the coin uses.
What Does a Masternode Do?
As we briefly talked about before, the first cryptocurrency to adopt masternode technology is the Dash network. In Dash’s blockchain, masternodes are used to send private transactions or instant transactions. Furthermore, they also have a governance role. Each masternode gets to vote on the executive schemes of the Dash network to carry it forward. Because they provide these functionalities, master nodes are key parts of Dash’s Proof of Service (PoSe) ecosystem.
Typically, masternodes function on a collateral-based system that resembles the Proof of Stake (PoS) protocol. The masternode candidate must own a significant amount of the native coin of the blockchain that it operates on. When the node is approved to be a masternode, it receives annual earnings in return for the service it provides for the network. Keeping the masternodes financially incentivized fosters network stability and is essential for creating a credible cryptocurrency.
Almost every consensus protocol has a mechanism for rewarding the nodes that maintain the network. Because Dash was the first coin to implement a masternode tier to its blockchain, it’s generally assumed that masternodes can only be applied to PoSe-based cryptocurrencies. But this is a misconception. They can be applied to all cryptocurrencies, regardless of whether they’re based on PoW, PoS, or any other consensus procedure.
A masternode functions like a server. It contains a full copy of the blockchain ledger and it also takes on additional responsibilities depending on the type of blockchain it operates on. Once a masternode is employed, it takes up a unique series of functions such as validating instant or private payments like in the case of Dash Coin, or powering decentralized exchanges like in the case of Block Net and Exscudo. Another example is Syscoin, which applies masternode functionalities to its decentralized marketplace where users can access the blockchain equivalent of peer-to-peer commerce websites such as eBay.
So what a masternode does depends on the blockchain it’s employed on. Overall, you can think of masternodes as nodes with exclusive permissions on the blockchain that are customizable according to the network.
Main Differences Between Mining and Masternodes
Masternodes can do what regular and full nodes do and more. But they operate on a different algorithm.
The main difference between the masternodes and the other types of nodes is that what masternodes do isn’t mining. However, it’s true that by operating a masternode you can generate a substantial passive income, just like mining.
To run a masternode, you don’t need to invest in an ASIC miner or a competitive GPU like you do when mining cryptocurrencies. However, what you do need to run a problem-free master node is a VPS setup. While hosting a masternode on your desktop computer is possible, there are risks associated with that. To mitigate those risks, VPS is a great solution.
VPS is a cloud server that is a fully functional installation of an operating system within a virtual machine. The virtual machine allows the VPS provider to run more than one system (usually Linux) on one server. It’s ideal for hosting a masternode because VPS offers guaranteed uptime, redundancy in case of hardware failure, and a static IP address.
To become a masternode operator, you need a dedicated static IP, an account on the official wallet of the blockchain, and some substantial IT skills. But because a masternode operator’s task is not solving complex mathematical problems, it requires much less electricity to run compared to light nodes.
However masternode operators are usually content with the job since they receive a reward daily, or even a couple of times a day depending on the network. When masternodes are employed, they typically receive a large portion of the block prizes as they take up the responsibility of sustaining the blockchain.
Difficulties of Running a Masternode
Maternodes are much more resource-intensive to operate compared to normal nodes and full nodes. Plus, operating and maintaining a maternode requires much more technical knowledge and time.
A masternode operator is entitled to perform the functions that are assigned to them, depending on the network they are on. Unlike light node operators, their tasks are not the same for every network. They can be validating InstantSend or PrivateSend on Dash network, something else on another blockchain.
Plus, they need to provide a dedicated server, dedicated IP address, and 24/7 connectivity. Masternodes upload and download massive amounts of data everyday. For these reasons, running a masternode can be quite costly at times.
Profitability of Master Nodes
The prize you earn from operating a masternode depends on various factors that are not so straightforward to calculate because each project functions in a different manner and each masternode is unique.
To be eligible to operate your own masternode, first, you need to own a significant amount of collateral in the blockchain’s native coin. For example, to run a Dash masternode, you need to be holding 1,000 DASH, which can hit up to hundreds of thousands of dollars in fiat currency. However, if you are into hodling anyway, this wouldn’t constitute a huge problem for you.
Because you don’t need to get expensive mining gear, masternodes are often seen as a relatively simple alternative to mining. But making a substantial profit out of running a masternode can be challenging.
The biggest challenge is the relatively high initial investment. Even though you don’t need to get expensive gear to run a masternode, initially, you need to lock up a significant amount of cryptocurrency, just like staking your coins on a PoS network. You get the reward for your staked coins eventually, but you do need to invest in it with capital.
Apart from the initial investment, masternodes require a dedicated static IP, which could be costly to maintain.
If you are interested in becoming a masternode, you can visit masternodes.online, which offers real time information on blockchains that you can provide this service for.
A Few Words Before You Go…
In a nutshell, masternodes are full nodes with additional responsibilities and additional requirements to enter. They perform several other functions apart from just validating transactions and adding new blocks to the blockchain. They don’t mine cryptocurrencies. Instead, they carry out the tasks that are assigned to them by the blockchain, such as validating instant or private transactions, participating in the governance of the blockchain, or validating other smart contracts to keep the system in the blockchain functioning. This way, they help the decentralization of a network by providing blockchain-specific services.
Because of the tasks they perform and the responsibility they take on, masternode owners are usually rewarded generously. For this reason, they draw the attention of cryptocurrency investors who are looking for new ways to generate more income from the industry. However, becoming a masternode operator requires not only a significant initial investment but also some technical capital and serious IT knowledge. If you think you can handle these, operating a masternode can be a great occupation for a cryptocurrency enthusiast.