Premining

What Is Premining?

Premining is the act of mining or the creation of a quantity of blockchain-based tokens or "coins" before a cryptocurrency is launched to the public. Premining is associated with initial coin offerings (ICOs) as a way to reward founders, developers, or early investors into the project. Because premining effectively dilutes the outstanding stock of tokens, large premines are often frowned upon in the crypto community.

Because cryptocurrencies are "mined" using a consensus system such as proof-of-work (PoW), premining essentially begins the mining process by a group of insiders before the blockchain's official launch.

Note that the practice of premining should not be confused with "Premine," an alternate cryptocurrency that trades under the symbol PMC.

How Premining Works

Premining refers to the process of creating a stock of coins for an inside group before a cryptocurrency's Initial Coin Offering (ICO), effectively reserving coins for the developers of the coin.

There are a number of reasons why a cryptocurrency might go through a premining phase.

Premining is similar conceptually to the practice of offering equity stakes to the founders or employees of a startup before that company's initial public offering (IPO) via sweat equity. The premined coins that are set aside will create value for their holders after those coins become tradable.

Disadvantages of Premining

Premining has acquired a negative connotation in the world of cryptocurrency. During the ICO era, from 2017 to 2018, many private developers would mine and allocate a number of coins to themselves before releasing the open-source code of the currency to the public. This practice led to distrust among cryptocurrency investors and fostered a lack of transparency in many digital currencies.

By not disclosing that there was a premine, unscrupulous developers sought to create high demand and inflate the price of their coins before the ICOs. After the ICOs, these developers and other insiders would release the coins back into the market. Of course, once the coins had been released back into the market, the price would plummet and cause financial loss to outsiders.

Corrupt premining is also sometimes done for currency exchanges. The regulators of these exchanges will demand that the developers give them some of the coins as payment before a cryptocurrency is listed on the exchange. As regulators, their concern should be about the technological capability of the cryptocurrency or whether it is a currency created for legitimate purposes. However, in instances of corrupt premining, their interest is in any quick and easy profit that can be made if the price of the cryptocurrency increases after it is listed on the exchange.

Advantages of Premining

Advocates for premining argue that without these rewards in place, there will be less incentive for developers and early miners to build new cryptocurrencies and mining networks.

Cryptocurrency developers also use premined coins as a method of payment for other developers and programming experts to further develop the coins for efficiency, effectiveness, anonymity, etc. In this respect, premining is similar to a startup company that rewards its early workers with stocks instead of cash, hoping that the company will grow to a stage where the stock value will go up.

Another legitimate reason for premining occurs before a new cryptocurrency project plans to launch an ICO. Similar to how a stock’s IPO includes a pre-sale to affluent investors and institutions who get a priority position for investing in the stock, early investors of a cryptocurrency receive a number of premined coins according to their respective contributions to the ICO project.

While these reasons are legitimate, they do have their critics. Members of the crypto community may see large premines as a red flag for possible fraud or a pump and dump scheme by the developers. Premining also creates a reserve of coins that can be sold by founders on the market, depressing their value.

Premining Versus Instamining

Premining is different than instamining, although sometimes they are incorrectly used interchangeably. Instamine (also called "fastmine") occurs when blocks of the cryptocurrency are released to the public but are mined at a faster rate than intended by just a few miners within the first couple of hours or days of launching.

A cryptocurrency that has been released and that has been premined or instamined should be scrutinized carefully by an investor before they make the decision to invest in it in order to ensure that the developers behind the coin are not just trying to make money. They should be committed to creating a sustainable, alternative currency for use in online marketplaces for the long-term.

Example of Premining

Ethereum (ETH) is one of the noteworthy cryptocurrencies that premined a large number of coins before going public through an ICO. Ethereum is the second-largest cryptocurrency by market capitalization, as of 2020. Bitcoin is the first largest as of 2020.