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YouTube warns it might make your viewing experience worse if you don't turn off your ad-blocker
(www.businessinsider.com)
this post was submitted on 22 Nov 2023
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You're correct that they're not doing live transcoding when a video is played. That's way too expensive in every regard. There are still ways to embed ads dynamically into the video without requiring live transcoding. They likely have 5-10 qualities they encode to, and segment the video into 10s segments, so a 5 minute video would be cut into 30 segments, and then each of those files encoded to multiple qualities upon upload.
That way when playing, if your Internet gets slow, the player can seamlessly downgrade to another quality. These small files concatenated together appear like one long video. Adding some ads served from the same servers as the content could be done dynamically for each request and be difficult to block without impacting the video content delivery, since you can't have uBlock Origin block the domain hosting the content.
Realistically, they probably don't do this approach because you don't know if the ad was loaded because of buffering, but never viewed, so the ad network gets less metrics and therefore the ads are less valuable. Also, I would bet the content upload and distribution team are completely separate from the ad team, so that cross collaboration is more difficult to implement.
I think there's a simpler reason; if you embed ads as part of the video linking to a specific timestamp becomes a nightmare. One person might have no ad, another might have a 30 second ad, and a third might have 5 minutes of ad. Attempting to link to a time after the ad would give three different timestamps, and loading that timestamp could give you the clip you want or could drop you right in the middle of an ad.
To solve that issue you'd need some way for the client to determine the "true" timestamp, but then you're also giving ad blockers a way to determine where the ad is so you're back to square one.