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Bitcoin is a decentralized, digital cryptocurrency:
Decentralized – Bitcoin’s value is protected by the fact that all of the individuals who use it have access to the record of total bitcoin transactions. The record is called a blockchain, and it exists on every computer in a peer-to-peer network. For this reason, bitcoin does not require a central bank like the US Federal Reserve or a transaction company like MasterCard to verify the currency or the transactions made with it.
- Digital – There is no physical currency or rare metal value attached to bitcoins. However, they cannot be duplicated like other digital information can (think “copy and paste”) because of the verification that takes place when transactions are added to the blockchain.
- Cryptocurrency – Bitcoins and bitcoin users are protected with robust cryptography: new bitcoins cannot be arbitrarily added to the network and users’ transactions cannot be seen by third parties.
Anybody can join the peer-to-peer bitcoin network and use their computer’s processing power to validate transactions and add them to the blockchain. When transactions have been verified (the computer checks the bitcoin has not already been spent), computers need to complete another mathematical problem (called a proof-of-work). The first computer to finish these steps for a group of transactions (called a block) and add them to the blockchain is rewarded with a set number of bitcoins. This process is called bitcoin mining.
There are two regulatory features in the blockchain algorithm. These help to retain and gradually increase the value of bitcoin.
- The difficulty of the proof-of-work adjusts to the amount of computing power in the system, keeping the frequency of new blocks being added to the blockchain at around ten minutes.
- The size of the bitcoin reward for each new block is halved every few years.
Bitcoin Mining: Then, Now and in the Future
Bitcoin was first introduced in 2009 by a person or group of people using the pseudonym Satoshi Nakamoto, after their white paper outlining how the cryptocurrency was made public the year before (Nakamoto, 2008). Since then it has grown exponentially, and now approximately 600,000 transactions are made with bitcoin every day.
Competition in bitcoin mining has resulted in the development of highly specialized mining computers and practices. To be profitable, any kind of mining has to produce more value (in rare metals or bitcoins) than the value of the resources it consumes. Like physical mining operations, bitcoin mining requires investment in infrastructure and equipment as well as ongoing consumption of energy resources.
The first bitcoin miners used regular desktop computers to verify transactions and complete the proof-of-work. They found that using the graphics processing units (GPUs) in their gaming computers was faster than using the central processing unit (CPU).
Computers designed specifically for bitcoin mining were introduced in 2013. These application-specific integrated circuits (ASICs) transformed bitcoin mining into a serious industry, and now all profitable bitcoin mining is done with them.
As bitcoin rewards are inconsistently earned, bitcoin miners often “pool” their computers. All users in a mining pool share each reward earned by other users in the pool.
These developments, caused by increasing competition for bitcoin miners as more and faster miners join the network, have resulted in increasing levels of investment in mining operations. Now, bitcoin data centers are installed around the world, usually in places where electricity is cheap.
Scarcity and diminishing returns
Despite these developments – all intended to maximize profit by increasing computing power with less energy – bitcoin mining faces a similar profit-risk to mineral mining: scarcity and diminishing returns.
Bitcoin rewards for mining halve regularly, and mining blocks will stop earning any bitcoins when there are around 21 million bitcoins in total. In effect, bitcoins are a limited resource that is extracted from math, rather than from the earth. As more bitcoins are mined, fewer become available. Eventually, even the fastest, most efficient mining rigs will be unprofitable.
Investors in bitcoin mining either sell bitcoins they earn or keep them, hoping that even after this limit has been reached people will continue to sell and use the currency and its value will steadily rise.
Profit is still to be made in bitcoin mining, and edge technology in computing and energy consumption will help investors to maximize these profits. However, with this increasing scarcity returns will diminish over time.
This risk of scarcity and diminishing returns is not new to mining, of course. However, mineral mining does face increasing scarcity and will reach a limit in the near future as natural resources are depleted.
A question of which mining operation is more profitable must be answered with an assessment of the risk of diminishing returns as the resource becomes increasingly scarce.