The Real Costs of Virtual Money

by on December 3, 2013 at 7:12 am in Economics, Web/Tech | Permalink

Bitcoin - virtual moneyBitcoin miners, just like gold miners, use real resources to produce bitcoins. How much? In April when bitcoins traded for around $100 the electricity consumption of bitcoin miners was an astounding 1000 MGW hours a day, enough to power about 31,000 US homes or some $150,000 in daily expenditure.

As the price of bitcoin rises, so do the mining costs. Thus, today with bitcoin trading around $1000 the costs are much higher. According to BlockChain’s Bitcoin Statistics, miners are currently using 98,000 MGW hours or $14 million dollars of electricity a day to mine bitcoins. (One wonders, whose electricity?) And that is just the electricity costs, miners are also spending on hardware which has evolved from CPUs, to graphics processors to field-programmable gate arrays (FPGAs) and now to application-specific integrated circuits (ASICs).

Unlike the resource costs of a gold standard, which Milton Friedman once (over?) estimated at some 2.5% of GDP ever year forever, bitcoin mining may slow once the bitcoin limit of 21 million bitcoins is reached.  Even that is tricky, however, because bitcoin mining currently subsidizes transaction costs so these will rise as bitcoin mining declines. Transaction costs are a necessary cost for a useful purpose so not all the mining is a net cost. Printing money is cheaper than gold or bitcoin mining but don’t forget that moving around fiat currency, by Brink’s truck or electronically, also has resource costs.

Hat tip for discussion to Eli Dourado.

Addendum: It’s an interesting bit of economics to ask why the cost of electricity doesn’t impact these numbers (even though it is used to calculate these numbers!).

barry December 3, 2013 at 7:44 am

I don’t think the USD price of bitcoin and the cost of mining are related. Bitcoin does become cryptographically and computationally harder to mine as time goes on – and this means it gradually takes more computational resources, and more electricity (although this is counteracted by moore’s law).

But the market price of a bitcoin is entirely unrelated to this mechanism.

Rahul December 3, 2013 at 8:09 am

Over last 24 hours Blockchain.info shows 4600 BTC mined at an estimated electricity cost of ~15 million dollars.

That’d evaluate to $3000 per Bitcoin. If the going rate is $1000 per bitcoin why does mining make any sense? What gives?

Or is “whose electricity?” really the key question here, I wonder…..

Dan Weber December 3, 2013 at 8:53 am

It’s probably the total power of all miners, and so it could include a lot of people spending 50 cents of electricity to get 20 cents of bitcoins and not caring, while people with dedicated GPUs are more efficient.

That or the number is just made up.

JWatts December 3, 2013 at 11:52 am

That’d evaluate to $3000 per Bitcoin. If the going rate is $1000 per bitcoin why does mining make any sense? What gives?

Because for the overwhelming amount of people it’s a hobby. It’s cool to say you’re a bitcoin miner.

Doug December 3, 2013 at 7:18 pm

Given how difficult it is for US citizens to buy Bitcoins, due to Federal anti-terrorism and money-laundering laws, it can be easier to mine a coin or two than actually buy one. A lot of people in apartments, particularly students, don’t pay for their electricity utility costs, but have it bundled in a flat monthly rent. As long as they stay below a certain threshold they pay the same no matter what. So mining a small amount of Bitcoins doesn’t cost them anything in electricity costs.

Bski December 3, 2013 at 5:00 pm

Time to mine in a State that subsidizes electricity.

libert December 3, 2013 at 11:39 pm

So it’s time to mine in a State.

Rahul December 4, 2013 at 2:45 am

Electricity costs per kWh are so variable, even within the US and by time of day, consumption etc. I wonder how that website arrives at a number any ways. I think that’s where the biggest inaccuracy lies.

sri December 4, 2013 at 1:04 pm

There is something called velocity of money that determines value not exact cost of mining

David Schwartz December 5, 2013 at 4:07 pm

Sadly, I believe the real reason is that a lot of Bitcoin mining is done by botnets and PUPs, so the person getting the Bitcoins is not the person paying for the electricity.

Gavin Andresen December 3, 2013 at 7:54 am

Last I checked, the blockchain.info estimate did not take into account the huge efficiency gains of the current generation of ASIC hardware. We are in the middle of a mining efficiency arms race.

And efficiency will continue to improve as technology improves; miners have the right long-term incentives (process as many transactions as efficiently as possible, put excess heat generated to some good use, etc.).

Rahul December 3, 2013 at 8:02 am

The rise of Bitcoin mining costs is an integral core feature of the idea & not a bug, right? I mean, I’m still confused as to what exactly this post is trying to say.

Dan Weber December 3, 2013 at 8:54 am

It’s an economist trying to attack Bitcoin on technical grounds, a battle for which economists are incredibly poorly equipped.

The economists should instead attack Bitcoin on monetary grounds, which is as easy as shooting fish in a barrel.

Peldrigal December 3, 2013 at 11:52 am

*applause*

Raphfrk December 3, 2013 at 8:04 am

The difficulty adjusts so that there is 1 block every 10 minutes. If the price rises, then the value of the 25 bitcoin reward increases. This causes more miners to start mining, which causes the block rate to increase, which then causes the difficulty to rise.

The equilibrium is that the block reward + transaction fees would match mining costs. In the long run, miners might shift to countries with low electricity costs.

Douglas Knight December 3, 2013 at 1:40 pm

Instead what we see is that bitcoin mining goes to countries with capital controls, so that local currency buys electricity buys bitcoins = foreign currency.

colby December 3, 2013 at 8:11 am

BitCoins are ethereal computer-entry digits that can be created instantly in unlimited amounts at no cost.

Thus, the analogy to gold, gold-mining and infrastructure/transaction resource costs is bogus.

Ben Bernake and the Federal Reserve are much better at creating such instant magic-money, by the Trillions.

Explodicle December 3, 2013 at 8:19 am

25 Bitcoins are created every 10 minutes at a massive cost, not infinite instantly for free. It’s similar to fiat currency in that it has very little intrinsic value, but the supply is fixed and there is no seigniorage.

nl7 December 3, 2013 at 8:43 am

The supply is beyond the control of any one institution and grows at a more predictable rate than gold. Theoretically gold could experience big supply changes with disasters, discoveries, or new inventions (which either emphasize or de-emphasize gold’s industrial and electronic applications). But since Bitcoin is fiat, it grows at the predetermined rate. And today nobody can actually control that rate alone. It’s more like the idealized version of gold standard than gold is, except for the fact that it has no intrinsic value.

Adrian Ratnapala December 3, 2013 at 8:48 am

And if I understand this correctly, gold’s “intrinsic” value is less than its financial value. Although I actually have no idea what that last sentence I wrote means — can anyone either explain it, or else explain what is wrong with it.

Anthony December 3, 2013 at 9:25 am

The “intrinsic” value of gold is the estimated price it would command if it had all its physical properties but was not historically seen as a store of value or a medium of exchange. Gold goes some things better than competing metals, and would thus still be worth something to its various industrial users. I’ve seen estimates that this value is on the order of $300 – $500/oz, but I have no good idea where that came from. It soul of definitely be more expensive than silver, as it is a better conductor of heat and electricity, and far more tarnish-resistant.

Mark Thorson December 3, 2013 at 12:05 pm

No, it’s not. Silver conducts electricity better than gold. Gold is used to plate contacts in connectors because it is a noble metal, not because of its conductivity.

Todd Fletcher December 3, 2013 at 9:17 am

“BitCoins are ethereal computer-entry digits that can be created instantly in unlimited amounts at no cost.”

Please, tell us how you’ve hacked the blockchain to achieve that result? Because a lot of people would be interested to know this, among them the developers of Bitcoin.

colby December 3, 2013 at 11:04 am

The current arbitrary rules of BitCoin are not the only possible and eternal rules.

Who made the current rules ? Who could change the current rules (openly or secretly) ?
Who has the power to exploit BTC rules and rule-making for individual gain at the expense of others ?

What ‘can’ be done with ethereal BTC is not limited by its ‘current’ (apparent) rules and structure. That’s why one must examine its fundamental nature. Bernie Madoff’s investment vehicle started off as a very attractive, innovative venture with big profits for early clients/investors, but with Bernie ultimately controlling the rules of the game. That’s how Ponzi schemes work.; what is seen versus what is unseen.

XVO December 3, 2013 at 11:35 am

But nobody controls the rules of the game with BTC. They are in the code where everyone can see them. They can’t be changed unless 50% of the miners decide to switch to new rules.

Raphfrk December 3, 2013 at 11:54 am

They can’t be changed with agreement of just the miners. Miners can make the rules more restrictive if 50% of them agree/collude. These are called soft-forks. Certain blocks that would have been valid are subsequently rejected beginning at the fork point.

They can’t relax the rules. Miners could agree (by majority of the hashing power) to reduce the payout per block to 12.5 bitcoins instead of 25, if they wanted. They aren’t likely to do that, because then they would get less reward per block. It would be a soft fork. Once they agree on that rule, blocks that paid out 25 bitcoins would be rejected by more than half the miners and so would never end up in the blockchain.

However, they can’t make invalid blocks into valid blocks. They could create a blockchain that has those invalid blocks, but the other users’ software would just reject that chain, starting at the first block with an invalid block. If a miner created a block which paid 200 bitcoins reward, then it would be rejected by users (merchants and their customers) and other miners. Even 51% of the miners wouldn’t be able to force merchants and their customers to agree to the change.

To change the rules needs everyone to update at the same time. This has happened due to bugs in the software and if there is strong agreement to the change. The are called hard-forks, and are difficult to manage, since you have to convince everyone to update.

Mark Thorson December 3, 2013 at 7:01 pm

If the NSA created Bitcoin in the first place, they will be sitting on a sufficient hoard of Bitcoins. They also have sufficient compute power to be the majority of miners. So, they could change the rules, at the risk of tipping their hand. Far more sensible is to let things ride and see where it goes. If Congress were pressured to cut their funding, they might be self-sufficient without that funding. At that point, national security will finally have been achieved.

Peldrigal December 3, 2013 at 11:55 am

I thought economists had some understanding of mathematics. Was I wrong?

David Schwartz December 5, 2013 at 4:08 pm

If that’s true, create a thousand of them at no cost and you’re an instant millionaire. Oops, you can’t do that.

T. Shaw December 3, 2013 at 8:22 am

Are “they” creating more Bitcoins each day? If so, how did the US$ price rise from $100 to $1,000?

Here is all I have to say about Bitcoin, “I wish I got in at $100!” Wiping away a tear . . .

mofo. December 3, 2013 at 8:52 am

Speculation mostly. That, and people using BTC to funnel money out of restricted economies.

Dan Weber December 3, 2013 at 8:55 am

Bitcoins are being created constantly, but at an ever decreasing rate, asymptotically approaching 21 million coins.

Explodicle December 3, 2013 at 8:25 am

“Whose electricity?”

FUD. You’re aware that Bitcoin has moved on to ASICs, so nearly all botnet mining is done for Litecoin, not Bitcoin. Any botnet operator wasting cycles on BTC is paying a high opportunity cost vs Litecoin.

Jørgen December 3, 2013 at 8:40 am

Surely not all this electricity is wasted? I live in hydropower-abundant Norway and heat my house by (relatively cheap) electricity. Any electricity costs of bitcoin mining in my living room should be perfectly offset by the thermostat-controlled heater consuming less, right? (There’s still the wear and tear on the processor and fan, the noise cost etc)

When will we see bitcoin-producing electric heaters being marketed?

Adrian Ratnapala December 3, 2013 at 8:47 am

Also where. It makes sense in Norway because electricity for some reason is as cheap as natural gas (actually I don’t believe that, but apparently it works for you). It works in Australia where no-one has central heating. But in most countries where much heating needs to be done, there are more efficient means.

nl7 December 3, 2013 at 9:00 am

I think this was tongue in cheek, but isn’t this a thermodynamic matter? There’s a limited amount of energy, and if a big portion is going to heat then that detracts from the portion going to computing, right?

I’m sure the heat generated by computers is less energy efficient than the heat generated by heating systems (since computers see heat as a waste product, I’m pretty confident here). Your computer is putting energy into making computations and happens to generate heat waste; your heating system is putting energy into generating heat, so it’s focused on that task and almost certainly more efficient about it. Your computer hardware is designed to dissipate heat, not to concentrate and distribute it. So an equivalent amount of energy put into your computer would generate less heat than in your heating system. It would also be distributed less effectively, unless you have some special setup.

This also just makes intuitive sense to me, but someone correct me if I’m missing something obvious. Leaving aside the economics of it and looking at physics, if a heating system could take X energy and make Y% of that energy into usable home heating, whereas a server farm or whatever could take X energy and also make Y% of it into heat, plus generate some level of computations (or other computing tasks) Z, then you’ve seen a huge step up in efficiency of energy usage (knowing that Y% plus Z could never exceed X). A lot of energy is lost to friction. Unless the heater is quite inefficient relative to the computer, or the computer has substantial specialized inputs (all of which would cost energy at the front-end in manufacturing) that alter the scenario somehow, then you wouldn’t expect to get the SAME amount of home heat per joule from both, but also get a bunch of cryptographical computations.

Apologies for the rough explanations and inexact terminology, since I’m neither engineer nor physicist. Someone please correct me if I’m way off base here.

Dan Weber December 3, 2013 at 9:30 am

> I’m sure the heat generated by computers is less energy efficient than the heat generated by heating systems

If it’s resistive heat, nope. (Well, except for what’s lost to electromigration, but you probably don’t care about that.) Essentially all the energy going into a computer has to change into heat.

If it’s a heat pump system, then this doesn’t apply.

Anthony December 3, 2013 at 9:34 am

As an electric heater, a computer, like anything else, is 100% efficient. I can heat a room using a 1500 watt space heater, or 15 100 watt light bulbs. If there is a fan circulating the air thoroughly, the result will be the same, except that the room with the heater will be much darker. We generally use space heaters because they’re set closer to the floor, and are less likely to break. But if you otherwise wanted that many light bulbs in the room, you could dispense with the heater.

Poinstion December 3, 2013 at 10:32 am

@Anthony:

A point/question from someone who admittedly last encountered these subjects in high school:
Doesn’t the wavelength make a difference in how the heat is processed? Radio waves would bleed out of a room; on the other hand, a photon being accepted in your eye turns into heat eventually, right?

Anthony December 3, 2013 at 10:51 am

Not so much the wavelength as the transparency of the room. A room with many windows will be somewhat less effectively heated by light bulbs than one with no windows, because that part of the energy will escape. Though lots won’t, because incandescent bulbs are not very efficient at producing light from electricity. You would lose more to the outside if you used 1500 watts of fluorescent bulbs, and have a much brighter room.

JWatts December 3, 2013 at 12:15 pm

As an electric heater, a computer, like anything else, is 100% efficient.

To be precise, this would be true for an electric resistance heater. However, those are fairly inefficient and aren’t used for most central heating requirements, at least in the US, where electric heat pumps are common.

Furthermore, in the case of generating heat from a computer, unless you are circulating the heat well with a fan, then you would end up with a very localized hot spot and a cooler room.

AB December 3, 2013 at 1:29 pm

There’s a minimum amount of heat that must be generated by computing (though this is not without controversy):
http://en.wikipedia.org/wiki/Landauer%27s_principle

Rahul December 3, 2013 at 1:37 pm

We are very far from this limit though, in practice, right?

Dan Weber December 3, 2013 at 8:56 am

> $14 million dollars of electricity

I love dollars dollars.

Dan Weber December 3, 2013 at 9:06 am

While I’m complaining, mousing over the “share this” icon should not do a full-screen pop-up.

Z December 3, 2013 at 9:39 am

I smart man once said that mass movements become a business and then become a racket. Bitcoin has always had the trappings of a mass movement. You see it in the comments here. Supporters with little knowledge of how Bitcoin works vigorously denying the obvious facts of Bitcoin. It is why I am a skeptic of the enterprise. Anytime I see believers whipping themselves into a frenzy over anything, I know we’re in for a bad ending.

JWatts December 3, 2013 at 12:16 pm

Probably, but it sure would be profitable to know exactly when the bad ending would occur.

Z December 3, 2013 at 12:28 pm
JWatts December 3, 2013 at 1:02 pm

A shady online marketplace that anonymously sold drugs and guns has virtually disappeared, leaving illegal vendors believing they’ve been scammed out of as much as $100 million.

Well that’s a shocker. And yes, this may well be a sign that the bitcoin bubble is about to burst. Bitcoin supporters have taken on the air of evangelists in the last few month, but then again so have Tesla supporters.

Z December 3, 2013 at 1:10 pm

At least Tesla supporters will go out in a blaze of glory ;-)

Next up is the thorium-powered car craze.

JWatts December 3, 2013 at 4:59 pm

Pfft. I upstage your “thorium-powered car craze” with my “E-Cat cold fusion powered flying zeppelin high speed rail car”

Mark Thorson December 3, 2013 at 8:20 pm

Whoa, there! What about my genetically-modified, brain-implanted seagull for delivering Amazon small items? FAA doesn’t have jurisdiction over birds.

dead serious December 3, 2013 at 2:53 pm

That’s pretty awesome. The name of the site wasn’t a glaring signal?

Maybe it will buy the internet public at large a few days’ respite from the “Buy guns, gold, bitcoins, canned goods!!!!!” group.

Effem December 3, 2013 at 10:13 am

This is not the cost of “bitcoin” per se, but the cost of creating too much USD vs physical resources…eventually the demand will flow into physical resources.

Mark December 3, 2013 at 10:49 am

Two points, $14 million in electricity costs is assuming a pretty high price for electricity (~ $0.14 / kWh). If bitcoin mining consists mostly of people on their home computers, it might be realistic. But if bitcoin mining is more like setting up a data warehouse, the price they’d pay for electricity would be much lower because industrial rates are almost always much lower than residential rates.

This bring me to the second point. Electricity isn’t priced very efficiently. Fixed costs are bundled up into the variable charge. So the marginal costs of producing the next kWh is something like $0.03-$0.04, but typically customers are paying upwards of $0.10 (the numbers above work out to about $0.14 / kWh) because they’re also paying for all the wires, substations, transformers, etc. What ends up happening is high-usage customers subsidize low-usage customers because low-usage customers don’t pay enough to cover the wires and such going into their homes. So the actual deadweight loss of mining bitcoins shouldn’t be the electricity cost TC cited above (about $0.14 / kWh), but the marginal cost of producing the electricity (~ $0.03-$0.04) which would make the cost less than $3.5M. Still significant, but much less than the $14 given above.

JWatts December 3, 2013 at 12:20 pm

My utility has a fixed cost, a given charge for the first 1000 kWH, and then a smaller charge for any kWH’s over the first 1000 per month. I don’t recall exactly what the marginal retail cost is, but I believe it’s around $0.09/kWH.

Mark December 4, 2013 at 11:03 am

$0.09/kWh seems like a pretty reasonable number for the marginal retail cost. But the marginal retail cost still (typically) includes many fixed costs that aren’t actually marginal. So if bitcoins increases electricity use, the cost to society isn’t the marginal retail rate, it’s the marginal cost of the electricity. And the marginal cost of electricity is usually less than $0.04. So when doing an economic analysis trying to show the costs to society that mining bitcoins adds, the correct number to use is the marginal cost not the marginal retail cost. This article implies a $0.14 number so they’re probably using an average electricity cost.

Infopractical December 3, 2013 at 1:01 pm

Indeed. My business has a nice electricity contract for cheap energy in Texas. I believe this is the result of a collective, but having just started, learning the details hasn’t yet been a priority. We get $.05 electricity. I could (but don’t) mine bitcoin in the office, at least to some degree, and pass the cost off as part of the business (who would ever really know) allowing additional tax advantages. As the mining spread gets very thin, the only miners who remain will be the ones taking every possible advantage in the process, likely including illegal, but hard to prove, tax advantages.

albatross December 3, 2013 at 1:46 pm

Now, I’m visualizing nuclear power plant operators running Bitcoin mining operations on the side, to consume otherwise-unwanted power during low-demand times.

Mark December 4, 2013 at 11:04 am

There are actually times when the price of wind electricity goes negative. Perfect time to start mining bitcoins!

gwern December 3, 2013 at 11:02 am

> Unlike the resource costs of a gold standard, which Milton Friedman once (over?) estimated at some 2.5% of GDP ever year forever, bitcoin mining may slow once the bitcoin limit of 21 million bitcoins is reached. Even that is tricky, however, because bitcoin mining currently subsidizes transaction costs so these will rise as bitcoin mining declines. Transaction costs are a necessary cost for a useful purpose so not all the mining is a net cost.

One of the interesting questions is what will happen to the hashrate as the block reward continues falling to trivial levels: right now, the block reward means that there’s a fixed pot of gold for each block, and everyone is in an arms race to get it. But the point of proof-of-work is to make it hard to do double-spends and allow distributed consensus about what the true blockchain is! I’m reminded of an economics point I believe I saw here once: “the right number of falling houses in an earthquake is not zero”. The point being that perfect security is not optimal, but wastefully expensive. Right now, there have been… 1? 2? double-spends ever. And those were questionably double-spends at best. So I think the block reward may well be over-incentivizing mining.

MT December 3, 2013 at 11:15 am

hello
“* Electricity consumption is estimated based on power consumption of 650 Watts per gigahash and electricity price of 15 cent per kilowatt hour. In reality some miners will be more or less efficient.”

today’s efficiency is around 1-2W/GH.

Alex S. December 3, 2013 at 11:34 am

Is the expansion of the “monetary base” of the bitcoin possibly grounded on Moore’s Law? Faster computers lead to more mining of coins. I guess that faster computers also means relatively lower electricity bills.

XVO December 3, 2013 at 11:43 am

No it’s a hard limit of 21 million coins. After all the coins have been mined then the miners are paid with transaction fees. But as far as I understand the computing power can only give a relative advantage because the block chains complexity is ramped up or down depending on the total amount computing power used for mining so that it takes roughly the same amount of time to mine a block.

None of the miners are using cpus or gpus anymore. They are using custom built computers that use special ASICs to mine. ASICs are circuits designed specifically to mine bitcoins with maximum efficiency.

Joel December 3, 2013 at 5:52 pm

“After all the coins have been mined then the miners are paid with transaction fees”.
The Bitcoin system is far from simple but bad terminology doesn’t help either, as this sentence illustrates.
The activity that one calls “mining” as nothing to do with creating new bitcoins, and it should better be called “block-building” or something like it. This activity is essential to the day-to-day working of bitcoin and will continue for as long as Bitcoin exists — it will not stop when the 21 millions coins are minted.
At least this is my understanding, I am no expert on Bitcoins. Please tell me if anything in the above is incorrect.

But then this is a little bit worrisome for the long-term future of Bitcoin. Will the difficulty of building-block continue to increase over time (after all bitcoins are minted) or will it stop ? My understanding (but here I am really not sure) is that it has to keep increasing to prevent fraud, but then that means that the transaction costs will increase (assuming that in the long run, the number of transaction stagnates,
for example when the whole economy is in it Bitcoin), and may become problematically high…

Raphfrk December 4, 2013 at 5:30 am

The reward for each block is equal to the minting fee + transaction fees. At the moment the minting fee is 25 bitcoins and tx fees are ~0.1 bitcoins, so the minting part of mining is the most important. Calling the minting of coins “mining” is reasonable.

In addition, “mining” consists of 2 parts. There is block creation (assembling a list of valid transactions which complies with all the rules) and hashing (finding a valid solution to the hash problem). The 2nd one is closest to “mining” and it is what generates the heat/consumes electricity.

There is a hard limit of 1MB to each block. Blocks at the moment are around 200kB, so the limit isn’t a problem. The default software has a “soft” limit at 256kB. By default, it won’t create blocks larger than that, but will accept blocks up to 1MB. Assuming the most basic transactions, that works out as a 7 transaction per second hard limit. They are hoping that when the blocks hit the 256kB soft limit, they will get some info about the dynamics of hitting the 1MB limit. However, the effect might simply be pools changing the soft limit to 300kB.

Once transaction space becomes limited, then tx fees should increase. Paying more would jump your transaction forward in the queue.

When the minting fee is eliminated, then the only reward becomes transaction fees. There are discussions about increasing the block size. On the one hand that would decrease transaction fees, but on the other hand, an increased block size allows more transactions. More transactions would make bitcoin more useful, so could increase the value of each bitcoin.

This is a conflict of interests between “store of value” and “transaction system” camps. A small block size means that the network is more easily distributed, so safer from central control. However, larger block sizes mean that it is a more useful transaction system (allows more than 7 transactions per second). Even with the 1 MB limit the block chain is more than 10 GB in size and growing.

A larger block size means that mining pools that have fast internet connections have an advantage (perhaps the majority of mining pools end up in the same data center). When a new block is found by another pool, a pool has to wait to download the block. A pool which spends 5 minutes out of 10 downloading the block is at a disadvantage to one that only needs 10 seconds. Small blocks mean that lost time due to block download is not significant for most pools, so there should be more pools. Running independent full nodes also becomes harder.

Mining work secures all transactions in the block chain. If you have a 10 bitcoin transaction, but the fees for the block are only 0.5 bitcoins total, then your transaction isn’t really that secure. The cost of faking 6 confirms would be 3 bitcoins worth of hashing, so it would be worth it to double spend the 10 bitcoin transaction.

There was some discussion about implementing assurance contracts to allow payment for hashing. In the example, the 10 bitcoin transaction guy might pay 0.01 bitcoin for miners who provide 100 bitcoins worth of hashing on top of his transaction. This is only really necessary for large transactions, so they should end up paying for high hashing power.

Joel December 4, 2013 at 8:44 am

Thanks for the explanations.

Boonton December 3, 2013 at 12:13 pm

So why not set up a bitcoin like currency where ‘mining’ is accomplished by solving difficult but actually useful computational problems?

albatross December 3, 2013 at 1:47 pm

Finding a way to do this would be a huge win. Maybe solving protein folding problems?

David Schwartz December 5, 2013 at 4:12 pm

If you want to pay people for solving useful computational problems, you can do so. You can even do so in Bitcoins. But that has nothing to do with mining,which is solving an actually useful computational problem — securing Bitcoin transactions.

Infopractical December 3, 2013 at 12:58 pm

Let’s not forget the additional costs of standard fiat money, including salaries and political control. These are not trivial. Bitcoin may eventually find itself in greater need of paid security (banks with trust) and incur some of these costs, but that need will likely never be so high.

mulp December 3, 2013 at 9:37 pm

“bitcoin mining may slow once the bitcoin limit of 21 million bitcoins is reached”

The limit of bitcoin in actual circulation will never be reached, and in fact the total number of bitcoin in circulation will end up shrinking continuously at some point.

It seems an early bitcoin advocate did a bit of house cleaning and only a few days after putting his diskdrive in the trash did he remember the 7500 bitcoin stored on the drive.

Even if he could figure out where the drive ended up in the landfill, he can’t mine the dump for the disk drive, assuming the drive has not been damaged beyond repair. Unless he were to buy the dump using investors betting he can find the drive and recover the data.

Marc Roston December 3, 2013 at 10:16 pm

This seems pretty straightforward why someone mines coins that cost more to mine than their value today. At least two arguments make this rational, I think:
1. Your expected return to holding the bitcoins produced and selling at a later date exceeds to expected return on the cash spent on electricity and hardware to mine;
2. As the marginal cost (in computing cycles) rises, bitcoin N is cheaper to produce than bitcoin N+1. Depending on that rate of increase (convex function, I believe?) then the average electricity cost of a bitcoin may rise fast enough that a miner should be very willing to mine at a marginal cost greater than current average price.

Rahul December 4, 2013 at 2:41 am

Your #1 seems wrong because:

If the expected return to hold & sell exceeds the cash spent on mining why not just buy? How does it matter if the Bitcoin you are holding was mined or bought?

David Schwartz December 5, 2013 at 4:14 pm

In fact, buying is better because it adds to demand immediately, raising the value of your Bitcoins. Mining has almost no effect on either supply or demand. It’s even more dramatic if your choices are to hold Bitcoins you already have or sell them to buy mining hardware.

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