The economics of Bitcoin mining

There is a new paper (pdf) by Huberman, Leshno, and Moallemi on that topic, I found it very useful.  Here is the abstract, non-newbies can skip ahead to the second paragraph:

Many crypto-currencies, Bitcoin being the most prominent, are reliable electronic payment systems that operate without a central, trusted authority. They are >enabled by blockchain technology, which deploys cryptographic tools and game theoretic incentives to create a two-sided platform. Profit maximizing computer servers called miners provide the infrastructure of the system. Its users can send payments anonymously and securely. Absent a central authority to control the system, the paper seeks to understand the operation of the system: How does the system raise revenue to pay for its infrastructure? How are usage fees determined? How much infrastructure is deployed?

A simplified economic model that captures the system’s properties answers these questions. Transaction fees and infrastructure level are determined in an equilibrium of a congestion queueing game derived from the system’s limited throughput. The system eliminates dead-weight loss from monopoly, but introduces other inefficiencies and requires congestion to raise revenue and fund infrastructure. We explore the future potential of such systems and provide design suggestions.

Recommended to many of those who are otherwise merely baffled.


Yep. Total noob question here, but how does BTC work when that last coin is mined, the 21 millionth? No more mining, so who's doing all the computing work to make the blockchain function?

This may be totally obvious but I don't care if I'm embarrassing myself here, genuinely want to understand.

Two points. 21 million btc won't be reached for another hundred years or more. In this case, computation costs could conceivably fall to 0. Second, and more important, the assumption has always been that once Bitcoin scales to a large enough size, transaction fees will be sufficienct incentive to serve as "miners' revenue". Hope that helps.

Computation increases entropy and requires capital, how could computation costs fall to 0?

A "miner's fee" market develops. Users attach a market based fee to the transaction to better their place in the transaction queue of miners. Miner's collect these fee's in place of the block reward. At scale these will replace the block reward when it goes to zero.

Every time you make a transaction, you can include an arbitrary transaction fee (it's like a tip for the miners). Miners can decide whether or not to include your transaction in the next block based on how much of a fee they will collect. So if nobody wants to maintain the blockchain anymore, fees will rise until enough people are induced to maintain it again.

Thanks for all of these answers

Does the volatility of bitcoin prove or disprove its reliability as currency?

Yes. It may reflect the demand for goods that are illegal or the demand for currency that your government does not want you to have because they do not want you to purchase other currencies. In other words, is cryptocurrency a derived demand from other goods and services.

I'd assume some tax avoidance too.

And capital control avoidance (China)

What is interesting about blockchain technology is that it can form not only the basis of a currency, but also the basis of an electronic contract...that if y happens, x will be paid...that is automatically enforced without the use of the courts.

While many focus on using bitcoin technology and cryptocurrency for illegal activities, I'm interested in how blockchain technology and electronic contracts could be used to stop corruption in developing countries.

For example, goods may be stopped at the border or held in warehouses due to bogus customs claims (identification, mislabeling, etc), or require payment above duties to corrupt officials to facilitate a transaction. A classic hold up problem. Can electronic contracts using blockchain be used ... goods in a warehouse are automatically released unless x happens and that x claim is verified by a third party inspection agency selected by the buyer and seller and approved by the government in advance of the transaction so that there is less room for customs corruption. Similarly, if the identity of the buyer and the seller is undisclosed it makes it difficult for a customs official to ask someone for money...who do you ask for the bribe, and that third party inspection agency is requesting to see why the goods have been tied up. And, they don't have any money to offer the bribe either.

This is why Ethereum > Bitcoin in many regards; Ethereum includes so-called "smart contracts" in the protocol.

As long as the customs officer has a role, say checking for drugs, granted by the state and they have a way of identifying the shipment they can require a bribe. They can tell the third party inspection agency they still have authority and shipment XYZ isn't going anywhere until there is a payment associated with it. They don't have to know the buyer or seller.

What if a default rule kicks the dispute upstairs to a different level or different brand, and out of the hands of the local official. What if the record of default rule kick upstairs dispute resolution incidents gets published.

Think hard about how you would change behavior with default rules, assignment to third party reviewers, non-disclosure or interface with a person who has no money to offer in a bribe.

different brand?? I don't know how that got there. ignore the phrase until I recall what I meant.

I'm assumming approval of the third party inspection/escrow agency by the state is not ceding authority to them to carry out customs inspections and other state functions.

In that case the state, separate from the parties in the contract is exerting authority, and thus the contract can not bind the representative of the state. The contract can state what the buyer or seller will pay on not pay if a custom officers demand a bribe, but can't automatically take it out of the hands of the local official because the contract has no authority in that regard. And if the customs official interfaces with somebody with no money their shipment doesn't go through. They don't just give up and let the shipment through, they punish the shipments without money until the shippers are forced to come up with the money.

I came across two applications of the type that may interest you

The electricity consumption is the elephant in the room:

Bitcoin is really going high in major way, it will be interesting where it all goes since right now the only way looking is up and I don’t think it’s really going to change much. It’s great to make investment on this but it is important to keep eye on all the factors around, as only through these we will be able to gain well. I don’t do much in these since I prefer Forex trading and that’s easier with OctaFX broker since they are having low spreads, fast execution and various such stuff, it makes trading a lot easier!

Almost as good as cash, cannot be stashed out of reach of the elite, credentials extorsion irreversible : I really can't wait to live in the Mad Max universe.

Does the volatility of bitcoin prove or disprove its reliability as currency? what's your thinking mate.

A great paper. As I now interpret blockchain, it creates a market for transactions and thus we can treat this market as an alternative to a "hierarchy," which is currently used to do transactions inside a bank. Since markets usually work better than hierarchies, it is likely that blockchain will work better than the existing system. Does this make sense?

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