Luqman Shaukat Tuesday 11 February 2020
The following is a comprehensive report on the phenomena of coin mining in CryptoSpace. For the purpose of this report, to illustrate the functionality of crypto currencies, the block chain and the reasons for ‘coin-mining’, BitCoin (BTC or XBT) has been used as an example.
What is Coin-Mining
Bitcoin mining is the process of adding transaction records to Bitcoin’s public ledger of past transactions or blockchain. This ledger of past transactions is called the block chain as it is a chain of blocks. The block chain serves to confirm transactions to the rest of the network as having taken place. Bitcoin nodes use the block chain to distinguish legitimate Bitcoin transactions from attempts to re-spend coins that have already been spent elsewhere.
Bitcoin mining is intentionally designed to be resource-intensive and difficult so that the number of blocks found each day by miners remains steady. Individual blocks must contain a proof of work to be considered valid. This proof of work is verified by other Bitcoin nodes each time they receive a block.
The primary purpose of mining is to allow Bitcoin nodes to reach a secure, tamper-resistant consensus. Mining is also the mechanism used to introduce Bitcoins into the system: Miners are paid any transaction fees as well as a “subsidy” of newly created coins.
This both serves the purpose of disseminating new coins in a decentralized manner as well as motivating people to provide security for the system.
Bitcoin mining is so called because it resembles the mining of other commodities: it requires exertion and it slowly makes new currency available at a rate that resembles the rate at which commodities like gold are mined from the ground.
The Difficulty-Metric and the role of Equilibrium in Coin Mining
Another reason Economic-purists or enthusiasts such as myself enjoy the mechanisms by which BitCoin is steadily released into the market is due to the role of Equilibrium in ascertaining volume. FIAT Currencies and Central Banks have been simply unable to tackle the problems of inflation, productivity, capital flows and macroeconomic autonomy for the last century (though that is a report for another time). Here CryptoCurrencies offer a collective, efficient and productive alternative.
The Bitcoin mining network difficulty is the measure of how difficult it is to find a new block compared to the easiest it can ever be. It is recalculated every 2016 blocks to a value such that the previous 2016 blocks would have been generated in exactly two weeks had everyone been mining at this difficulty. This will yield, on average, one block every ten minutes.
As more miners join, the rate of block creation will go up. As the rate of block generation goes up, the difficulty rises to compensate which will push the rate of block creation back down. Any blocks released by malicious miners that do not meet the required difficulty target will simply be rejected by everyone on the network and thus will be worthless.
When a block is discovered, the discoverer may award themselves a certain number of bitcoins, which is agreed-upon by everyone in the network. Currently this bounty is 12.5 bitcoins; this value will halve every 210,000 blocks.
Additionally, the miner is awarded the fees paid by users sending transactions. The fee is an incentive for the miner to include the transaction in their block. In the future, as the number of new bitcoins miners are allowed to create in each block dwindles, the fees will make up a much more important percentage of mining income. That is the optimal outcome.
A short note on the Economics of Coin-Mining and the Finite Supply
At the time of writing, the reward is 12.5 bitcoins, which at time of writing is worth almost $82,687 USD. Although it’s not nearly as cushy a deal as it sounds. There are a lot of mining nodes competing for that reward, and it is a question of luck and computing power (the more guessing calculations you can perform, the luckier you are). Furthermore, the costs of being a mining node are considerable, not only because of the powerful hardware needed (if you have a faster processor than your competitors, you have a better chance of finding the correct number before they do), but also because of the large amounts of electricity that running these processors consumes.
And, the number of bitcoins awarded as a reward for solving the puzzle will decrease. It’s 12.5 now, but it halves every four years or so (the next one is expected in 2020-21). The value of bitcoin relative to cost of electricity and hardware could go up over the next few years to partially compensate this reduction, but that is not certain.
Bitcoin is like gold in many ways. Like gold, Bitcoin cannot simply be created arbitrarily. Gold must be mined out of the ground, and Bitcoin must be mined via digital means. Linked with this process is the stipulation set forth by the founders of Bitcoin that, like gold, it have a limited and finite supply. In fact, there are only 21 million Bitcoins that can be mined in total. Once miners have unlocked this many Bitcoins, the planet’s supply will essentially be tapped out, unless Bitcoin’s protocol is changed to allow for a larger supply. Supporters of Bitcoin say that, like gold, the fixed supply of the currency means that banks are kept in check and not allowed to arbitrarily issue fiduciary media.
If there are any other questions that you would like me to answer please do let me know. Not all CryptoCurrencies function in the same way as bitcoin, but the entire market (currently valued at around $500 Billion, touted to reach the $1 Trillion by the end of the year) represents a significant disrupting force on the current economic system. A cursory analysis of the CryptoCurrency market suggests that the technology, and the market itself, is in an early phase of adoption and development, by no means secure or free from volatility, but a look into the future for sure. If selected appropriately, technically and fundamentally, some CryptoCurrencies (Alt-Coins: Tronix, Leadcoin, SirinLabs Token, Ripple, and Mainstream:BitCoin, Ethereum, LiteCoin) represent high-return investment opportunities with a (relatively, as compared to global Equities, Commodities and Debt Securities) high risk ratio, for now, with much much larger upside potential.
Luqman Shaukat is the Technical Advisor is BitcoinDubai.ae and Private Client Advisor at LuxuryProperty.com