Written By Malik Corbett
Let me be clear from the onset of this edition of Mining Bytes, Bitcoin is a wonderful technology. It is one of the most important innovations of our lifetime. However, to ignore the limitations of this technology is unwise if we truly wish to predict how cryptonetworks will evolve over the next 3-5 years.
It is inevitable that, like any form of rapid technological innovation, most of the cryptocurrencies that are around today will become obsolete. I am not going so far as to say that Bitcoin will not survive, but I believe it is safe to say that even a diehard Bitcoin maximalist would agree that in order for Bitcoin to thrive it must evolve the network to address the scalability challenges. A maximalist would say that it will happen and maybe they will be proven correct. However the one thing we can draw from history is that technology does not stop and wait for a group of people (no matter how great their ideas may be) to figure out how to solve a problem. Innovation is what moves the world forward.
Bitcoin has a Governance Problem
Blockchain governance is important because it determines how cryptonetworks handle many issues. These include technical upgrades of the system such as forks, who gets to run the validator nodes (block producers) and how are monies allocated on development projects. How decisions are made has a direct impact on the growth of the network and ultimately the value of the native token and sub-tokens of the cryptonetwork.
PoW is a Plutocracy Too
In a scathing blog post called Governance, Part 2: Plutocracy Is Still Bad, written by Ethereum founder, Vitalik Buterin, he criticized DPoS consensus protocols and went as far as calling the protocol a plutocracy. However, I would argue that Proof-of-Work consensus protocols like those implemented by Ethereum and Bitcoin are also systems that encourage plutocracy as well.
Specifically, I argue that the Bitcoin protocol is flawed with strong elements of plutocracy because of two factors that I will now describe in detail. First, the cost of becoming a Bitcoin miner is extremely expensive and thus forms a high barrier to entry where most people are prohibited from participating in the mining process. This leaves the opportunity for a few wealthy individuals, or “whales” as they called in the crypto-world, to profit off of PoW mining.
Secondly, the concentration of power in the Bitcoin network is segmented in a few regions around the world, mainly in China where low electrical power cost and government subsidies provide a huge advantage over miners in other locations who don’t have access to cheap power to run the expensive hardware required to participate in the Proof-of-Work protocol.
Miners Impact the Bitcoin Network?
Bitcoin miners play a very important role in the network as a de-facto central bank. Not only do they secure the network transactions, they upgrade the network’s software (forks) and are a big factor in setting and maintaining crypto-monetary policy. Miners in PoW mechanisms such as Bitcoin pose systemic risk to the entire network. When evaluating a cryptonetwork such as Bitcoin, one should consider the strength and impact of the miners and the consensus protocol.
For instance, when prices are free-falling will the miners buy more tokens to stabilize the price or will they sell to pay for operational cost? As we have seen over the past 10 months, miners can get stuck in a negative reflexive feedback loop. The fear is that if the spot price falls significantly below the cost of production, it could rapidly intensify the speed of this feedback cycle and undermine the integrity of the network and leaving it susceptible to a 51% attack from nefarious actors.
How is the Bitcoin Consensus Game Played?
First of all, there is only a limited supply of bitcoins that can be mined. There are only 21 million bitcoins and the 17 millionth bitcoin was mined in April of last year. Being a miner in the Bitcoin network is a game and a costly one if you are trying to compete for the finite amount of Bitcoins remaining. However, because Bitcoin’s protocol operates on a proof-of-work algorithm which requires an expenditure of computing power, both the computing power and the network difficulty to solve cryptographic puzzles increases as miners approach the maximum number of Bitcoin’s meant to exist at 21 million.
Proof-of-Work protocols such as the one that Bitcoin implements, requires miners to use specialized computer hardware called application-specific integrated circuits or ASICs. These powerful computers are used to solve cryptographic puzzles. To that end, there is only one vendor which has a monopoly on the ASIC market; that company is the Chinese firm, Bitmain.
To that end, let’s now calculate how much it would cost to play the Bitcoin game as a miner and mine just one (1) Bitcoin. Assuming we are using a Bitmain Antminer S17- 56 TH / s which is priced at $2,159.00 according to their website, let’s assume that the BTC current price is $5,238, and a network hash rate of 45,763,744,613 GH/s. If each miner has a hash rate of 56 TH/s that implies 0.002203 BTC per day. So a single Antminer will generate an estimated 30 day return of 0.06608 BTC or $346.13.
Bitcoin Costs are Not Uniform Around the World
Besides the cost of Hardware which will cost hundreds of thousands of dollars to build a farm of ASICs, electricity cost is another major cost factor for miners. Hence, location plays a big factor in competing. In a report released last year by Elite Fixtures, a lighting and furniture firm, the cost to mine one Bitcoin is about $26,170 in South Korea compared to $3,274 in India. In another report published by Crescent Electric Supply Company estimating the cost of mining Bitcoin in the United States, it turns out that Louisiana is the cheapest US state to mine Bitcoin, at an average $3,224. The data showed an AntMiner S9 would use 17,773.344 kilowatts of electricity and take 548.56 days to mine just one Bitcoin!
However, in China where most of the hashing power is generated, the cost is an average $3,172. In fact the average electricity cost in China is $0.08 per kWh compared to $0.13 kWh in the US. The location of your mining operation dramatically impacts PnL. As a result, only a few elite institutional miners have the capital and resources to chase cheap electricity around the world to compete for Bitcoin.
So far we have just calculated an estimated on cost for hardware as well as the non fixed cost of electricity. We haven’t even factored in the cost to staff a team of engineers which will maintain all the sophisticated hardware or the cost of the data centers to house these powerful mining rigs. Nevertheless, geographic location impacts the ability of a miner competing. Which brings me to another glaring weakness in the Bitcoin protocol; concentration of power.
Concentration of Power
For all the talk of decentralization as it relates to Bitcoin, the truth is that only a few people in the world really control Bitcoin network’s hashing power, and they are mostly concentrated in China due to the low cost of power.
This centralization of mining power could undermine the very assumptions that Bitcoin’s PoW protocol uses to ensure the security of the platform. The concentration of power makes it more likely that one entity (or cartel) could amass 51% of hashing power.
Therein lies the security problem with PoW networks and especially the current Bitcoin network. In a recent CoinDesk article published in March, titled Bitcoin Miners Are Investing Again, Expecting a Cheap Power Boom Soon, Bitcoin miners in China who already have a competitive advantage because of cheap electricity cost, have made deals with mining farms and hydroelectric plants to give them even more of a cost advantage. According to that same article, miners in China have a typical electricity cost of “around 0.25 yuan, or $0.037, per kilowatt hour (kWh) for hosting equipment for miners”, thus, are getting even more of a cost savings with the deals. Any cost savings for miners is critical for survival in a bear market.
In conclusion, there is no perfect system. However, to pretend that Bitcoin doesn’t have deep structural issues that can undermine the security of the network is to play the fool. I think it is best to describe Bitcoin’s consensus protocol as a concentration of rich elite institutional miners that have built a huge barrier of entry to becoming a profitable miner. In other words, Bitcoin is a Plutocracy.