Bitcoin approaching diminishing returns

There’s been a lot of bad news about Bitcoin in the media recently — the problems at the Mt. Gox exchange, regulatory action in China and Russia, the Silk Road arrests and, more recently, a $2.7 million Silk Road hack.

This is on top of the more endemic problems of Bitcoin, which I’ve written about before.

But now a new Bitcoin issue has come to my attention, which I’ve somehow missed. And this issue basically is the death knell for the currency, even if all the other problems get fixed.

The problem is in Bitcoin’s most fundamental mechanism. The way the system works is that members of the Bitcoin community run computers that do mathematical calculations. In return for these calculations, they get Bitcoins, and the community gets processing power for keeping track of transactions.

Peter Leeds

Peter Leeds

“Right now, the two functions are wrapped up in each other,” said Peter Leeds, a financial expert and publisher of Penny Stocks.

Over time, miners get fewer and fewer Bitcoins in return for the processing they are providing. Meanwhile, the number of transactions is going up — and the price of Bitcoins is falling.

“Early on, basic hardware could be used to mine Bitcoin profitably,” Leeds told Hypergrid Business.

Today, however, miners are using special-purpose ASIC cards and putting server farms in regions with extremely low costs of electricity. According to the Bitcoin mining profitability calculator, the result is about $2.50 a day in revenues for some with a $1,000 custom Bitcoin mining computer — and that’s before you subtract out the electricity costs and the labor costs of setting this up and managing it. If the price of Bitcoin falls to $100, the revenues drop to $0.80 a day.

The price of a single Bitcoin on Bitstamp, the largest exchange. (Image courtesy BitcoinCharts.)

The price of a single Bitcoin on Bitstamp, the largest exchange. (Image courtesy BitcoinCharts.)

“It becomes less worth it for people to become part of the system,” said Leeds.

One possibility is to separate out the mining function from the transaction processing. For example, exchanges or Bitcoin payment processing firms could step up and keep track of the transactions. But this would increase transaction costs and centralize the system.

“It’s going directly opposite to what the intention of Bitcoin was in the first place,” he said.

As a result, Leeds said, it’s now too risky to get into Bitcoin mining or investment.

“A┬álot of people are getting involved in this wave late, and they will get burned if they get involved now,” he said. “In my opinion there’s only downside from here.”

Instead, he recommends that companies interested in doing business in Bitcoin use a third-party processor like BitPay or Coinbase to handle the transactions.

“Those types of businesses should do fine, because they’re not married to the survival of Bitcoin or the price of Bitcoin,” he said.

maria@hypergridbusiness.com'

Maria Korolov

Maria Korolov is editor and publisher of Hypergrid Business. She has been a journalist for more than twenty years and has worked for the Chicago Tribune, Reuters, and Computerworld and has reported from over a dozen countries, including Russia and China.

  • Sean Murphy

    If mining becomes unprofitable, miners will drop out, and the difficulty of confirming blocks will go down. If the difficulty goes down, the remaining miners can mine profitably.

    • Right now, the difficulty is pegged to processing speed, not the number of miners, but maybe this can be changed. They would also have to change the fact that there are only a fixed amount of Bitcoins that can be mined in total. They could also increase the payment for processing trades, giving miners a little extra incentive to stay in the game.

      They would have to change the rules quite a bit, though, especially as processing speed keeps increasing. Will Bitcoin evolve fast enough to stay ahead of these issues? At this point, it’s impossible to tell.

      • Sean Murphy

        Difficulty is pegged to the time it takes to mine 2016 blocks. It adjusts to make the average time to create a block be 10 minutes. If the average time it takes is less than 10 minutes, indicating a large amount of processing power, the difficulty goes up. If the average time is more, the difficulty goes down.

        If a large number of miners stop mining, the total power available will go down, the time to find a block will go up, and the difficulty will adjust down at the next 2016th block.

        • I thought the system was pegged so that every four years, a fixed number of Bitcoins would be created, and this number halves every four years, so that even if the number of miners stayed the same, they’d still be getting fewer and fewer Bitcoin each.

          • Sean Murphy

            Sort of. The block reward halves every 210,000 blocks, which if the difficulty keeps the average creation time at 10 minutes, will be every four years. Currently, the blockchain is ahead of schedule, due to all the new mining equipment and ASIC’s coming online. Miners also get the transaction fees for all transactions included in their block, which is expected to outpace the mining reward reduction as adoption continues.

          • Tick

            Sean, I’m not sure that adoption will continue that fast. In fact some businesses have stopped accepting Bitcoin.

  • cwest

    those doing the mining will start charging mining fees at a fraction of the cost of credit card companies, problem solved

  • Anton Grimes

    Dude is unreal dumb

  • DKO87

    Miners will be fine. Take a look at what was happening before early 2013, when the price of bitcoin was much lower, and all mining was being done by GPUs. The difficulty would go up and down, riding the edge of profitability related to hardwareelectricity costs vs price of bitcoin.

    That is what will happen with ASICs as they hit the current hardware technology limits. Right now it is still a race to produce a state-of-the-art machine (Cointerra has put out something that is very close). Once state-of-the-art machines are widely available, the difficulty will level off, and miners will be rewarded at a pretty flat rate. Just enough to make it worth it.

  • Sebastian

    Bitcoin is already outdated technology, you should see Ethereum project, which will be a cryptocurrency with integrated programming language, so you can create cryptocurrency within cryptocurrency and many other things.