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Part of what makes Bitcoin so clever is that it actually assumes self-interested behavior by Bitcoin miners. Both mining and transactions are decentralized and do not require counter-party trust. Barriers to entry are were low.

(ASIC mining rigs with sufficient processing power to mine bitcoin are now priced in the tens of thousands of dollars. This is due to the more mature status of the blockchain; Bitcoin is vulnerable to first mover’s advantage, just as the P2P Foundation warned.)

Virtual money, real consumption

Bitcoin is produced on a schedule, no matter how much computing power is applied to mining it. Thus supply never meets demand, resulting in ever higher prices being paid for more computing power, due to the associated electricity requirements.

Chart of bitcoin production vs electricity usage

Chart by L. Bragagnolo

The following is my mediocre, ad hoc Google Translate translation from Italian to English of an excerpt from Lucio Bragagnolo’s original article, Denaro virtuale, consumi concreti:

We must solve two basic problems.  Who guarantees in case of adverse events, as there is no central bank; and more importantly, what should the many pay for the financial misadventures of the few? Currently, there is no one to call out wrong doers.

The cost of bitcoin

Recall the magic that makes Bitcoin profound:

…scores of independent computers all over the world running at full speed in the hope of capturing new Bitcoin, and in the process verifying transactions for free. Those computers need power, and that power needs to be generated. True, whoever owns the servers is paying a huge electricity bill… Moreover, the design of Bitcoin guarantees that electrical consumption increases dramatically, indefinitely.

Miners compete in a zero sum game requiring greater and greater computing power without a corresponding increase in the rate at which new Bitcoins are mined. This is immutable, as it is part of Bitcoin’s design. That is the point illustrated by Bragagnolo’s price versus quantity chart above.

Perverse incentives

The more general problem, one that always lurks in economic and mathematical models, is negative externality. Fraud is a negative externality, and the case of Mt. Gox is an example. Sadly, we now have another.

High-performance computers that are dedicated to important research for US national agencies are being misused to mine dogecoin, a blockchain-based cryptocurrency similar to Bitcoin.

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