Block reward halving raises barriers to Bitcoin mining

The price of bitcoin barely changed when the Bitcoin block reward halved in early July, unsurprisingly as the reduction was long anticipated. Transaction volume, mining capacity and transfer fees remained roughly the same, to the casual observer the halving had no impact on Bitcoin.

A closer examination reveals, however, that the block reward halving has substantially raised the barrier to entry for new miners without impacting the ability of incumbents to mine profitably. With the largest five mining pools and companies controlling over 75% of mining capacity, Bitcoin mining is now an oligopoly. Contrary to Satoshi’s original intent, Bitcoin users must now trust a small group of miners to act honestly.

(The economic effect of block reward halving on Bitcoin mining is described in detail in “Minting Money With Megawatts” by Sveinn Valfells and Jon Helgi Egilsson published in the Proceedings of the IEEE, Volume 104, Issue 9, September 2016.)

This development is important. Mining secures the integrity of the distributed Bitcoin ledger. It is an indispensable function in clearing bitcoin transactions, and one of the few profitable services in the open, permissionless Bitcoin ecosystem. As evidenced by recent battles about the evolution of the Bitcoin standard, miners can either foster improvements in Bitcoin technology or stifle them. Bitcoin’s future is predicated on reliable mining operations.

Ironically, the oligopoly in mining is brought about by Bitcoin’s success as an alternative, trustless currency and payment system. Following the appreciation in value of bitcoin in the past few years, Bitcoin mining has to a large extent shifted onto systems using application specific processors (ASICs) deployed in bespoke data centres. Both processors and data centres are designed for maximum achievable power efficiency. The costs of securing these primary production factors are considerable, new entrants must now deploy capacity worth tens of millions of dollars corresponding to several percent of the network to stand a chance of mining profitably within reasonable time horizons. Under such conditions, only well-capitalised companies with access to latest microprocessing technologies and data centre facilities command the resources to enter mining.

Breakeven zone for new Bitcoin mining capacity before and after the recent block reward halving for cloud deployment using advanced ASICs. The shaded area marks the range within which new miners can profitably add capacity. From Valfells and Egilsson, Proc. of the IEEE, Vol 104, Issue 9, September 2016.

The current mining market structure can change in several ways. The first is through improvements in microprocessing technology. Unlike many other microprocessors, Bitcoin ASICs run continuously at full capacity. While Moore’s law still applies to peak processor output efficiency, each new generation of microprocessors will open a window to entry into the mining market every three years or so. Access to new microprocessors could shift balance between the existing miners or give advantage to a new entrant.

Cheaper power generation technologies could also make new deployment strategies viable. For example, more efficient photovoltaic cells, especially if combined with inexpensive batteries, could eventually make solar powered mining farms in sunny and arid areas less expensive than hydroelectricity supplied data centres in temperate climes.

Another potential way of breaking into mining would be to embed mining processors into networked devices and utilise their computational power when they are idle. Mass manufacturing of embedded processors could lower prices of mining processing power; and mass deployment of embedded capacity could allow discovery of inexpensive pockets of electricity supply.

New computing technologies could also radically change the cost-performance characteristics of specialised microprocessors, including Bitcoin ASICs. The data overhead of Bitcoin is low, and the processor function is relative simple, which makes Bitcoin mining in many ways ideal application to test new computing platforms, such as graphene processors or quantum computers.

The oligopoly in Bitcoin mining runs contrary to Satoshi’s intentions and weakens the trustless, distributed character of Bitcoin. If, however, the potentially game-changing trends in energy and computing continue, the current market structure will eventually be undermined or overturned by more efficient technologies. New generations of inexpensive, widely available energy sources and Bitcoin ASICs may open the market to new entrants, diversify the pool of mining power away from incumbents, and restore the trustless nature of Bitcoin.