Does Proof-of-Work… Well… Work?
When I became familiar with blockchain in 2013, I quickly recognized that the introduction of scarcity into the internet economy would change it forever. The limited supply of bitcoin and the introduction of new coins every 10 minutes started a rat race of bitcoin miners in which miners went from being a decentralized network of individuals to a huge industry with “corporate” miners owning thousands of machines.
How did we end up here? To answer this question, I spent about three years of my time and I managed to get the results peer-reviewed and published in the academic journal Electronic Markets.
As Bitcoin was not taken very seriously back in 2013, I embarked on a quest during my master’s degree studies at the Vrije University Amsterdam to find out how big the business behind the first successful blockchain was. I took a deep dive into all available public data to find out how large and profitable the mining industry is. It turned out to be a rapidly growing multibillion-dollar business that is in an intense hardware arms race for the fastest, most efficient and most profitable bitcoin mining computer.
With the Proof-of-Work approach of mining, all mining computers compete to create the next block in a blockchain. The faster such a computer is, the bigger the chance to find the next block and get a reward of newly created bitcoins. This incentivized a lot of people to invest in hardware to be the one that finds the next block. It’s a bit like the gold rushes in the 1800’s where people buy shovels and pickaxes to be the one that finds the next gold vein.
In the early days of the Bitcoin network, it was possible to mine bitcoins by using the GPU of your PC’s video-card. The competition for mining bitcoins intensified when ASIC computers entered the market. These specialized mining computers are only useful for bitcoin mining and quickly evolved in terms of their computing power and energy efficiency. This competition for the fastest and most efficient mining rigs had many winners and losers. Turning on the newest hardware meant you were able to mine more bitcoins at a lower cost than other miners in the network. Those older miners saw their mining profits dwindle until the moment it was better to turn the hardware off, as the electricity costs were higher than the bitcoin gains. The leftover value of this hardware was basically zero, as you could not use it for something other than bitcoin mining.
In my research, I looked at the first five years after the bitcoin value was above $5, from 2012 to 2016. In this period, the bitcoin price both had a rapid rise to around a $1000 and a crash back to below $200. During these early days of blockchain, the network hashrate increased by over 300,000 times and about $2 billion of bitcoin was mined (based on their value at the time the coins were mined). After the first big boom at the end of 2013, the increase in mining power clearly suggested, just like in 2018, that people still believed in the technology and kept competing to mine the coins. Doing this in a profitable way became harder and harder over the years, though.
When calculating the hardware and the energy costs, it quickly became obvious that a lot of people must have been losing a lot of money. For the $2 billion of bitcoin, about $2.1 billion in hardware was needed. (About $300 million was still operational at the end of the measurement period.) And, to keep the hardware running, about $900 million was spent on electricity, using a conservative price of 12 cents per kilowatt-hour. To run a profit with the increasing energy costs, prices as low as 3 cents per kilowatt-hour were needed. This is not something you can still do as an amateur hobby project in your attic.
There are several scenarios where bitcoin mining can be profitable but these all have very negative side effects:
- Centralized economies of scale: Large companies can get a discount on the purchase of hardware and energy. This leads to a situation where it is impossible for a large network of decentralized miners to exist as they can not compete in a profitable way.
- Increased transaction fees: The decreasing amount of miners can increase the amount of fees before they include transactions into blocks.
- Unfair market access: Important players like hardware manufacturers are basically creating the goose with the golden eggs. It would be beneficial to them or mining partners to use the newest hardware for their own gain first before giving competing miners access to this. This way they’re ensured they can use hardware during the most profitable times.
- Single point of failure: The lower the amount of miners in the Bitcoin network, the easier it is for a single player to take over the network or harm the network by selling off large amounts of bitcoins or shutting down machines.
I believe the current hardware arms race in the Bitcoin network will lead to a decreasing amount of players. This will make the network very vulnerable to outside attack by governments, who could potentially requisition hardware of some big players, or to attack from the inside of a miner cartel that takes control of the rules of the network. Events like bitcoin halvings can also lead to large players suddenly switching to competing networks as their profitability changes too suddenly.
Bitcoin is a successful first proof-of-concept of blockchain technology, but it must address the above issues as well. Without tackling these, Bitcoin will probably not be a leading player of the truly free decentralized internet that is coming.
Besides proof-of-work (PoW) blockchain projects like bitcoin, there other blockchains projects like proof-of-stake (PoS), delegated proof-of-stake (DPoS) and many more.
Unlike PoW, PoS is based on the participants’ coin stake. The more coins the staker has, the more likely he will add a new block of the transaction to the blockchain. The staker’s rewards are only the transaction fee. DPoS is a variation of PoS. With DPoS, coin holders can use their balance to elect a list of nodes to be allowed to add new blocks of transactions to the blockchain. PoS is more like wining a lottery, while DPoS gives all coin holders more influence in the network.
Among all the new DPoS blockchains there is Telos, which we are happy to have our reward mechanism for the gaming industry called QUDO, running on.
QUDO will not be driven by a mining arms race but instead it will get evenly spread among all the stakeholders (players, game developers, service providers, etc). This way all QUDO token holders have the chance of being included in the decision making and governance of the ecosystem.
