The Value of a Hash: How Cryptocurrencies are Secured by Hardware
As a former nuclear reactor operator, computer engineer, and a co-founder of a blockchain technology firm, MIMIR Blockchain Solutions, I think it’s pretty safe to say that, many conversations taking place around blockchain are simply too granular for mainstream thinking to easily absorb. In order for blockchain to truly be more integrated into society, this needs to quickly change, and basic questions around this emerging topic need to be more clearly addressed.
One particular question I repeatedly find myself being asked is why is a cryptocurrency worth X, or even, anything at all? Truth being told, this is not a question easily answered in just a few minutes of conversation. For instance, one of the best explanations I have read to date is a well-done argument made by Adam Hayes (The New School for Social Research) in “A Cost of Production Model for Bitcoin”. In this work, Hayes raises an important question on the value of Bitcoin as a commodity using the marginal cost of production to establish the useful price. Although this article is very insightful, the writing is more technical than the average reader needs to comprehend. Therefore, it may make greater sense for interested parties to first take a step back and consider examining the value of a cryptocurrency from a completely different perspective, namely infrastructure and security.
When evaluating a “useful price”, it is critically important to consider that a cryptocurrency is, frankly, worthless without security. If anyone was capable of creating coins outside the defined rules of the system, cryptocurrencies would not act as a viable mechanism for exchange. Therefore values are only as secure as the infrastructure they are supported by.
For those who do not know already know, the single biggest attack vector, in decentralized systems like cryptocurrencies, is the 51% attack. This type of attack may only occur when a single individual or entity has more than 51% of the mining (computational) power in a cryptocurrency network. For a deeper understanding of this topic you can read a publication by Mario Dian titled, “Cost of a 51% Attack and Security of Bitcoin, Monero, Litecoin and other Cryptocurrencies.” The critical point to understand is that during a 51% attack, the blockchain could be manipulated to allow the same coin to be spent more than once, something called a “Double Spend” problem. Additionally, the system could also be manipulated to prevent some individuals from transferring any value whatsoever. This sort of manipulation would not only undermine the security and usefulness of the system, it would ultimately cause the value stored to be untrustworthy. Thus, the price of a cryptocurrency would plummet following any successful 51% attack.
Given the immense value stored in cryptocurrencies as evident by current trading levels, something my colleague Nick Fierro recently discussed, you may be wondering why we haven’t seen a 51% attack on Bitcoin or Ethereum. Simply put, the cost of attacking the system supersedes the amount of value that could be gained by actually attacking it in the first place. In order to have 51% of the computational power in a large cryptocurrency network, an immense amount of money must be spent to acquire the computing hardware. Most of this hardware is custom built for this type of work, but it has little use elsewhere. Due to this specialization, an attacker would incidentally be diminishing the value of his/her investment in hardware and the underlying value of his/her cryptocurrency holdings relative to the attacked network.
The idea of hardware supporting cryptocurrencies simply doesn’t get enough focus. In fact, in Dian’s article, he gives rough calculations of this hardware cost that err on the low side (see Dian’s table of values below). This table summarizes the cost of hardware and electricity necessary to attack the largest cryptocurrency networks for a single day in August of 2017. This table is presented below:
In reality, the cost of attacking a cryptocurrency network per day is not limited to the cost of electricity and the devaluation of equipment alone, it also includes the marginal cost of opportunity lost due to an attack — and this could be large. For example, compare the values from the above table with the following graph of total Bitcoin revenue paid to miners each day from October 4th, 2017.
One can clearly recognize that revenues derived from mining bitcoin dwarfs power and hardware costs. This further supports my strong belief that hardware must be more secure to ensure the value of cryptocurrencies.
Keep in mind, an attacker would need more than 50% of the mining power to attack the system. This means the attacker would be winning at least 50% of the mining revenue each day, even during the attack, but those winnings would become useless once confidence had been eroded in the system. Looking at this idea more deeply again based on the graph above, for the worst day in August of 2017, this number is approximately 3 million USD. So the realistic total cost per day is the cost of the reduced value of the coins, the cost of the reduced value of the hardware, and the cost of the electricity to power the computers. This is one reason why cryptocurrencies have value: They are secured by the infrastructure that supports them, and this infrastructure is of non-trivial cost.
At the end of the day, when asking whether or not a cryptocurrency is worth its face value, one should understand that these systems are only as useful as their security. For the largest networks, it is clear that the barrier to entry to perform an attack is immense. For these networks, it is also evident that the marginal cost of an attack, is greater than the theoretical benefit. This may not always be the case, for smaller systems in particular. However, one thing’s for sure, the infrastructure behind cryptocurrencies is more critical to preserving the value of cryptocurrencies than one may understand. Hopefully that is considered the next time someone asks why a cryptocurrency is worth X.
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