Mining of crypto-currencies
Crypto currency is a new phenomenon of currency that has become a big thing in the digital world. It is a digital asset that is designed to be used as a currency or medium of exchange. It uses cryptography for securing the transactions and for controlling the generation of extra units of currency. In a broad sense, crypto currencies are considered to be the subset of digital currencies or virtual currencies (Narayanan et al. 2016). However, it is a lesser known fact that, these digital currencies were invented as a by product of some other invention. The first crypto currency was Bitcoin, and invented by Satoshi Nakamoto. This currency is still the most used digital currency. Nakamoto never intended to invent this coin. In his paper, ‘Bitcoin: A Peer-to-Peer Electronic Cash System”, Nakamoto says that, he wanted to build a digital cash system with no central entity being present. He observed that, the for many decades, the trusted third party based transaction systems failed, hence, he felt a need for decentralized digital cash system (Nakamoto 2008). This resulted in the invention of Bitcoin in 2009, which uses the peer-to-peer network for preventing double spending. It has no central server or authority. Regarding the security issue, Nakamoto says that, if there is no third party, the chances of fraudulent activities get reduced automatically. This currency could be accepted by all parties over the internet across the world. After Bitcoin was introduced, numerous crypto currencies emerged. Some of the major crypto currencies other than Bitcoin (BTC) are, Litecoin (LTC), Ethereum (ETH), Zcash (ZEC), Ripple (XRP), Monero (XMR), Dash (DASH) etc. Litecoin was introduced in 2011, second to Bitcoin. It is based on open source global payment network. It offers a faster confirmation of transaction than Bitcoin. Ethereum is launched in 2015. This uses Smart Contracts and Distributed Applications (Granger 2016). These two are most common crypto currencies other than Bitcoin. As the world is becoming more digital with a rapid technological advancement, the era of crypto currency has just begun.
Mining of the crypto currencies can generate rewards for the miners. It is a process of legitimizing and authenticating the crypto currency transactions. In the digital world, people can make some profit by investing some money in the equipment and spend time in mining the digital coins. Most of these coins are script based. Hence, knowledge of scripting is a foremost criterion for mining the coins (Eyal and Sirer 2014). The other basic resources are electricity, computers, internet connections and some cash, needed to mine crypto currencies. Mining requires many specialized servers, which are not suitable for normal computing and lots of cooling is required too. When more than 1000 people work in a space, things become difficult. Hardware as well as software, both is required for mining. For a small home based miner, mining a few coins using the home system can be possible. But for mining 100 coins per day for a long time, large commercial users can only afford the equipment and bear the cost of electricity. Bitcoin has to spend $80,000 as a monthly electricity bill. This amount of money is not feasible for a small home based miner (Murray 2016).
Costs and viability of mining Bitcoin
The mining process requires effort, time and money. One should understand the amount of effort needed and then proceed with the mining. Recording every transaction in the ledger, making a block, and adding it to the blockchain by authentication is a time taking process. A proper hardware needs to be selected. These are special computers, known as mining rig. Next, a proper wallet should be chosen to add the coins. After that, downloading the software and joining the mining pool are required. Technical knowledge is very essential in this work. From writing a script to making a blockchain, requires effort, training and knowledge. Thus, it can be said that, larger companies have more of the resources and capabilities than the small home based miner (Kirkpatrick 2017).
Figure 1: Mining process of Crypto currencies
(Source: Granger 2016)
The terms associated with mining Bitcoin are Hash Rate, Bitcoins per Block, Bitcoin difficulty, Electricity Rate, Power Consumption, Pool fees, Time Frame, Profitability decline per year, and Conversion rate. Hash Rate is the rate of problem solving and refers to the performance of the miner. This is measured in MH/s (Mega hash per second), GH/s, TH/s and PH/s (Lacoma 2016).
A hash rate must be high to mine more number of bitcoins.
Constant amount of Bitcoins are generated each time a mathematical problem is solved. Number of Bitcoins in a block starts with at 50 and halts at 210,000 blocks that takes around four years. The current number of awarded Bitcoins is 12.5 per block (Gil 2017).
Electricity consumption is a major thing in Bitcoin production. This incurs a heavy cost and profitability depends on this cost.
For mining, the miner needs to join a pool. It is a group of miners joining together to mine more efficiently. Joining the pool deducts a fee for maintaining the operations. Once the coins are mined, the profit is divided among the members depending on their contributions.
Time frame also influences revenue. The more time will be spent on mining, more coins would be generated and revenue would increase. Viability and profitability also depend on the conversion rate. There is uncertainty about the conversion rate in the future and since, it is still in the developing stage, the value is not stable too (Marian 2015).
If the example of a Bitcoin mining at a hash rate of 14 TH/s is taken, with 2% mining pool fees, 1375W electricity consumption, $0.12 per KW and 12.5 Bitcoins reward per block, 0.11 Bitcoins a month would be generated. The estimated costs are as follows:
Figure 2: Estimated cost for Bitcoin mining
(Source: Beigel 2017)
Hence, the cost of mining Bitcoin includes the software, hardware, internet and a massive amount of electricity cost. If more coins could be mined, more profit it would bring in. Since, the world is moving towards digitization, people are becoming aware about the digital cash. The world has already moved into cashless transactions with credit and cards and similarly, the optimistic people say that the crypto currencies would also be popular in the future (Barber et al. 2012).
Hard currencies are those, which have a stable exchange rate for a long period of time. US Dollar, German Mark, Euro, GBP, and Japanese Yen are the most noted hard currencies of the world. For a crypto currency to be a real threat to any hard currency, say, US Dollar, it would require a potential reserve currency. This indicates that the central banks in all over the world must hold a wide reserve of crypto currencies to pay off the international debt obligations. This also indicates that, some important commodities, such as, crude oil must be priced in a particular crypto currency and not in USD. People are not yet aware or certain about the future of the crypto currencies and hence, the credibility and the faith on this new system are still not present. Hence, the crypto currencies have a long way to go before they could pose a real threat to a hard currency, like, USD. However, the scopes for threats arise while using the crypto currencies are the cases of tax collection on transactions by the governments, and ability to implement the law to fight the criminal activities in crypto currency transactions (Mannarino 2017). It is also said that, the crypto currencies have the power to transform the financial markets where there would be no centralized authority and no third party. Banks could work together with the crypto currencies to reduce the risks and to foster and design the appropriate innovations in the future. However, the banks are apprehensive about the impacts of crypto currencies as it promises to bring decentralized banking services system and create micro markets, removing the intermediaries (Undheim 2014)
At the same time, the underlying technologies of the crypto currencies are too big for the banks. If the boom for the digital currencies continue, it would be difficult for the banks to handle the pressure. Although, the hard currencies are expected not to be affected by these new currencies, hence, the threat would not be big.
There have been some criminal activities by using the crypto currencies. One of the most infamous examples of fraudulent activities is the case of Silk Road website. It illegally sold drugs and used Bitcoins for transactions. The founder, Ross W. Ulbricht, was arrested in 2013 and the online block market was closed down. He was convicted for money laundering and drug trafficking (Birtles 2017). All the currencies in the world have faced illegal activities, which led to the formulation and enforcement of laws to prevent the money laundering. But, the case is different with crypto currencies. Poorly developed regulations, difficulty in tracking the transactions, anonymity, huge international network and inability of the owner to reverse a fund transfer and restore the value of the money if it is lost or stolen are the major opportunities for the cyber criminals (Brown 2016). According to a report by Bloomberg, in the last 1 year, crypto currency phishing scams have led to a loss of around $225 million. It has been found that, investors are tricked to send money to some internet addresses that pretend to be a charity or funding site for the digital coins related to the technology of Ethereum blockchain. Over 30,000 people became victim of the Ethereum related criminal activities and each lost around $7,500. This type of crime has become a major concern in the digital financial world (Chen and Nakamura 2017).
Figure 3: Criminal activities with Ethereum
(Source: Chen and Nakamura 2017)
Along with hacking, scamming and phishing, tapping the project loopholes is another type of crime with the crypto currencies. A bug in the Smart Contract Project, DAO or Decentralized Autonomous Organization, which is built on top of the Ethereum, was exploited to steal $55million of Ether. In case of Bitcoin, the scams happen specifically on individual holders and not on the ICO related campaigns (Engle 2015).
10% of the total Bitcoins is traded in China. After the invention of Bitcoin, it was mostly traded in China. Currently, the Chinese government is expanding its interest as well as investment in the Ethereum blockchain, than on Bitcoin (Fink 2017). Experts point out many reasons for China’s interest on a digital currency. Firstly, millions of citizens do not have access to standard banking due to infrastructural issues in the country (Huang 2017). Secondly, the international payments are charged high, and a digital currency could remove some of the extra fees. Thirdly, since the crypto currencies maintain a public ledger for each transactions; hence, the block chain transactions can be easily traced and that allows easier finding and removing corruption. Lastly, it would help in faster economic analysis with real time data. This would be helpful in the developmental plans and activities faster.
As the central bank of China is developing its own crypto currency, it is the first nation to do so. Lower operational costs, more efficiency and better control on the illegal flow money are the potential reasons for this step by the PBoC. The major implication of this would be a significant drop in the usage of cash. The money supply in the nation would be controlled, and the economy is expected to be more stable. With digital money, the tendency of people holding cash would be reduced and deflation would be controlled. Since, China is showing interest in digital currency, it is expected that some other countries would like to do the same. Thus, digitization of money can occur faster. The demand for the crypto currencies would increase in the international market, and more mining would happen (Birtles 2017).
Conclusion
In the end, it can be said that, crypto currencies are bringing new era in the digital cash market. With the advancement of technology, this new trend of digital cash is becoming more popular. Although, it has a very costlier process to mine, still companies are seeing the potential in it. The decentralized cash system, peer-to-peer networking and absence of third party made this a profitable option for the businesses. The recent interest of the Chinese government in its own crypto currency is expected to give a boost to this new system.
References
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