Why You Shouldn't Mine Bitcoin in 2017
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Bitcoins are digital fiat currency passed directly bitcoin difficulty december 2012 winter two people without the need for a trusted third party, such as a bank. Thus Bitcoin is the means of payment of bitcoin. Unfortunately the two, bitcoin and Bitcoin the medium of exchange and the means of payment are often mixed carelessly in discussions of bitcoin. This note is primarily about bitcoin—the medium of exchange—rather than Bitcoin—the means of delivering them. It is the very nature of money that its usefulness depends on how widely it is accepted so called network externalities and thus the dominant currency tends to suppress potential competitors and is itself hard to displace.
Thus while bitcoin is likely to continue to dominate over its cryptocurrency rivals, the key question is whether it is likely to seriously challenge national currencies such as the U. In this note I will review the factors that determine the value of a currency and how they might apply to the long run value of bitcoin and thus its prospects of ever achieving a stable value.
Bitcoin difficulty december 2012 winter regard to the protocols and algorithms underlying big B Bitcoin difficulty december 2012 winter, many have claimed potentially dramatic improvements in how payments are made, and titles of all sorts more generally are maintained and transferred.
The difference between cash physical banknotes and coins and other means of payment such as checks, wire transfers, Visa, and Paypal, is that the payment of cash is made directly between the parties to the payment, i. All other means of payment involve trusted third parties, such as banks, credit companies, and exchanges, that keep records of the ownership of money and its transfer from one party to another. These alternatives describe means of paymentnot what is being paid, i.
These various means of payment can be used to make payments in any money desired. Wire transfers of bank balances can make a payment in whatever currency the bank balance is in—U. This distinction between means of payment and money is very important.
Money by its nature combines the functions of a medium of exchange the thing paida store of value the inventory of that medium held pending paymentand a unit of account the unit in which things are priced.
While a medium of exchange can potentially be anything acceptable to the payee barterand almost any durable good can store value uncooked ricethe unit of account function of money stands out as its most central and critical quality. As such, the value of that unit—the value of the money—what it can buy—is basic to its usefulness.
Like standards of weights and measures, the nominal value of money is almost bitcoin difficulty december 2012 winter established by governments,  while its real value is determined by markets. The various means of payment of that money—can be and generally are privately developed and provided Visa, Paypal, bank checks, etc.
So how is its value determined? Like everything else, its value is determined by the interplay of supply and demand. New bitcoins are minted by a publicly visible formula at a decreasing rate until its supply approaches 21 million units in There are currently about Currently an additional 25 bitcoins are minted every ten minutes and they are issued to miners for verifying that bitcoin used in transactions are not counterfeit. Their price is not fixed to anything and they are not redeemable for anything.
They can be exchanged for dollars or other national currencies for whatever buyers are willing to pay and sellers are willing to accept. Thus the story of the determination of the value of bitcoins bitcoin difficulty december 2012 winter on the demand side. Such a system is the opposite of the gold standard or my real SDR currency board system  in which the value of the monetary unit is fixed and the supply adjusts to the market bitcoin difficulty december 2012 winter at that price.
Bitcoin is a system with centralized control via a rule of the supply of money and decentralized market based determination of its value, while the gold standard was a system of centralized determination of the value of money and decentralized, market based determination of its supply. Who demands bitcoins and what factors influence that demand? Money of any kind is demanded and held in order to have some available when we want to make a payment or to buy something.
Money holdings also reflect the lack of synchronization of the timing of receipts of money, such as for wages, and its expenditure. An inventory of ready cash and or bank account balances or credit is needed in order to make payments. However, as with any other inventory, there is a cost to maintaining it. A very large amount of empirical evidence supports the theoretical expectation that the more expensive it is to hold cash between its receipt and expenditure, the less people will hold.
When the interest rate opportunity cost of holding money is high, cash holdings, like all other inventories, will be reduced.
When inflation is higher a tax on holding cashcash holdings will be lower. When the cost of holding money bitcoin difficulty december 2012 winter one or the other of these ways is more uncertain, e. The value of a bitcoin, or any other money, is measured by what it can buy. This has two dimensions, a how widely it is accepted in payment; and b how much it can buy where it is accepted?
Thus the best measure of the value of a bitcoin in the second sense is its exchange rate with the U. Over the three months between November 1, and February 1, its price exchange rate on the Mt. These reflect huge bitcoin inflations and deflations. The price on the Mt.
Bitcoin difficulty december 2012 winter has removed Mt. As a result of such volatility, virtually nothing is priced in bitcoin, even things that bitcoin difficulty december 2012 winter be purchased with them. Many who pay with bitcoin and most merchants that accept them never actually hold them for more than a few minutes. Bitcoin difficulty december 2012 winter in Japan and instantly transfers them to the merchant selling the toy. Thus the buyer pays dollars and the seller receives dollars but with bitcoin transferred between them.
The risk of exchange rate movements is thus minimized. Trusted third party transaction processors like bitpay  or coinbase  absorb the exchange rate risk over the up to ten minute verification periods. While such trusted third parties provide badly needed support for bitcoin transactions, they bitcoin difficulty december 2012 winter the alleged uniqueness of direct peer-to-peer payments.
So far the use of bitcoin bitcoin difficulty december 2012 winter a negligible fraction of total payments but not trivial and is growing.
However, the fact that few bitcoin transactors actually hold them, and the fact that all bitcoins in existence must be held by someone, implies that the bitcoin difficulty december 2012 winter to hold bitcoin today bitcoin difficulty december 2012 winter almost totally from speculators.
As long as speculators think the value of bitcoins will continue to increase they will be willing to continue to hold or add to the stock they now hold.
This will maintain or increase their value. The moment speculators lose such optimism or decide to cash out while they are ahead, the price of bitcoins will fall and bitcoin prices have experienced a lot of both. For the value of bitcoins to stabilize, the transaction demand for them the demand to hold modest inventories of them in order to make payments with them will need to increase to the point that it crowds out or at least dominates the speculative demand for them.
This is not impossible, but in my view is very unlikely. The use of bitcoin at this point is driven more by ideology than economics. If goods and services are not priced in bitcoin, however, it will bitcoin difficulty december 2012 winter suffer from the added cost of exchanges between bitcoin and the dollar or other national currencies at the time of a payment. Bitcoin enthusiasts point to its current low cost of transfer when making payments as a source of its attractiveness and thus its future demand.
However, this claim is subject to two challenges. The first is that the means of payment used by bitcoin i. Bitcoin is equally usable for any other medium of exchange. The entire payment infrastructure that has been developed and continues to develop for bitcoin could be used to make payments with U.
This is the model used by rival cryptocurrency Ripple. Two simple modifications could replace bitcoin with U. Rather bitcoin difficulty december 2012 winter being fixed bitcoin difficulty december 2012 winter a rule, the number of dollars in the bitcoin like system would be whatever people paid for, dollar for dollar, and existing Bitcoin exchanges would accept and hold traditional dollars currency or deposits in exchange for the same quantity of digital dollars to be used via the Bitcoin system.
The systems of mobile phone payments in local currencies that are growing rapidly around the world are similar in many respects but require the central accounting records of a trusted third party. These systems are driving down the costs of making payments and are instantaneous faster than bitcoin, which must first authenticate that the bitcoin are genuine.
A P2P system has inherent technical challenges and is likely to always be slower than systems relying on trusted third parties. The use of M-Pesa in Kenya to make small payments of Kenyan Shilling and remittances from abroad has grown at a spectacular bitcoin difficulty december 2012 winter. Based on the record keeping of a trusted third party, M-Pesa payments are simpler and quicker than bitcoin payments.
Such new technologies are also driving down the costs of making payments. Cash in and out when buying or selling M-Pesa is almost all in cash requiring street vendors or physical windows rather than virtual exchanges with all digital payments as with bitcoin.
The cost of M-Pesa or Bitcoin type payments should be less than credit payments such as Visa, or Master card because users must pay for the currency in advance of its use and because credit payments can be reversed with charge backs.
Each has its advantages and disadvantages and there is room for both. The miners, who perform the service of authenticating bitcoins used in every transaction, are currently remunerated on the basis of the first to complete the authentication of a payment block public ledger of transactions earning newly minted bit coin. Over time as the number of bitcoin minted declines to zero and the number of transactions to authenticate increases should that happen the remuneration to miners will fall and will need to be supplemented with fees to ensure that the authentication service bitcoin difficulty december 2012 winter to be provided.
Aside from providing its own medium of exchange, Bitcoin is one among many means of payment. Competition and further technical innovations promise to lower the cost of making payments in any currency and it is difficult to see any particular advantage for Bitcoin and considerable disadvantages in this regard. If a well-defined transactions demand for bitcoin does not emerge to sustain its value, and it is difficult bitcoin difficulty december 2012 winter see why it would, its value will remain at the mercy of the whims of speculators.
My expectation is that it will never achieve importance and that it is likely to vanish all together, giving way to more robust means of payment of more stable mediums of exchange.
However, it deserves the chance to compete. Bitcoins are digital monetary units created according bitcoin difficulty december 2012 winter a well-specified rule, which will gradually increase their total supply to 21 million sometime beyond This is a critical service to prevent the multiple use of the same bitcoin double spending problem given the ease of making electronic bitcoin difficulty december 2012 winter of what are digital codes to begin with.
Bitcoin may be purchased from those who have them at a mutually agreed price. Such transactions may be conducted face to face or via exchanges established for this purpose.
A significant infrastructure has been and is being developed to facilitate these exchanges between bitcoin and national currencies, thus introducing an important role for trusted third parties. The digital records of the receipt and transfer of bitcoins are maintained in thousands bitcoin difficulty december 2012 winter copies of Block Chains public ledgers on the internet. The approach uses public key and private key encryption much like email, where our email addresses are public for everyone to see but our passwords are hopefully known only to us.
If I receive an email from your address I can be confident it came from you if you keep your password secret. Apps have been developed for bitcoin users to separate their transactions from all others. For this purpose and to further simplify the transaction and exchange process, trusted third parties provide on-line wallet and related services.
The ultimate purpose of bitcoin is for making payments for the purchase of goods and services or the discharge of debts. They may be used to make a payment to anyone person or merchant willing to bitcoin difficulty december 2012 winter them anywhere in the world. Given the extreme volatility of their value, a number of trusted third parties have been established to take the exchange rate risk by guaranteeing the exchange rate at which bitcoins can be acquired and resold as close to simultaneously as the authentication process permits usually no more than ten minutes.
Thus a merchant selling goods priced in dollars can accept the bitcoin equivalent at the moment of the settlement and resell them for dollars without holding them more than a few minutes.