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Bitcoin Mining for Profit

Should you mine bitcoins? In short, probably not. Bitcoin mining requires significant computational power, which requires electricity, expensive hardware, and space. Your return on investment will depend heavily on the number of other miners there are and how much computational power they're providing. Because the number of bitcoins distributed to the network is not affected by the number of miners, the more miners, the more diluted the reward will be.[1] Bitcoin mining can only be profitable for those with the most efficient hardware, in terms of energy and capital efficiency, and cheapest electrical power. Because hardware manufacturers have the lowest capital costs per mining device, many profitable Bitcoin-mining companies manufacture their own hardware. These manufacturers may also hire their own research and development engineers to design newer and more efficient computer chips (i.e., ASICs) for Bitcoin mining. In summary, Bitcoin mining is an extremely competitive business and will likely become more so as Bitcoin adoption increases.

Perhaps if you have your own wind farm or solar panel array and have more electricity than you know what to do with, you might be able to mine bitcoins profitably. But it still requires careful consideration of the capital costs and the opportunity cost compared to just buying bitcoins directly. A common mistake in estimating the viability of a Bitcoin-mining venture is to put too much weight on the exchange rate (in whichever other currency you're using). You should always compare the return from Bitcoin mining against the number of bitcoins you could have purchased for the same initial investment. The future exchange rate should make little difference in your investment decision. If it is not profitable to mine bitcoins today when the rate is $200 per bitcoin, it makes no difference if they will be $1,000 per bitcoin tomorrow; you should just buy bitcoins instead of mining them.

It is also important to reasonably project the future hash rate. Although it is impossible to predict the future, more than likely the network hash rate will continue increasing very quickly during Bitcoin's first 10 years. See the following example calculation, keeping in mind that even if mining is more profitable than buying bitcoins directly, it's still a lot more work!

Example calculation: To mine or to buy?

Example calculation: To mine or to buy?

Scenario #1 - Difficulty increases by 100% per month

Scenario #1 - Difficulty increases by 100% per month

Scenario #2 - Difficulty increases by 200% per month

Scenario #2 - Difficulty increases by 200% per month

If you decide to purchase Bitcoin-mining hardware, be wary. Anyone selling Bitcoin mining hardware has calculated that it would be more profitable to sell to you rather than use the hardware to mine himself. Carefully do your research on the vendor, the hardware details, and the shipping timelines. Receiving a mining device a few months later than you anticipated can mean the difference between a positive and a negative return on your investment (because the network hash rate will be higher).

Theoretical Hash Rate Limits

As computers become more powerful and energy efficient, and especially if Bitcoin adoption continues to increase exponentially, the network hash rate is expected to grow significantly. How high can it go? If more and more computers start mining and the price of a bitcoin remains fixed, eventually the amount of bitcoins each miner earns won't cover the costs of electricity. Ultimately, it can be argued that the limit of the network hash rate depends on the energy efficiency of the mining hardware (see Table 8-1).

Table 8-1: Energy Efficiency of Different Forms of Bitcoin-Mining Hardware (Calculated as a Ratio Between Hash Rate and Power Consumption)

Energy Efficiency of Different Forms of Bitcoin-Mining Hardware (Calculated as a Ratio Between Hash Rate and Power Consumption)

Profitability threshold curves for comparing hardware efficiency, electricity cost, and network hash rate on the Bitcoin network. Given your current electricity cost, a curve can be drawn that relates the efficiency needed by your mining hardware (in J/GH) to be profitable, for a certain network hash rate. If you can draw a point below your electricity cost curve for your mining equipment, then you'll be able to mine profitably on the Bitcoin network.

Figure 8-5: Profitability threshold curves for comparing hardware efficiency, electricity cost, and network hash rate on the Bitcoin network. Given your current electricity cost, a curve can be drawn that relates the efficiency needed by your mining hardware (in J/GH) to be profitable, for a certain network hash rate. If you can draw a point below your electricity cost curve for your mining equipment, then you'll be able to mine profitably on the Bitcoin network.

If bitcoins increase in value, the relative cost of electricity decreases, and the breakeven point for the network hash rate increases. If a mining device has an efficiency of 0.8 J/GH and electricity costs only 0.01 mBTC per kWh, the network hash rate at which mining would no longer viable would be 18,000 PH/s, corresponding to a difficulty of 2.5 trillion. So is it possible the hash rate could go even higher than it is today?

The ASIC designs in Table 8-1 show that the energy per hash drops as the feature dimensions decrease. If we assume that in the future high-efficiency 14 nm ASICs that use only 0.1 J/GH will exist, then at 0.01 mBTC/kWh the breakeven hash rate would be greater than 100,000 PH/s. Computer chips made with features smaller than 14 nm dimensions don't exist yet, but Moore's law[2] has persistently defied predictions by skeptics that computer chips have reached the smallest feature sizes possible. Clearly, the network hash rate could potentially be enormously higher than it is today.

Decentralization in Bitcoin Mining

Bitcoin's success depends on being a decentralized network. In its infancy, anyone could join the Bitcoin network as a mining node; however, now mining is done primarily by professionals with resources, expertise, and capital well out of reach of the average Joe. Is this trend recentralizing Bitcoin? This is a subject of debate among Bitcoin users, miners, and developers.

Another related subject we haven't discussed in detail yet is the limit to the number of transactions that can be included in each block. Obviously, a real, physical limit exists in the sense that an individual cannot include an infinite number of transactions in any block. However, a smaller limit is imposed as a rule in the Bitcoin protocol (i.e., although the physical limit might be in the range of millions of transactions per block, the rule-based limit is in the thousands of transactions range). The original purpose of this self-imposed limit[3] was to prevent the blockchain from becoming bloated with pointless transactions (i.e., spam), but some have argued that the limit serves a greater purpose, which is to maintain decentralization.

In addition to having a computing device that can perform SHA256 hashes very quickly, mining nodes and relay nodes must have sufficient storage space to store a full copy of the blockchain. If the blocks that make up the chain become much larger than they are now, not only will miners need faster computers, but their systems will also need the capability of storing substantial amounts of data (possibly in the form of large data centers). This would further increase the capital requirements of miners and inevitably lead some to abandon the profession. Fewer mining nodes would make the network more centralized by degrees. For this reason, some miners have advocated for limiting the number of transactions per block to a small number (although this would ultimately drive up transaction fees). Is such a desire justified?

Although it's a complicated issue, we can use the gold mining analogy to explain. Is gold a centrally controlled commodity? Very few people, by percentage, have the resources, time, and expertise to mine gold. However, no monopoly exists on gold mining; any well-financed venture can search for gold and attempt to mine it. Similarly, even though Bitcoin mining might no longer be viable for casual users and instead become a venture performed by companies and organizations, a single institution would never obtain sole control of Bitcoin mining. Nonetheless, it is best to keep a close eye on the future number of Bitcoin miners.

  • [1] Strictly speaking, the number of individuals involved in mining is irrelevant, of course; only the amount of computational power applied to mining matters.
  • [2] Moore's law is an observation by Gordon E. Moore, cofounder of Intel, that the number of transistors on computer chips doubles approximately every two years. This has held true for over 40 years, largely because feature sizes on computer chips have continued to get smaller.
  • [3] In this case, the limit was imposed by trusted developers of the core Bitcoin software. The protocols encoded in this core software are typically supported by a majority of miners and therefore usually determine the properties of the longest blockchain on the network.
 
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