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Home Article categories Business strategy and finance Is Bitcoin a worthy investment or a reckless risk? (part 2)

Is Bitcoin a worthy investment or a reckless risk? (part 2)

By Oleg K Temple, January 2018

PART 2 — How cryptocurrencies are made

Read part 1 of the article here: https://www.cornerstonesworld.com/article/is_Bitcoin_a_worthy_investment_or_a_reckless_risk

 

 

In order as to evaluate the investment appetite, it is important to comprehend how new coins enter the system. Bitcoins are automatically generated as a reward for record keeping through a process known as mining. Every transaction conducted using Bitcoins needs to be verified multiple times before it can be added to the eternal blockchain. Bitcoin has no central governing body, such as a central bank, it is strictly peer-to-peer technology. As such, miners volunteer their computing power, by configuring their machines to observe transactions and act as arbiters to confirm the same result. This process involves formidable computing power and the problems the computers have to solve, become exponentially more complicated as the years go by. In 2010, one could begin mining Bitcoins using nothing more than the CPU of one’s desktop computer. In 2014–2015 it was hard to remain competitive without dedicating an Intel i7 with a premium graphics card such as a GTX 850 or higher.  

Many investors saw the potential of converting electricity into gold and poured money into sprawling ‘computer farms’ comprising hundreds or even thousands of dedicated computers designed for one purpose only: mine Bitcoins 24 hours per day. This surge even caused a deficit of mediocre video cards on the market. Notably, in Iceland and Russia there are entire factory-sized hangars filled with myriads of dedicated machines working day and night. The greatest difficulty with maintaining so much computing power for years on end is a reliable power supply, as well as the challenge of keeping the units from melting. Aside from the wear and tear of the video cards from the brutal process, the mining operations have been very profitable indeed.

Essentially, the more computing power you have at your disposal, the more likely you are to solve the problem first and be awarded the freshly minted coins. Initially, 50 coins were created for every solution, four years later the number was halved to 25 then halved again to 12.5 (where we are now) and soon will drop to less than 7. This is the artificial scarcity of the currency taking its toll, as fewer and fewer coins enter the supply pool. Nakamoto envisaged a finite number of Bitcoins to be capped at 21 million. It is estimated that the very last coin will be created in 2140 and henceforth, the miners will only be rewarded with commissions on transactions, with no new coins created ever.

Apart from freshly minted coins, minders also receive transaction fees. Thus far, these levies are optional, however, miners may prioritise the transactions with higher fees.

The most appropriate analogy we have seen so far, is that of a game of poker played around a large table with no tokens or money on board. To ensure that no one cheats, numerous observers are invited to keep score of every game, their notes are compared at set intervals and the exact result is added to a scorecard for all to see. This formula keeps everyone honest—the players AND the observers.

As the mining profitability declines and the complexity of mining computation skyrockets, those who have invested millions into the giant mining farms have opened services to spread and diversify their risk. Some of them create and sell dedicated miners, computers designed for a single purpose. Others offer people wishing to dabble in mining, but avoid the hassle, the convenience of buying ‘hashing power’ from them, i.e. purchasing some of their computing power for a monthly retainer or similar. Elaborate commission programmes have been set up, whereby the anointed may share in the profits, by becoming evangelists for the service. In other words, they offer an affiliate programme of sorts—join their programme, convert whomever you can, bring clients to the company and enjoy healthy commissions. Depending on your optimism versus cynicism concentration, this may sound like an excellent affiliate programme or a shady pyramid scheme. To make a logical deduction, let us follow the money. Mining is first and foremost a business, geared toward maximising productivity and income. Insurance policies are a good thing to have, however, if mining was such a sure thing, easy as shooting fish in a barrel, why would they share their glorious hashing power with you? No one can guarantee how quickly you will see a profit, should you decide to roll the dice and drop a couple of thousand Euros into mining. Essentially, you are converting real-world money into a virtual currency you do not intend to spend for some time. Is this a safe and secure store of wealth, will it appreciate and how long will it last? Will governments and banks find a way to put a leash on cryptocurrency or corrupt it somehow? It is certainly not doing the standard economic model any favours, as it bypasses the middlemen entirely. No one has the foggiest idea. All we know is that at present it is running helter-skelter and has turned the global financial system onto its head.

Do you remember the story that blew up in 2011 with the video game World of Warcraft by Blizzard? The enthralling game had such a profound effect on players that they began buying virtual weapons and rare items with real-world money! Where there is such a heavy demand, a supply chain will naturally sprint up. WoW farming was born, most notoriously in prisons of China, where inmates were forced to play the game for 10–15 hours per day, so that the guards could sell the finds online. Bitcoin mining is not at all that nefarious, however, it is not like a domain-selling or server hosting company either. Before you invest, just ask yourself this simple question: if this was such a mega-profitable goldmine, why would they sell it to me for a fraction of its alleged worth? Charity? Goodwill? In business? Highly unlikely. The mine would be no good to you if it is located near the summit of an active volcano, or collapses as soon as you start digging.

Our advice? Either play hard or go home. If you believe that cryptocurrencies are not going anywhere, invest in a serious farm, or share the load of such an investment with a few trusted friends or colleagues. If you have doubts, find a safer way to make money. There is no point reminiscing about how many Bitcoins you would/could/should have bought back in 2010, when one man paid 10,000 Bitcoins for a couple of pizzas. That ship has sailed. Today, Bitcoin is worth well north of US$15,000. Is it worth that much to you is the only question that matters. If you have faith that cryptocurrencies will continue to climb in value, go for it, but like in all gambles—bet only what you can afford to lose.

Thus, we have established that mining is a record-keeping service, the competitiveness of which has a direct correlation to computer processing power. Every block, comprising the blockchain, is stamped with a cryptographic signature of its predecessor, utilising the SHA-256 hashing algorithm, which we will not go into here. Suffice it to say that the system is virtually infallible, as it consists of monitors locked in a vast network, who tirelessly cross-check one another prior to updating the public log. It is also worth noting that the difficulty of mining has been steadily going up, increasing by about 1,250% between 2014 and 2015. The difficulty of the equation is cranked up every 2,016 blocks, which works out to about a fortnight. This is why in 2018 we are too late to the mining party—if you are planning to launch a mine now with an investment below €15,000 you are, sadly, wasting your time. Which actually makes sense—how can one expect to earn multiple Bitcoins within a few months on hardware worth less than a SINGLE Bitcoin?!

Nowadays, as explained, there are numerous outfits running hundreds of machines with multiple premium video cards. Unless your power supply and hardware come free of charge, there is simply no way to be competitive at mining in the current climate without a very substantial investment. To somewhat reduce risk and reduce the erratic nature of the income stream, small-timers may choose to dive into the dwindling pool of joint or pooled mining. Or in other words, participate in a network that mines together and shares the proceeds. The only drawback here is reality, as proceeds are distributed fairly, i.e. the miners with the most powerful computers receive the lion share of the take. So we are back to square one—mining is simply not worth the effort without several dozen powerful machines at your disposal.

What happens when an unstoppable object meets an immovable force? Let’s hope that we never have to find out. Bitcoin, however, is not unstoppable and what goes up, must come down. This article took just over a week to research and compose in late December 2017. During this time, the cryptocurrency managed to hit a record high and then proceeded to lose about 40% of its value. Its volatility is unpredictable and unprecedented. This is probably just a dip, or it could be a permanent correction. Will it recover and rally in the coming months? Perhaps. However, eventually, reality will not be denied. There is a very finite amount of wealth on planet Earth, so the cap of speculative confidence is out there somewhere. Will the cryptocurrency reach US$50,000 per BTC? How about US$100,000? The answer is a confident maybe. All we can do is tell you about the risks in the Final Part of this article.

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