Minting Money With Megawatts - How To Mine Bitcoin Profitably

c© Copyright Sveinn Valfells & Jon Helgi Egilsson 2013-15.

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Minting Money With MegawattsHow to mine Bitcoin profitably

Sveinn Valfells, PhD1 & Jon Helgi Egilsson2

1linkd.in/wtaHi5

2Faculty of EconomicsUniversity of Iceland

Presented at University of Iceland, April 17, 2015

Sveinn Valfells, PhD & Jon Helgi Egilsson Minting Money With MegawattsPresented at University of Iceland, April 17, 2015 1

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Outline

1 A Brief Outline of Bitcoin

2 How to Mine Bitcoin Profitably

3 About the Authors


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A Brief Outline of Bitcoin

Outline



3 About the Authors


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Bitcoin Is A Platform For Storing And Transmitting ValueBitcoins are tokens for transacting on a distributed ledger, the blockchain [1, 2, 3]

Figure : Private–public key public used forauthentication (top); transactions broadcaston a peer-to-peer network (bottom).

Figure : New transactions timestamped withSHA256 hash every 10m.


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The Blockchain Has Many Potential ApplicationsBitcoin 2.0: Applications and extensions of the blockchain [5, 6]

“[T]he distributed ledger underlying [the Bitcoin] payment systems is asignificant innovation”

— Bank of England [4]

Text, multimedia embedded into theblockchain.

Multi-signature transactions.

Colored coins: Tagged Bitcoinsredeemable for assets.

Sidechains: Alternate blockchainsconnected to Bitcoin blockchain.


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Bitcoin Has Large Addressable MarketsBitcoins are fungible, divisible, impossible to counterfeit, supply is prescribed

“Money is whatever is widely accepted, be it gold, bitcoin or theimmovable circular stones of Yap in Micronesia.”

— FT [7]

Global asset classes (value storage)

Private investment in gold >$1T [8].

London housing stock >£1T [9].

Global payment streams (value transmission)

Growing global non-bank payments (major economies) >$609B (2011) [10].

PayPal 25% YOY increase in payment volume to $180B in 2013 [11].

“In an extreme case, virtual currencies could have a substitution effecton central bank money if they become widely accepted.”

— ECB [12]


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Bitcoin Is Growing Like Bacteria In A Petri-DishMoney will rotate into cryptocurrencies from traditional assets, payment streams [13, 14, 15]

Cryptocurrency economics: Endstate is one dominant network, 2–3 runners-up.

Price Supply Market Cap TurnoverCurrent $219 14.1M $3.1B $19.0B

Annual growth rate 1.7× 0.3× 2.0× 2.0×Sveinn Valfells, PhD & Jon Helgi Egilsson Minting Money With Megawatts

Presented at University of Iceland, April 17, 2015 7/ 23


Bitcoin Ecosystem Is Rapidly EvolvingDeveloped countries lead Bitcoin adoption [17, 18]

Milestones to date (2009–15):

> 5.5M downloads of official client.

5M active hosted wallets.

Accepted by 75,000 merchants.

?300Petahash computing power.

>$600M in venture funding fromleading VCs.

Ecosystem of exchanges, paymentprocessors, ATMs, payment cards,wallets, miners, vault storage, PtPlending.

Bitcoin foundation established.

Over 6,000 full nodes active.

Figure : Active Bitcoin nodes [16].


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Many Governments Recognize BitcoinRegulatory framework for cryptocurrencies is falling into place [19, 20, 21]

[Virtual currencies] may hold long-term promise, particularly if theinnovations promote a faster, more secure and more efficient paymentsystem.

— Ben Bernanke, November, 2013

Relevance Regulatory situationUS Largest

economyFederal authorities define as asset (IRS) orcurrency (FinCEN); CA legislates, NY regulates.

CN 2nd largesteconomy

Credit bubble, FX controls in place, authoritieseffectively shutting down Bitcoin exchanges.

DE Largest EUeconomy

Recognized as “private money”.

UK LargestFX/goldmarkets

Same tax treatment as FX and investment gold.Bank of England research into use of digitalcurrencies.


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Bitcoin Is Not Fully De-RiskedMainstream adoption faces hurdles

For

Strong brand recognition.

5+ years of development.

Diverse community of committedparticipants.

Rapidly growing market cap,turnover.

Rapidly growing ecosystem.

Regulatory acceptance in many keyjurisdictions.

Against

Consumer adoption still limited.

Market cap small, liquidity low.

Ecosystem immature.

Conflicting regulatory approaches.

Concentrated ownership.

Potential for market manipulation,collusion.

Regulatory uncertainty in some keyjurisdictions.

Lack of price anchoring.


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How to Mine Bitcoin Profitably

Outline



3 About the Authors


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Hashes Protect The Integrity Of The BlockchainMiners search for SHA256 hashes of new block headers [22]

SHA256 example:

The quick brown fox jumps over the lazy dog

c03905fcdab297513a620ec81ed46ca44ddb62d41cbbd83eb4a5a3592be26a69

Blockchain hashing:

Field Purpose Updated when... Size (Bytes)Version Block version number New protocol version 4hashPrevBlock 256-bit hash of the previous

block headerA new block comes in 32

hashMerkleRoot 256-bit hash based on allof the transactions in theblock

A transaction is accepted 32

Time Current timestamp asseconds since 1970-01-01T00:00 UTC

Every few seconds 4

Bits Current target in compactformat

The difficulty is adjusted 4

Nonce 32-bit number (starts at 0) A hash is tried (increments) 4

Block Hash345 981 000000000000000003e560d227c225b5cdf 7bcee3358d53222d5d0af 6240db4d


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Hashes Protect The Integrity Of The BlockchainMiners search for SHA256 hashes of new block headers [22]

SHA256 example:

The quick brown fox jumps over the lazy dog.

b47cc0f104b62d4c7c30bcd68fd8e67613e287dc4ad8c310ef10cbadea9c4380

Blockchain hashing:

Field Purpose Updated when... Size (Bytes)Version Block version number New protocol version 4hashPrevBlock 256-bit hash of the previous

block headerA new block comes in 32

hashMerkleRoot 256-bit hash based on allof the transactions in theblock

A transaction is accepted 32

Time Current timestamp asseconds since 1970-01-01T00:00 UTC

Every few seconds 4

Bits Current target in compactformat

The difficulty is adjusted 4

Nonce 32-bit number (starts at 0) A hash is tried (increments) 4

Block Hash345 981 000000000000000003e560d227c225b5cdf 7bcee3358d53222d5d0af 6240db4d


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Miners Claim New Issue And Transaction FeesReward for computing timestamp of new blocks [15]

New issue halves every four years.

Supply limited to 21M Bitcoins or21 × 1014 Satoshis.

Market sets transaction fees.


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Mining Is A Growing MarketMining uses custom processors (ASICs) and data centres [15]

Total investment ≥ $100M (est).

Rapid transition from CPUs to GPUs toFPGAs to ASICs.

Mining revenues $568M per annum.


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Miners Compete For Network ShareCosts determined by design of processors and data centres

X Incremental hashing capacity.

B Bitcoin price.

S + F New supply plustransaction fees.

h0 Initial hashing capacity.

C Operational costs.

z Technological factor ofproduction.

NRE Non-Recurring Engineeringcosts.

T Amortisation period.

π(X ) =X

h0 + X× B × (S + F ) − X × C − 1

T×(

X

z+ NRE

)(1)


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Profit Function Determines Network SizeKey points are function of technology and investment time horizon

Maximum hashrate

hCAP =B(S + F )

C(2)

Hashrate of maximum profitability

h∗ =

√h0B(S + F )

C + 1zT

(3)

Breakeven hashrate

hUpper/LowerBE = h0 +

(B(S + F ) − h0(C + 1zT

) − NRET

)

2(C + 1zT

)

±

√(B(S + F ) − h0(C + 1

zT) − NRE

T)2 − 4(C + 1

zT)h0

NRET

2(C + 1zT

)

(4)

Implied amortisation TImplied

From discriminant in Equation 4, calculate implied amortisation, TImplied , (shortestprofitable payback period).


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Moore’s Law Is Key Efficiency DriverSemiconductor technology will improve efficiency in near and medium term

C Operational cost.

CLC Co-location and power cost.

POW ASIC energy efficiency.

PUE Datacentre energyefficiency.

UTZ Equipment utilisation.

C =CLC × POW × PUE

UTZ(5)

CLC NRE INV POW PUE UTZ$/kW/month $ $/PHa/s W/GHa/s None None

Generation One 150 2M 10M 0.8 1.2 0.8Generation Two 100 4M 1M 0.4 1.1 0.9

Generation Three 50 8M 0.5M 0.1 1.03 0.99999

Table : Characteristic price and performance numbers for three generations of Bitcoinmining ASICs and their deployment environments [23, 24].


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Network Fast Approaching State Of The ArtFirst and second generations outdated at $219 and 327 PHa/s [15]

First generation no longer profitable.

Second generation close to economic limit.

Only Generation Three has short paybackTImplied .


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Network Has Room For GrowthGeneration Three can triple network size at current price

hLowerBE hUpper

BE h∗ hCAP MarginT = 0.5 PHa/s PHa/s PHa/s PHa/s %

Generation One nan nan nan 133 -146Generation Two nan nan nan 491 33

Generation Three nan nan nan 4660 93

T = 1Generation One nan nan nan 133 -146Generation Two nan nan nan 491 33

Generation Three 360 465 409 4660 93

T = 3Generation One nan nan nan 133 -146Generation Two nan nan nan 491 33


T = 5Generation One nan nan nan 133 -146Generation Two 340 352 346 491 33


Generation Three is “State of the Art”.

Maximum processor power efficiencydoubles every three years [25].


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Mining Has Room For Profitable GrowthOnly well capitalized miners with latest technology are competitive

Network size Mining network supports profitable growth to ≈ 1200 PHa/s.

Power usage Estimated total power requirement ≈ 120 MW (using Gen Three).

Efficiency Efficiency can improve substantially while Moore’s Law is valid.

Dynamics Miners will compete on technology, operational efficiency and costof capital.

Endstate Window to entry has narrowed, market will consolidate to 3-5leaders.

Revenues Revenues will shift from new issue to transfer fees.

Key factors Expectations of Bitcoin price and volatility will determine level ofinvestment (TMarket versus TImplied).

Surprises New applications, eg, merged mining with sidechains; newprocessor platforms, eg, graphene.


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About the Authors

Outline



3 About the Authors


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About the Authors

Some Relevant Previous Remarks

Bitcoin is potential dynamite waiting to be ignited.

— Communication with Teddy Shalon, August, 2011

Bitcoin can easily be projected to rise to $20 – $120 within three years.

— Communication with Pamir Gelenbe, January, 2013

We expect Bitcoin mining revenues to grow to $600M within three years . . . networkcapacity will rise 50–300×. The total energy requirement will be at least 12 MW andpossibly as much as 70 MW.

— Memorandum to Landsvirkjun, August, 2013 [26]

I encourage people to do their own research and only risk as much as they are willingto lose in Bitcoin or any other virtual currency.

— BBC Newsnight, November, 2013

MtGox failure is not systemic . . . trend of Bitcoin will continue upwards but will beinterspersed with price spikes and corrections.

— BBC World News & BBC World Business Edition, February, 2014


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About the Authors

References

[1] Satoshi Nakamoto. Bitcoin: A Peer-to-Peer Electronic Cash System. http://bitcoin.org. May 24, 2009.

[2] Wikipedia. Bitcoin. http://en.wikipedia.org. Retrieved April, 2015.

[3] Dirk Merkel. Bitcoin for beginners, Part 2. http://www.javaworld.com. December 6, 2011.

[4] Robleh Ali, John Barrdear, Roger Clews and James Southgate. Innovations in payment technologies and the emergence of digital currencies.http://www.bankofengland.co.uk. Quarterly Bulletin, Q3 2014.

[5] Bitgo. Based on graphic by Bitgo. http://www.bitgoinc.com/. Downloaded April, 2015.

[6] Adam Back, et al. Enabling Blockchain Innovation with Pegged Sidechains. http://www.blockstream. October 22, 2014.

[7] Financial Times. Iceland’s daring raid on fractional reserve banks. Financial Times. April 9, 2015.

[8] Wikipedia. Gold reserve. http://en.wikipedia.org. Retrieved June, 2013.

[9] Savills. UK Housing Stock Climbs [to] £5T. http://www.savills.co.uk. February, 2013.

[10] Global Finance. Payments Volumes Worldwide. http://www.gfmag.com. Based on BIS report published January, 2013.

[11] Ed Parry. Financials. https://www.paypal-media.com/about. Retrieved, April 2014.

[12] European Central Bank. Virtual Currency Schemes. http://www.ecb.europa.eu. October, 2012.

[13] Wikipedia. Network effect. http://en.wikipedia.org. Retrieved June, 2013.

[14] Wikipedia. Geometric Brownian motion. http://en.wikipedia.org. Retrieved June, 2013.

[15] Blockchain.info. Bitcoin Block Explorer. https://blockchain.info. Retrieved, April 17, 2015.

[16] Bitnodes. Global Bitcoin Node Distribution. https://getaddr.bitnodes.io. Retrieved, April 14, 2015.

[17] Sourceforge. Bitcoin. http://sourceforge.net. Retrived April, 2014.

[18] CoinDesk. State of Bitcoin 2015: Record Investment Buoys Ecosystem. CoinDesk. April 10, 2015.

[19] Wikipedia. Legality of Bitcoins by country. http://en.wikipedia.org/wiki/Legality_of_Bitcoins_by_country. Retrieved April, 2014.

[20] HMRC. Revenue & Customs Brief 09/14. http://www.hmrc.gov.uk. March, 2014.

[21] Bank of England. One Bank Research Agenda . http://www.bankofengland.co.uk. 2015.

[22] Wikipedia. SHA-2. http://en.wikipedia.org. Retrieved February, 2015.

[23] The Bitcoin Wiki. Mining hardware comparision. https://en.bitcoin.it. Retrieved, August, 2013.

[24] Nermin Hajdarbegovic. Kncminer plans 16nm bitcoin mining asic launch in 2015. CoinDesk. November 18, 2014.

[25] Jonathan Koomey & Samuel Naffziger. Moore’s Law Might Be Slowing Down, But Not Energ Efficiency. IEEE Spectrum. March 31, 2015.

[26] Jon H Egilsson & Sveinn Valfells. Global Payment Processing Using Icelandic Energy Resources. Memorandum for Landsvirkjun. August, 2013.


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http://en.wikipedia.org

http://www.javaworld.com

http://www.bankofengland.co.uk

http://www.bitgoinc.com/


http://www.savills.co.uk

http://www.gfmag.com

https://www.paypal-media.com/about

http://www.ecb.europa.eu



https://blockchain.info

https://getaddr.bitnodes.io

http://sourceforge.net

http://en.wikipedia.org/wiki/Legality_of_Bitcoins_by_country

http://www.hmrc.gov.uk

http://www.bankofengland.co.uk


https://en.bitcoin.it

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