Cryptocurrencies — Just One Miner Thing

by John Dwyer, July 23, 2015
Industry Trends
Global, EMEA

Abstract

Bitcoin is approaching its seventh birthday, and despite the transactional history that now exists, the true potential of this technology is still obscure.

This report assesses where we are in the evolution of cryptocurrencies. Specifically, the report analyzes the economics of Bitcoin mining to build a picture of its efficiency as a system, its challenges, and the new approaches to distributed systems.

The success of Bitcoin will be driven by the success of Bitcoin mining and the efficient allocation of resources to this function. However, this report highlights a number of paradoxes which indicate that substantive changes may be required to the Bitcoin protocol.

These paradoxes include:

  • Mining permits value to be transmitted across the Bitcoin network securely. It is currently expensive and specifically designed to waste financial resources.
  • The number of BTC awarded to miners halves approximately every four years. Therefore, without an increase in the BTC price to offset this decline, the revenue from mining will fall to zero.
  • As the incentive to mine falls, mining capacity will leave the industry, and the cost of mining will fall. Consequently, this means a lower cost for a “51% attack” (a takeover of the currency) and thus greater risk of an attack.
  • Should the price of BTC rise, then the current trend of centralization of miners into pools would likely continue and thus raise the threat of a 51% attack.
  • Mining is a high-risk business. It was lucrative when BTC price was rising in 2012–2013, but since the price decline some high-profile miners have faced bankruptcy.
  • The cost of moving value via Bitcoin in a trustless environment, in a trusted way via the Proof of Work, is paid for by the capital providers to the miners, who then effectively subsidize the movement of value across the Bitcoin network.
  • Bitcoin is a decentralized autonomous organization, which means that no one person or party controls it. Thus, in order to make changes to the protocol, broad consensus from different parts of the ecosystem will be required, which could prove challenging.

“We are huge believers in the potential of distributed systems to radically drive innovation and disruption within finance, and we believe that the Blockchain is an incredible innovation,” says John Dwyer, a senior analyst at Celent and author of the report. “However, as we continue to analyze distributed systems and their impact, we will benchmark Bitcoin against ‘Blockchain 2.0,’ or new innovations that take some parts of the Blockchain, specifically the replicated ledger, and remove some of the flaws that we see in Bitcoin, specifically mining and Proof of Work.”

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned subsidiary of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

North America
Michele Pace
mpace@celent.com
Tel: +1 212 345 1366

Europe (London)
Chris Williams
cwilliams@celent.com
Tel: +44 (0)782 448 3336

Asia (Tokyo)
Yumi Nagaoka
ynagaoka@celent.com
Tel.: +81 3 3500 3023

Table of Contents

Executive Summary

1

 

Key Research Questions

1

 

Key Themes Driving Innovation and Disruption

1

 

Bitcoin’s Paradoxes

2

Three Important Dynamics

3

 

Technology and Finance

4

 

Technology and Regulation

4

 

Technology and Live Price

4

The Economics of Bitcoin Mining

5

 

Three Critical Correlations in Bitcoin

6

 

Two Key Observations of Procyclical Behavior

8

Conclusion: Assessing Bitcoin Vs. Our Five Key Themes

10

Leveraging Celent’s Expertise

11

 

Support for Financial Institutions

11

 

Support for Vendors

11

Related Celent Research

12

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