Game Theory for Bitcoin mining

Following news that Marathon have successfully installed their large bitcoin mining software in Quebec, I take a look at whether or not this makes any sense.

Bitcoin mining is quite simple in terms of, if the monetary value of the bitcoins you mine is greater than your hardware and electricity costs, you make money.

It’s complex as the price of Bitcoin fluctuates and due to several other reasons I look at below.


Mining Rewards, 

Firstly, the Bitcoin rewards from mining half every four years. This means that for the same amount of computer processing power, the successful minor will only receive half the number of bitcoin that they were used to receiving over the previous four years.

As the money supply reduces over time, the currency is deflationary and is likely to increase in value purely on that basis. While this is great for libertarians who see a deflationary currency as a solution to the constant printing of money, it is a problem for those who have invested money in mining hardware equipment. It’s a bit like buying a coffee shop when you know customers will only pay £1.25 for a coffee in four years and £0.63 after eight.

This may not be a problem if the value of Bitcoin increases. If miners receive half as many bitcoins per block mined, but the value of Bitcoin is twice as high then it won’t make much difference to them. Yet while they could be receiving the same amount, if Bitcoin’s price keeps going up, they will also have to deal with increased competition.

bitcoin-2722388_1920

Secondly, Game Theory – what is it?

Game theory refers to a situation where two people both have an incentive to make a decision that leads to the most unfavourable outcome for both parties. (For more details look up the Prisoner’s Dilemma.)

The key thing with Bitcoin mining is that no matter how many miners there are, the same amount of bitcoin will be mined. Bitcoin is mined when computers solve complicated hashing algorithms. The Bitcoin software observes how fast computers are solving these algorithms and increases or decreases the difficult to ensure that they get mined at a constant rate.

Here’s an example:

If there were only two people, Adam and Ben, mining Bitcoin in the world and they have spent £100 each on equipment, the ratio of rewards would be 50:50.

Now, Adam decides to double his mining equipment, spending £100 more. Suddenly he is taking two thirds of all the rewards. (66:33)

Then, Ben gets annoyed and does the same. He spends £100.

Now, the reward ratio is back to 50:50 as they both have the same processing power.

Yet, while they were spending £100 each, they are now spending £200 each for the exact same rewards.

Here we can see that each party has an incentive to spend more money increasing their mining systems but that this leads to the most inefficient use of resources. This is because increasing mining power leads to an increase in the share of rewards but does not increase the total rewards available. It’s not surprising that this race has led to a massive increase in energy use and carbon emissions.

Predictions?

It’s entirely possible that many of these bitcoin mining operations could end up running at a loss. They have invested based on assumptions, that the price of Bitcoin will go up, that only so many miners will enter the field, that electricity won’t rise by too much. One solution is that they mine other cryptocurrency coins but it could be argued these are riskier to mine as only a few will survive in the long run.

Personally, I would suggest caution against going into Bitcoin mining because of this problem explained by game theory. To experiment with mining on a laptop or small mining rig, try an ASIC resistant coin such as GarlicCoin which you never know, could become the next DogeCoin.


 

Article written by Tim Copeland

None of this is financial advice. I take no responsibility for any decisions you may make.

Disclaimer: I own various cryptocurrencies that may include the topic of the article. My main holdings are in XRP, DGB, NANO.

To get Bitcoin or Ethereum, sign up to Coinbase.

To exchange for Ripple (XRP), NEO (NEO) or Litecoin (LTC), sign up to Binance.

If this post has informed you or helped in any way, feel free to donate ETH to 0x8c854F441248936BD12EB32373bb16Aa99129483

 

 

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