Will bitcoin become worthless?

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Since the peak of the bitcoin craze last year, bitcoin prices have been steadily declining throughout 2018. At this time one year ago, I argued that bitcoin is useless for anything else than speculation. While it is still possible to profit from speculation, the profitability of bitcoin mining is diminishing, and thus at risk of underpinning the whole fundament of bitcoin, making the uselessness of bitcoin absolute.

For those unfamiliar with the concept of bitcoin mining, this is both the way new bitcoins are created as well as and how bitcoin transactions are verified. As a result, if mining became unprofitable and ceased operations, bitcoin would become an illiquid asset that could not be bought or sold, thus rendering bitcoin not only useless but also worthless.

Looking at the development in the price of bitcoin the value of one bitcoin has dropped 80% from   18 500 USD in December 2017 to 3300 USD today. An analysis from Coinshares estimated a market-average all-in cost of creation of approximately $6,800 per bitcoin based on a market-average capex based on all available pricing information, electricity cost of ¢5/kWh as well as depreciation of mining hardware.

However, as the primary cost driver of bitcoin mining is the cost of electricity, mining prices vary significantly depending on the country. At today’s levels, the mining cost of bitcoin is more than twice the cost of mining copper and gold. A research report from Elite Fixtures, which looked at the mining cost of bitcoin mining across 115 countries shows a cost of mining span from as little as $531 to a stunning $26,170 as shown in the table below.

bitcoin mining
Source: Elite Fixtures

According to this research, average mining cost lies at 7200 USD, and median mining cost at 6300, leaving a vast majority of mining locations unprofitable.

Even though mining becomes unprofitable in many regions, it is estimated that as much as 70% of all global mining is located in China. More specifically in the Sichuan region, where electricity prices are as low as 0.4 yuan per kWh (0.06 USD) and have a cool climate as cooling is one of the largest overheads in crypto mining. However, with bitcoin prices at 3300 USD, we are getting dangerously close to a break-even cost even in China, which is estimated at 3172 USD according to Elite Fixtures.

Despite this development, bitcoin investors are predicting a comeback for bitcoin, as break-even cost of mining has correlated with bitcoin prices over time. This is mainly due to the fact that Bitcoin has an automatic adjustment mechanism to discourage miners from dropping out of the pool when the price falls. The algorithmic puzzles that miners have to solve become more difficult when Bitcoin’s price rises, and less difficult when the price falls.

To complicate things even further, Bitcoin trades much like a commodity, and over time, the market price of commodities tends towards their marginal cost of production. A commodity perspective of bitcoin mining cost versus bitcoin valuation does not add up as mining has a dual purpose. As described in the introduction, the primary job of bitcoin mining is transaction verification.

Even though the difficulty adjustment artificially preserves the profit margins of miners to ensure transaction verification, rewards for mining are diminishing, and it is likely that it eventually trend towards a zero marginal cost of production. About 17 million of 21 million bitcoins have already been mined. As more bitcoins are mined, the system increases the difficulty of the cryptographic hashes that must be solved. Bitcoin also cuts the number of coins awarded to a miner in half every 2.1 million blocks. In July 2016, the reward was halved from 25 coins to 12.5. In May 2020, it will drop to 6.25 coins. To continue to incentivize miners to verify transactions, the only way to offset this development is by rising transaction fees and lower attractivity as a currency. And as bitcoin becomes useless as a currency, it loses its intrinsic value as an asset.

From my perspective, bitcoin is equally useless as anything else than a speculative asset today as I stated one year ago. The way it looks today, bitcoin has to double in price to reach break-even at the average cost of mining. What remains to see is whether the value of bitcoin fall below 3000 USD and stay at those levels, as it will render the majority of bitcoin mining unprofitable. If this results in a cease of mining, bitcoin as an asset may become worthless.

2 thoughts on “Will bitcoin become worthless?

  • December 12, 2018 at 9:13 am
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    None of us can predict the future, whether it regards Bitcoin or anything else. What many “experts” seem to misunderstand, however, is what Bitcoin actually is, and how it works. I have teached the course “Bitcoin, blockchain technology and the digital economy” at the Western Norway University of Applied Science (HVL) this fall and am happy to say that at least 60 new students now know more about Bitcoin and blockchain technology than most of those who claim to know.

    The heated debate about reduced energy tax for bitcoin mining this year, has also brought all of the misunderstandings up in the light. First of all, as you also mention in your blog piece, the proof of work is for securing the overall system, not to create new bitcoins. The new bitcoins are merely a payment for the security job. The Norwegian concept “bitcoin-utvinning” is therefore misleading, it should rather be “bitcoin-sikring”. The report from Skattedirektoratet that lead to the decision of excluding crypto mining from the reduced energy tax, sadly got this wrong from the beginning.

    What is Bitcoin other than a speculative investment (but again: isn’t most of finance sector’s activity “speculative investments”?)? According to Naval Ravikant, Bitcoin is “a tool for freeing humanity from oligarchs and tyrants, dressed up as a get-rich-quick scheme.”. And the “dressed up as a get-rich-quick-scheme” has done a lot of damage.

    Bitcoin is a platform and a possible information infrastructure (Internet is the foremost example of an II). It is both money and an underlying payment infrastructure. And one of the ingenious things about Bitcoin is that these two are completely separated. Bitcoin transactions can be carried by any communication medium (smoke signals, short-wave frequency radio +++) and as long as the message eventually reaches a Bitcoin mining node, it will be processed.

    Bitcoin has had, and will have, a huge impact on our technology development. But whether the system will be called Bitcoin or something else, we don’t know. But one thing is quite clear: if blockchain technology will have an important impact on the future of the Internet, it will be the open, permissionless version. Cryptocurrency has come to stay!

    Reply
    • December 12, 2018 at 9:15 am
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      Insightful comment as usual. Let me know if you would like to contribute with a guest blog post regarding crypto

      Reply

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