Bitcoin and its copycat cryptocurrencies have gone through a life cycle like many other digital trends. They have gone faster than many, but it shows us what to expect when the next Hot New Thing appears. (Gartner Research calls the portion of technology development before results or lasting value are in evidence the “hype cycle.”)
The basic concept of Bitcoin is that each new coin mined is more expensive than the coins preceding it. This establishes a situation where early miners of coins have an asset whose value should naturally rise over time. To have a valuation at all, however, there must be a market for coins.
Because Bitcoin was a way to exchange value without going to the bank, it got some credibility as a subversive thing to do. Criminals started liking Bitcoin, although it remains to be seen whether the coins can all be retrieved and turned into cash. People who just prefer to be a little subversive also got into buying Bitcoin with hard currency.
Suddenly, Bitcoin was a hot topic in financial circles. The mania was on, and the valuations started leaping upward. Interestingly, all that was necessary for the value of Bitcoin to vary widely was for one of the investors to try to cash in, “take profits” as they say in market reporting. It turns out “sell high” is fine advice, but the timing can be difficult to get right.
With the mania came the copycats. Now there are over 1500 cryptocurrencies, most created when the mania was already evident, led by Bitcoin. There are still plenty of opportunities to get in on the ground floor for a cryptocurrency, it’s just going to be one you’ve never heard of.
Only a fraction of the current valuation of cryptocurrency is the cost of mining. A bigger factor in the stunning increases in valuation are the stunning number of speculators buying in.
The method of mining is to do a calculation that finds the next available number in a complex cryptography scheme. Each new coin mined is expensive because of the calculations required. Each new correct answer is found in the same way a computer hunts for the next prime number: by computing values in sequence and seeing if it is a fit. The method is called brute force. When Bitcoin first came to prominence, I made the assumption it was an experiment, with the hidden objective of testing just how secure our encryption methods are.
Perhaps the experiment is to follow the evolution of a new, digital mania?
The obvious cost of coinmining is the electricity. Each new coin mined requires even more computation time than the previous. How much can that be? There was news from Sweden that a data center was to be built, consuming 10 MW of power usage just for the calculations associated with coinmining. Forbes reports coinmining consumed about 20,000 GW-hours of energy in the past twelve months. 20,000 GW-hours per year is an awkward set of units for us technical types. That’s the same as 224 MW of electrical power. In contrast, Hoover Dam (when it has enough water in Lake Mead) can produce about 1345 MW of power.
Speculation into coinmining has a carbon footprint. But it’s okay, coinmining only uses about the same power as consumed by the entire nation of Ireland.
The expense comes not only in the operating cost of the electricity. There is also the need for the computers themselves. There are data centers built, with severs dedicated to the calculation. A new digital trend is officially in the mainstream when bricks and mortar are dedicated to the technology.
This is just a case of “sweat equity,” except the equity scales with effort, and more effort is easily available by using more computers. Unlike sweat equity in your house, wealthy folks can spend their money to use more virtual sweat to gain more equity than us ordinary folks.
There is more than one way to get more computing power. Malicious software that does mining calculations on other peoples’ computers are becoming more common. I was interested to learn that the most common coinmining attacks are just extra stuff added to existing malicious code that does something else as well. Virus have been around for a while, and malware has evolved over time. Criminals getting in on a hot new digital trend relatively early is unusual. Coinmining is basically an opportunity to spend effort to gain something of value, so it stands to reason people will try to spend other peoples’ effort for that value.
I’m unable to name another criminal act with a carbon footprint.
It also appears the cryptography on the digital “wallets” where the currency is kept isn’t so good. One source says over $1 Billion in market value has been stolen in just the past six months, with individual thefts in the hundreds of millions of dollars worth of digital information.
Finally, we’re seeing some evidence that blockchain, the technology behind cryptocurrency, might actually serve useful purposes. IBM is touting it for many purposes requiring the equivalent of a digital serial number on records. It looks like using blockchain to serial number copies of artworks and media, such as music, photos or movies, could help preserve digital rights.
There is no evidence that cryptocurrencies will hold lasting value. There is no evidence cryptocurrencies will be a good investment. I recall the DotCom bubble in the early 2000’s, when hundreds of new business models and thousands of copycats raised investment before they had any evidence they might be successful. Especially with the large number of competing currencies, it is clear a mania is underway. The disruption when the mania crashes is to be expected.
Like nearly all new digital trends, only when the hype subsides and the noise quiets down will we see the emergence of actual value.