There is no crypto or blockchain company in the world more synonymous with mining than Bitmain. According to research from Sanford C. Bernstein & Co, the company owns 85% of the market for mining chips, which are the figurative brains inside special purpose-built computers that process transactions and produce new units of a given crypto asset. Furthermore, the company controls the most hashing power on the Bitcoin network (almost 35%) of any entity via its controlling stake in the network’s two largest pools, BTC.com and AntPool. This number may not mean much to casual observers and enthusiasts, but in crypto a miner, or set of miners, only needs to manage 51% of a network’s hashing (computer) power to control it.
That said, Bitmain’s pole position is not impervious, and the company’s public listing is taking place in a time of extreme uncertainty and turmoil within the broader mining community. Although crypto mining was an innovative solution to what was once an intractable problem, it is far from perfect and in some ways its flaws are growing. For instance, the process is expensive, wasteful, and leading to centralization in the sector. Therefore, the teams and developers behind Bitcoin and other platforms such as Ethereum, Monero, and the SIA blockchain seeking ways to block or reduce Bitmain’s, and its direct competitors’, power over their networks.
Anybody investing in Bitmain, purchasing a miner, or acquiring any of the crypto assets are mined needs to understand a few key items regarding the industry and its future outlook.
- Mining Is a Key Enabler of Decentralized Network Security
Blockchains are powerful because they are able to do something that centralized databases cannot, which is to facilitate agreement on the current state of a network in a trustless environment. They can do this because they utilize a sophisticated algorithmic process that enables all users to validate and disseminate authentic transactions, while at the same time block illegitimate and duplicative ones. The transaction verification process seeks to prove common-sense facts about a transaction, such as whether or not the sender has sufficient funds in its account and those funds have not already been sent to a different recipient. All of this is enabled by a program called a ‘consensus mechanism’. There are a variety of ways to reach consensus, with the most common being of Proof of Work (PoW).
Under PoW, participating nodes lend their computational power to a network, where they race against each other to solve a complex computational problem while simultaneously gathering and grouping legitimate transactions together into blocks. The winning node adds its block to the top of the chain and gets a reward in the form of new crypto. For example, the current mining reward for the Bitcoin blockchain is 12.5 Bitcoins, worth approximately $82k under today’s prices.
- By Design, Mining is Not an Efficient Process
The Proof of Work algorithms employed by Bitcoin, Litecoin, Ethereum, and other blockchains require a process known as ‘brute force computing’. This means that solving the complex computational problem that gives a miner the right to add a block to a network can only be done by randomly guessing solutions as fast as possible. There is no way to game the process or get an advantage over the competition other than by buying a higher number of more powerful computers. Furthermore, solving one block does not give a miner an advantage over the competition when it comes to a subsequent or future block.
It is also important to note that under Proof of Work blocks are added to their respective chains under specific time intervals, regardless of how much computing power is on the network. For example, Bitcoin adds a block on average every 10 minutes. To maintain this pace, the network automatically adjusts/increases the difficulty of the computational problem that miners are trying to solve. Simply put, there are no economies of scale when it comes to mining.
- Mining has Become an Arms Race
There is a direct correlation between the computer or hashing power that a miner controls and their expected success rate. This set off an arms race that has created exponential growth for companies like Bitmain, but which also threatens the overall decentralization and sustainability of networks like Bitcoin. When Bitcoin was first created nearly-ten years ago, blocks could easily be mined on basic computer Central Processing Units (CPUs). Eventually, it was discovered that Graphical Processing Units (GPUs) could be repurposed to mine crypto at a higher success rate than CPUs. As the price of Bitcoin and other assets accelerated, developers in the community created Application Specific Integrated Circuits (ASICs), which are highly efficient microchips that are custom-built for one specific purpose, to randomly guess solutions to the PoW algorithm employed by any given blockchain. The top ASIC miners can run between 14-16 terahashes (guesses)/second and cost thousands of dollars.
Unfortunately, given the price appreciations throughout crypto in recent years, not to mention the gold rush that took place in late 2017, mining any sort of PoW cryptocurrency profitably requires the individual to either purchase an ASIC miner or join a mining pool that shares revenue based on allocated computer power. It is also very helpful if the individual purchasing the miners is based in a cold climate to keep the machines cool and has access to cheap electricity, as this cost directly impacts the overall profitability of any mining operation. Recent studies have shown that Bitcoin’s energy consumption is analogous to the amount of electricity necessary to power a country like Switzerland for a year.
According to Bitmain’s IPO filing, the company earned $2.25 billion in revenue in 2017 from mining hardware sales and brought in $2.68 billion in sales during the first half of 2018. There is a saying that in a gold rush the only people who make money are those that sell the shovels; if that is the case then Bitmain is following this strategy perfectly.
- Bitmain’s Pole Position is Vulnerable
Despite Bitmain’s success to date, its executives may not sleeping well at night for a number of reasons. For one, their industry is becoming more competitive every day, and Bitmain must continue investing hundreds of millions of dollars in new ASIC chips to maintain its technological superiority and market share. For instance, one of Bitmain’s top competitors – if there is such a thing – Innosilicon claims to now have an ASIC miner called the Terminator3 (T3) that is superior to any miner on the market today based on speed, profitability, and overall efficiency. The T3 will be released in December this year. Startups continue to target the industry as well, with companies such as Squire who just raised $20 million to build ASIC miners.
That said, many crypto enthusiasts and interested parties do not feel that the answer to mining’s shortcomings is more efficient and powerful miners. There is a growing belief in the industry that mining should one day be avoided altogether, or at the very least the industry should become less reliant on ASICs, which as noted earlier consume huge amounts of energy and trend towards centralization. Parties looking for a complete shift away from Proof of Work typically advocate for a Proof of Stake (PoS) consensus mechanism. There are many variants of PoS, which are beyond the scope of this article, but in general the common denomination for any PoS system is that the nodes that add blocks place use a portion of their crypto holdings as collateral or a security deposit. If the validators do not act in appropriately in their role they risk losing all or a portion of their funds. Peercoin is the first cryptocurrency that utilized PoS, and most notably Ethereum is looking to transition into a PoS system. New blockchains such as Cardano are also implementing PoS. PoS systems are designed to require significantly less energy than PoW while offering the same level of security. There are also proposed throughput and scalability benefits to a PoS model, though none of this is proven at scale.
The other main strategy being utilized is altering the hashing algorithm of PoW systems to make them ASIC-resistant. As noted above, ASIC chips are designed to be highly efficient at one very specific activity, which could be running a given hashing function. If developers introduce subtle changes to an existing algorithm, it would make every ASIC miner running the old function obsolete. This is a strategy that was undertaken by privacy-focused Monero earlier this year. Additionally, the team behind the Sia blockchain just announced that they would do the same. However, in an interesting twist they are not completely making their blockchain ASIC-resistant, just incompatible with large-scale miners such as Bitmain. It will remain to be seen how strategies like these will work as miners such as Bitmain continue to try and diversify the blockchains that their miners can support. Most likely, it will turn into a bit of a cat and mouse game.
The current inflection point that the mining industry faces was in some ways inevitable. In the same way that Bitcoin’s pseudonymous creator Satoshi Nakamoto could not have predicted the protracted Bitcoin blocksize debate that dominated the industry for the last two years, it is hard to imagine that he or she could have foreseen the development of ASICs. In some ways, perhaps they would have been welcomed in the sense that their introduction meant that Bitcoin, and the broader crypto industry, had grown significantly. So, perhaps it is a positive that we reached this point. At the same time, now that we are here a significant shakeup is likely coming in the near-mid term. It will be critical for interested parties to follow the news closely.