Minting Money With Megawatts - How To Mine Bitcoin Profitably (University of Iceland)

1. c Copyright Sveinn Valfells & Jón Helgi Egilsson 2013-15. Creative Commons Attribution-NonCommercial-ShareAlike (CC BY-NC-SA) Minting Money With Megawatts How to mine Bitcoin profitably Sveinn Valfells, PhD1 & Jón Helgi Egilsson2 1 linkd.in/wtaHi5 2 Faculty of Economics University of Iceland Presented at University of Iceland, April 17, 2015 Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

2. Outline 1 A Brief Outline of Bitcoin 2 How to Mine Bitcoin Proﬁtably 3 About the Authors Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 2 / 23

3. A Brief Outline of Bitcoin Outline 1 A Brief Outline of Bitcoin 2 How to Mine Bitcoin Proﬁtably 3 About the Authors Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 3 / 23

4. A Brief Outline of Bitcoin Bitcoin Is A Platform For Storing And Transmitting Value Bitcoins are tokens for transacting on a distributed ledger, the blockchain [1, 2, 3] Figure : Private–public key public used for authentication (top); transactions broadcast on a peer-to-peer network (bottom). Figure : New transactions timestamped with SHA256 hash every 10m. Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 4 / 23

5. A Brief Outline of Bitcoin The Blockchain Has Many Potential Applications Bitcoin 2.0: Applications and extensions of the blockchain [5, 6] “[T]he distributed ledger underlying [the Bitcoin] payment systems is a signiﬁcant innovation” — Bank of England [4] Text, multimedia embedded into the blockchain. Multi-signature transactions. Colored coins: Tagged Bitcoins redeemable for assets. Sidechains: Alternate blockchains connected to Bitcoin blockchain. Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 5 / 23

6. A Brief Outline of Bitcoin Bitcoin Has Large Addressable Markets Bitcoins are fungible, divisible, impossible to counterfeit, supply is prescribed “Money is whatever is widely accepted, be it gold, bitcoin or the immovable circular stones of Yap in Micronesia.” — FT [7] Global asset classes (value storage) Private investment in gold >$1T [8]. London housing stock >£1T [9]. Global payment streams (value transmission) Growing global non-bank payments (major economies) >$609B (2011) [10]. PayPal 25% YOY increase in payment volume to $180B in 2013 [11]. “In an extreme case, virtual currencies could have a substitution eﬀect on central bank money if they become widely accepted.” — ECB [12] Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 6 / 23

7. A Brief Outline of Bitcoin Bitcoin Is Growing Like Bacteria In A Petri-Dish Money will rotate into cryptocurrencies from traditional assets, payment streams [13, 14, 15] Cryptocurrency economics: Endstate is one dominant network, 2–3 runners-up. Price Supply Market Cap Turnover Current $219 14.1M $3.1B $19.0B Annual growth rate 1.7× 0.3× 2.0× 2.0× Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 7 / 23

8. A Brief Outline of Bitcoin Bitcoin Ecosystem Is Rapidly Evolving Developed countries lead Bitcoin adoption [17, 18] Milestones to date (2009–15): > 5.5M downloads of oﬃcial client. 5M active hosted wallets. Accepted by 75,000 merchants. 300Petahash computing power. >$600M in venture funding from leading VCs. Ecosystem of exchanges, payment processors, ATMs, payment cards, wallets, miners, vault storage, PtP lending. Bitcoin foundation established. Over 6,000 full nodes active. Figure : Active Bitcoin nodes [16]. Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 8 / 23

9. A Brief Outline of Bitcoin Many Governments Recognize Bitcoin Regulatory framework for cryptocurrencies is falling into place [19, 20, 21] [Virtual currencies] may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system. — Ben Bernanke, November, 2013 Relevance Regulatory situation US Largest economy Federal authorities define as asset (IRS) or currency (FinCEN); CA legislates, NY regulates. CN 2nd largest economy Credit bubble, FX controls in place, authorities effectively shutting down Bitcoin exchanges. DE Largest EU economy Recognized as “private money”. UK Largest FX/gold markets Same tax treatment as FX and investment gold. Bank of England research into use of digital currencies. Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 9 / 23

10. A Brief Outline of Bitcoin Bitcoin Is Not Fully De-Risked Mainstream adoption faces hurdles For Strong brand recognition. 5+ years of development. Diverse community of committed participants. Rapidly growing market cap, turnover. Rapidly growing ecosystem. Regulatory acceptance in many key jurisdictions. Against Consumer adoption still limited. Market cap small, liquidity low. Ecosystem immature. Conﬂicting regulatory approaches. Concentrated ownership. Potential for market manipulation, collusion. Regulatory uncertainty in some key jurisdictions. Lack of price anchoring. Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

11. How to Mine Bitcoin Profitably Outline 1 A Brief Outline of Bitcoin 2 How to Mine Bitcoin Profitably 3 About the Authors Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

12. How to Mine Bitcoin Profitably Hashes Protect The Integrity Of The Blockchain Miners search for SHA256 hashes of new block headers [22] SHA256 example: The quick brown fox jumps over the lazy dog c03905fcdab297513a620ec81ed46ca44ddb62d41cbbd83eb4a5a3592be26a69 Blockchain hashing: Field Purpose Updated when... Size (Bytes) Version Block version number New protocol version 4 hashPrevBlock 256-bit hash of the previous block header A new block comes in 32 hashMerkleRoot 256-bit hash based on all of the transactions in the block A transaction is accepted 32 Time Current timestamp as seconds since 1970-01- 01T00:00 UTC Every few seconds 4 Bits Current target in compact format The difficulty is adjusted 4 Nonce 32-bit number (starts at 0) A hash is tried (increments) 4 Block Hash 345 981 000000000000000003e560d227c225b5cdf 7bcee3358d53222d5d0af 6240db4d Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

13. How to Mine Bitcoin Profitably Hashes Protect The Integrity Of The Blockchain Miners search for SHA256 hashes of new block headers [22] SHA256 example: The quick brown fox jumps over the lazy dog. b47cc0f104b62d4c7c30bcd68fd8e67613e287dc4ad8c310ef10cbadea9c4380 Blockchain hashing: Field Purpose Updated when... Size (Bytes) Version Block version number New protocol version 4 hashPrevBlock 256-bit hash of the previous block header A new block comes in 32 hashMerkleRoot 256-bit hash based on all of the transactions in the block A transaction is accepted 32 Time Current timestamp as seconds since 1970-01- 01T00:00 UTC Every few seconds 4 Bits Current target in compact format The difficulty is adjusted 4 Nonce 32-bit number (starts at 0) A hash is tried (increments) 4 Block Hash 345 981 000000000000000003e560d227c225b5cdf 7bcee3358d53222d5d0af 6240db4d Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

14. How to Mine Bitcoin Proﬁtably Miners Claim New Issue And Transaction Fees Reward for computing timestamp of new blocks [15] New issue halves every four years. Supply limited to 21M Bitcoins or 21 × 1014 Satoshis. Market sets transaction fees. Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

15. How to Mine Bitcoin Proﬁtably Mining Is A Growing Market Mining uses custom processors (ASICs) and data centres [15] Total investment ≥ $100M (est). Rapid transition from CPUs to GPUs to FPGAs to ASICs. Mining revenues $568M per annum. Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

16. How to Mine Bitcoin Proﬁtably Miners Compete For Network Share Costs determined by design of processors and data centres X Incremental hashing capacity. B Bitcoin price. S + F New supply plus transaction fees. h0 Initial hashing capacity. C Operational costs. z Technological factor of production. NRE Non-Recurring Engineering costs. T Amortisation period. π(X) = X h0 + X × B × (S + F) − X × C − 1 T × X z + NRE (1) Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

17. How to Mine Bitcoin Profitably Profit Function Determines Network Size Key points are function of technology and investment time horizon Maximum hashrate hCAP = B(S + F) C (2) Hashrate of maximum profitability h∗ = h0B(S + F) C + 1 zT (3) Breakeven hashrate h Upper/Lower BE = h0 + (B(S + F) − h0(C + 1 zT ) − NRE T ) 2(C + 1 zT ) ± (B(S + F) − h0(C + 1 zT ) − NRE T )2 − 4(C + 1 zT )h0 NRE T 2(C + 1 zT ) (4) Implied amortisation TImplied From discriminant in Equation 4, calculate implied amortisation, TImplied , (shortest profitable payback period). Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

18. How to Mine Bitcoin Profitably Moore’s Law Is Key Efficiency Driver Semiconductor technology will improve efficiency in near and medium term C Operational cost. CLC Co-location and power cost. POW ASIC energy efficiency. PUE Datacentre energy efficiency. UTZ Equipment utilisation. C = CLC × POW × PUE UTZ (5) CLC NRE INV POW PUE UTZ $/kW/month $ $/PHa/s W/GHa/s None None Generation One 150 2M 10M 0.8 1.2 0.8 Generation Two 100 4M 1M 0.4 1.1 0.9 Generation Three 50 8M 0.5M 0.1 1.03 0.99999 Table : Characteristic price and performance numbers for three generations of Bitcoin mining ASICs and their deployment environments [23, 24]. Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

19. How to Mine Bitcoin Profitably Network Fast Approaching State Of The Art First and second generations outdated at $219 and 327 PHa/s [15] First generation no longer profitable. Second generation close to economic limit. Only Generation Three has short payback TImplied . Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

20. How to Mine Bitcoin Profitably Network Has Room For Growth Generation Three can triple network size at current price hLower BE hUpper BE h∗ hCAP Margin T = 0.5 PHa/s PHa/s PHa/s PHa/s % Generation One nan nan nan 133 -146 Generation Two nan nan nan 491 33 Generation Three nan nan nan 4660 93 T = 1 Generation One nan nan nan 133 -146 Generation Two nan nan nan 491 33 Generation Three 360 465 409 4660 93 T = 3 Generation One nan nan nan 133 -146 Generation Two nan nan nan 491 33 Generation Three 331 1245 642 4660 93 T = 5 Generation One nan nan nan 133 -146 Generation Two 340 352 346 491 33 Generation Three 329 1768 762 4660 93 Generation Three is “State of the Art”. Maximum processor power efficiency doubles every three years [25]. Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 1 / 23

21. How to Mine Bitcoin Profitably Mining Has Room For Profitable Growth Only well capitalized miners with latest technology are competitive Network size Mining network supports profitable growth to ≈ 1200 PHa/s. Power usage Estimated total power requirement ≈ 120 MW (using Gen Three). Efficiency Efficiency can improve substantially while Moore’s Law is valid. Dynamics Miners will compete on technology, operational efficiency and cost of capital. Endstate Window to entry has narrowed, market will consolidate to 3-5 leaders. Revenues Revenues will shift from new issue to transfer fees. Key factors Expectations of Bitcoin price and volatility will determine level of investment (TMarket versus TImplied ). Surprises New applications, eg, merged mining with sidechains; new processor platforms, eg, graphene. Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 2 / 23

22. About the Authors Outline 1 A Brief Outline of Bitcoin 2 How to Mine Bitcoin Proﬁtably 3 About the Authors Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 2 / 23

23. About the Authors Some Relevant Previous Remarks Bitcoin is potential dynamite waiting to be ignited. — Communication with Teddy Shalon, August, 2011 Bitcoin can easily be projected to rise to $20 – $120 within three years. — Communication with Pamir Gelenbe, January, 2013 We expect Bitcoin mining revenues to grow to $600M within three years . . . network capacity will rise 50–300×. The total energy requirement will be at least 12 MW and possibly as much as 70 MW. — Memorandum to Landsvirkjun, August, 2013 [26] I encourage people to do their own research and only risk as much as they are willing to lose in Bitcoin or any other virtual currency. — BBC Newsnight, November, 2013 MtGox failure is not systemic . . . trend of Bitcoin will continue upwards but will be interspersed with price spikes and corrections. — BBC World News & BBC World Business Edition, February, 2014 Sveinn Valfells, PhD & J´on Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 2 / 23

24. About the Authors References [1] Satoshi Nakamoto. Bitcoin: A Peer-to-Peer Electronic Cash System. http://bitcoin.org. May 24, 2009. [2] Wikipedia. Bitcoin. http://en.wikipedia.org. Retrieved April, 2015. [3] Dirk Merkel. Bitcoin for beginners, Part 2. http://www.javaworld.com. December 6, 2011. [4] Robleh Ali, John Barrdear, Roger Clews and James Southgate. Innovations in payment technologies and the emergence of digital currencies. http://www.bankofengland.co.uk. Quarterly Bulletin, Q3 2014. [5] Bitgo. Based on graphic by Bitgo. http://www.bitgoinc.com/. Downloaded April, 2015. [6] Adam Back, et al. Enabling Blockchain Innovation with Pegged Sidechains. http://www.blockstream. October 22, 2014. [7] Financial Times. Iceland’s daring raid on fractional reserve banks. Financial Times. April 9, 2015. [8] Wikipedia. Gold reserve. http://en.wikipedia.org. Retrieved June, 2013. [9] Savills. UK Housing Stock Climbs [to] £5T. http://www.savills.co.uk. February, 2013. [10] Global Finance. Payments Volumes Worldwide. http://www.gfmag.com. Based on BIS report published January, 2013. [11] Ed Parry. Financials. https://www.paypal-media.com/about. Retrieved, April 2014. [12] European Central Bank. Virtual Currency Schemes. http://www.ecb.europa.eu. October, 2012. [13] Wikipedia. Network effect. http://en.wikipedia.org. Retrieved June, 2013. [14] Wikipedia. Geometric Brownian motion. http://en.wikipedia.org. Retrieved June, 2013. [15] Blockchain.info. Bitcoin Block Explorer. https://blockchain.info. Retrieved, April 17, 2015. [16] Bitnodes. Global Bitcoin Node Distribution. https://getaddr.bitnodes.io. Retrieved, April 14, 2015. [17] Sourceforge. Bitcoin. http://sourceforge.net. Retrived April, 2014. [18] CoinDesk. State of Bitcoin 2015: Record Investment Buoys Ecosystem. CoinDesk. April 10, 2015. [19] Wikipedia. Legality of Bitcoins by country. http://en.wikipedia.org/wiki/Legality_of_Bitcoins_by_country. Retrieved April, 2014. [20] HMRC. Revenue & Customs Brief 09/14. http://www.hmrc.gov.uk. March, 2014. [21] Bank of England. One Bank Research Agenda . http://www.bankofengland.co.uk. 2015. [22] Wikipedia. SHA-2. http://en.wikipedia.org. Retrieved February, 2015. [23] The Bitcoin Wiki. Mining hardware comparision. https://en.bitcoin.it. Retrieved, August, 2013. [24] Nermin Hajdarbegovic. Kncminer plans 16nm bitcoin mining asic launch in 2015. CoinDesk. November 18, 2014. [25] Jonathan Koomey & Samuel Naffziger. Moore’s Law Might Be Slowing Down, But Not Energ Efficiency. IEEE Spectrum. March 31, 2015. [26] Jón H Egilsson & Sveinn Valfells. Global Payment Processing Using Icelandic Energy Resources. Memorandum for Landsvirkjun. August, 2013. Sveinn Valfells, PhD & Jón Helgi Egilsson Minting Money With Megawatts Presented at University of Iceland, April 17, 2015 2 / 23