Hashing Out Hashrates

Understanding Bitcoin’s Network Hashrate as a Market In Its Own Right

All data as at December 1 2014

Introduction• This presentation will focus on the economics of

Bitcoin’s Network Hashrate – glossing over the technological complexities

• Give viewers an idea on the make-up of the network, and how this may evolve in the future due to underlying economic and business fundamentals

Understanding Hashrate• What is Network Hashrate, and what does it

tell us?

• Nature & Drivers of Growth

• Nature of Competition

• The Profit Motive: To mine or not to mine

What is “Network Hashrate”?• In the simplest terms, it is the amount of incentivised

computing power currently administering and securing the Bitcoin Blockchain

• Hashrate change is proportionately tied to difficulty changes every 2016 generated blocks (around two-weeks), to ensure a consistent and predictable block generation cycle of around 10 minutes.

• E.g. if Hashrate rises 10% during a 2016 block cycle, difficulty will rise 10%. If Hashrate decreases by 5%, difficulty will decrease by 5%, etc.

Recent Growth History• Since the November 2012 Reward-Halving, the

network has seen 62 difficulty changes, with an average difficulty change of +16.95%, with a standard deviation of +11.51%.

• Average time between difficulty changes has been 11.98 days, with a standard deviation of 1.26 days

• The difficulty has decreased 3 times since the halving, with the most recent time being in January 2013

Recent Growth History

Nature & Drivers of Growth• Main Inter-dependent Drivers

– Prevailing Market Price of BTC (Supply/Demand-Driven)– Prevailing Cost to Mine BTC– Competition in the Mining Industry– State of Mining Technology ($/GH, J/GH)

• This does not differ meaningfully from traditional physical commodities markets, like Gold and Iron Ore Mining

Supply & Demand / Cost & Price• In Short-term Equilibrium…

– If Cost to Mine < Cost to Buy, Mine -------> Hashrate Increase– If Cost to Mine > Cost to Buy, Buy --------> Hashrate Decrease

• In Medium-to-Long-term Equilibrium…– If Demand Exceeds Supply -> Price Increases -> Hashrate Increases– If Supply Exceeds Demand -> Price Decreases -> Hashrate

Decreases

• Sustained periods of increases or decreases in hashrate may indicate the strength of supply and demand forces / health of the market

Perfect Competition & Bitcoin Mining

Market

CharacteristicApplication to Bitcoin (short-to-medium-term: 0 – 3 years)

Application to Bitcoin (long-term: 3

years+)

All market

participants are

“price takers”

“Temporary price makers” dump/buy vast amounts of coins

on an exchange, causing dramatic instantaneous

negative/positive price movement, respectively. Once done

however, market power and future effects are

proportionately permanently reduced.

As bitcoins become less

concentrated due to inherent

scarcity, the gross majority of all

market participants will become

price takers

Homogeneous

Products

All bitcoins are homogenous and identical for the gross majority of practical intents

and purposes, and will always be.

No barriers of

entry and exit

No onerous barriers to entry or exit can by created by incumbents to restrict

competition due to Bitcoin’s open-source and global nature, and impracticality of

unified global regulation or licencing requirements, and this will always be the case

Property RightsThe Blockchain ensures that there is no doubt about ownership of Bitcoins and their

owner’s rights, and this will always be the case

Market Characteristic Application to Bitcoin (short-to-medium-term: 0 – 3 years)Application to Bitcoin (long-term: 3

years+)

A Large number of

buyers and sellers

There is currently only a relatively small number of buyers

and sellers compared to traditional markets, however, this

number is increasing exponentially in an analogous way to

other network-effect based disruptive technologies

Large number of different types

of buyers and sellers (investors,

merchants, exchanges,

remittance, etc.)

Zero transaction

costs

Transactions are theoretically free – but free transactions

are subject to the possibility of delays. Fees are not set by

the market, and are voluntary based on desired transaction

speed.

Transaction costs will be near

zero

Perfect Factor

Mobility

Factors of production (Location, Labour & Capital) are

almost perfectly mobile, allowing for adjustments to

changing market conditions

Factors of production are

perfectly mobile in the long

term

Non-increasing

returns to scale

Non-increasing returns to scale when an individual miner

or pool of miners approach 50% of network power. Huge

disincentives to exceed 50% of network hashing power.

Non-increasing returns to scale

Market CharacteristicApplication to Bitcoin (short-to-medium-term: 0 – 3

years)Application to Bitcoin (long-term: 3 years+)

Profit

Maximisation

Miners will sell at the intersection of

Marginal Cost and Marginal Revenue, except

during positive/negative hype cycles, where

sales strategy differs wildly across the

industry

Miners will sell at the intersection of Marginal

Cost and Marginal Revenue

Perfect

Information

In the short term, “Price Makers” prevent the

overall market from having access to perfect

information, as they can individually

influence market price.

Due to the open-source nature of Bitcoin, in

the long term, all consumers and producers

are assumed to have perfect knowledge of

price, utility, quality and mining methods.

No externalities

The only externalities are emissions due to

proportion of network using fossil-fuel to

provide electricity for mining, and waste

produced by obsolete mining equipment.

Externalities trending to zero due to

decentralised low-emission electricity (Solar,

Fuel Cell), and improvements in recycling

Trends & Heuristics• It suggested that in a

competitive market place, there is a natural tendency for the market to be dominated by three or four players – known as “The Rule of Three” (Henderson, 1976).

• This hypothesis was tested by observing the evolution of roughly 200 competitive markets (Sheth & Sisodia, 2002).

Trends & Heuristics

• Typical S&P500 Tech-Sector profit margin > 20%

– Semiconductor Businesses = 18-22% (source: http://www.businessinsider.com.au/sector-profit-margins-sp-500-2012-8)

• Profits are typically high in new markets

– Apple’s Original iPhone (2007) helped Apple achieve profits >16% for long periods of time until smartphone competition intensified.

The Cutting Edge –The Difference 6 Months Can Make

June 2014 December 2014 % Change

Hashrate 100,000,000 GH/s 300,000,000 GH/s + 300%

Retail-Best Miner Cointerra Terraminer IV Bitmain Antminer S4*

$/GH $2.99 $0.41 - 87.3%

W/GH 1.1 0.69 - 32.5%

* - Spondoolies-Tech SP-20 and ASICMiner Prisma have very similar $/GH and W/GH performance

Trends & Heuristics• Moore’s Law (and it’s

several variations) -> $/GH will become cheaper at a non-linear rate for the foreseeable future

• Koomey’s Law: GH/J has been doubling approx. every 1.5 years since the 1950s, and has been faster than Moore’s law.

Trends & Heuristics

• “Our goal is to get to 0.05 W/GHs, 0.03 $/GHs miners by mid 2015 and power more than 30% of the bitcoin network," Corem explained, adding that he believes these figures will help the company match its rival firms in the US and China”

- Guy Corem, CEO, Spondoolies-Tech

The Mining Mix

* Cloud miners sampled include PBMining (4.2PH/s), Cloudhashing.com ( 3.5PH/s @ $0.59/GH), Hashnest (3PH/s @ $0.44), Cex.io (2PH/s @ $0.63/GH)

Miner Type% of Network

HashrateTypical $/GH Typical W/GH

Cloud-Miners* ~5% $0.63 ~ 0.7

Retail-Miners 30% (+/- 10%) $0.4 0.69

Manufacturer-Miners 65% (+/- 10%) ~$0.30 ~0.50

The Mining Mix• The “Weighted Network-Average Miner” would mine for

between $0.3365 to $0.3565/GH and 0.548 to 0.586 W/GH

• This heuristic allows us to estimate the following, within a range of +/- 20%:

– Approximate cost to attempt sustained 51% attack

– Approximate cost to mine a Bitcoin

Conclusion• It’s not rocket science! Understanding it is just a mix of

understanding disruptive evolutionary technologies and managerial economics.

• Perfectly Competitive Markets tend to stay that way in the long-term – so expect more groundbreakingtechnological improvements, more competition, and more of the same old managerial economics at work!