Bitcoin Mining: Road to Riches for Some, Road to Ruin for Others

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Bitcoin mining, the road to riches for some, is becoming the road to ruin for others, as the costs of the equipment required to mine Bitcoin spirals out of control. Early adopters have made fortunes mining Bitcoin, but late arrivals are finding it difficult to do more than break even and those who are just now entering the Bitcoin mining industry might not even recoup their original investment.

There are now more than 220 digital currencies in circulation, most of them based on the Bitcoin model. They range in price from $27,505 for 42 Coin which, as the name implies, will only issue 42 coins, to a group of 40 to 50 currencies priced at one cent or less but, for most people, Bitcoin is synonymous with digital currency.

A Brief Primer on Bitcoin Mining At its simplest level, digital cryptocurrency mining is analogous to cracking a password, a process done every day by hackers all over the world. The simplest way to crack a password is to run through all the permutations of every possible password, one at a time, varying one character at a time until the right combination of letters and numbers unlocks the program. This process requires a great many calculations, rising to an order of magnitude of trillions of calculations per second.

In the digital currency world, Bitcoin miners are doing the same thing, throwing trillions of possible solutions for the same password code into the password field on a database file until the right one is found. Each time that someone solves the password, they receive a number of Bitcoins equal to the perceived difficulty of the solution, and additional "hashes" or decimal places are added to the "key code," making it that much harder for the next Bitcoin miner to solve the puzzle again.

The Development Curve from Geek Thing to Investment Vehicle After its secretive beginnings in 2009, Bitcoin grew slowly in popularity, staying under the mass media radar, known mostly to computer geeks and currency wonks who were able to get in on the ground floor. Early adopters could mine Bitcoins with nothing more than a personal computer and an internet connection. That changed gradually, as more and more people became aware of the potential for making vast sums of money by mining Bitcoins. As more people became Bitcoin miners, the more the complexity of the code increased, to the point where faster, more powerful computer systems forced the older, slower systems out of the business, creating a kind of Bitcoin arms race to see who could build the fastest Bitcoin mining machines.

The net result of these escalations has been to radically increase the entry level costs for would be Bitcoin miners from a few hundred dollars to as much as $20,000 for the latest state of the art equipment. The problem for the Bitcoin industry is that even with this heavy duty equipment, the average break even point is around 100 days. After 200 days, the machine that was state of the art six months ago is now obsolete because the Bitcoin software automatically increases the difficulty of the code to be broken by 10 percent every ten days. After 200 days, a typical system would be running at 25 percent of its original efficiency, too slow to win any Bitcoin, when competing with the even faster next generation of Bitcoin mining hardware.

This is analogous to the historic gold rushes of the 19th century, which began with individual prospectors panning for gold nuggets in streams around each strike in an ancient, labor-intensive process, but grew into heavy duty industrial operations that grind tons of rock to extract a few ounces of gold at a time in a capital-intensive environment.

The End Game for an Apocalyptic Currency Bitcoin has now reached the level of sophistication at which individual miners do not stand a chance against Bitcoin mining consortia, called "guilds" consisting of dozens to hundreds of Bitcoin miners who are pooling their computing power and dividing the proceeds when they are awarded Bitcoins.

According to the belief system about digital currencies, each digital currency has a set number of "coins" that will be generated. With Bitcoin, no more than 21 million coins will ever be issued. According to this theory, it should take 136 years to fully deploy the 20,999,999 coins the system is designed to produce under the current rules..if you believe the people at the Bitcoin Foundation, which controls the mining process. This creates a problem for anyone investing in Bitcoins because the Bitcoin Foundation is a self-perpetuating trade organization, whose dues paying members nominate and elect candidates to the Board of Directors, which has control over the Bitcoin code, including the power to issue more coins, reducing the value of existing coins.

Once the last coin has been issued, the Bitcoin mining process will shut down forever because there will be no more fresh Bitcoins to pay the miners with. Without the miners, there will be no one testing, evaluating and forcing updates to the encryption code. Without that service, there will be nothing to protect Bitcoin database - and the value of the currency - from hackers and other miscreants, including former Bitcoin miners from attacking the system, causing the value of the Bitcoins to plummet. Anyone still holding Bitcoins will be left holding the bag....but that will not happen until 2140, when the last Bitcoin is finally distributed.

Bitcoin enthusiasts believe Bitcoin will become the world's reserve currency, replacing the dollar as the international medium of exchange, making them Bitcoin millionaires. Bitcoin critics are convinced the end is coming a lot more quickly than 2140 due to a combination of bad publicity, increasing competition from other electronic currencies, increasing regulation by national governments, tax law change, and Mt. Gox-like collapses among Bitcoin players.

Bitcoin mining may have been a road to riches for some, but it may become the a road to ruin for others because, whenever the music finally stops, some people are going to get hurt.

By Alan M. Milner Look for me on Twitter@alanmilner

See also: Bitcoin Warning Signs for New Investors

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