Bitcoin was the hottest investment in the last few years. Touted by many as the new digital gold, crowds of crypto fanatics have been driving its price higher. There is no doubt that the invention of cryptocurrencies has been a great achievement. No longer are we dependent on currencies issued by Central Banks. This decentralized currency has many advantages. It allows holders to perform transactions without being tracked. This is the main reason Bitcoin is highly used among dark web users, and the prefered currency among people involved in illegal activities.
Being a decentralized currency, prevents third-party seizures and taxes from being charged on both the transactions and potential capital gains. As Bitcoin approaches a new all time high, it is important to keep in mind its limitations. On one hand the fact that Bitcoin is a completely computerized currency. Allows highly skillful hackers to easily steal it. The fact that it is untrackable is a double edged sword. As we have seen in 2018, $1.1 billion worth of cryptocurrency was easily stolen. Recently the Feds have seized $1 billion in stolen Bitcoin from Silk Road, once the biggest marketplace on the dark web.
Given the decentralized aspect of Bitcoin. It relies heavily on Bitcoin miners. These 21st century miners do not use pickaxes or canaries to warn them when to run. They mine virtual gold that is incredibly scarce and highly valued. They rely on powerful hardware connected in order to process transactions. As transactions are processed miners unlock new Bitcoin blocks. There are only 21 million Bitcoins available. In the first 10 years since the launch of Bitcoin 18.5 million coins have been minted. That leaves roughly 2.5 million Bitcoins to be mined until 2140. Based on Zeno’s paradoxes, the output of Bitcoins mined is reduced every 4 years.
So far Bitcoin mining has been an incredibly profitable activity. But that is not guaranteed to continue. In essence Bitcoin miners rely on different variables. Despite that it is mainly influenced by two main variables. The price of the Bitcoin they mine and their electricity cost to process the transactions. Given that Bitcoin has been trading around all time highs, even with the reduction this year in mining blocks. The increase in price has made up for that. Instead miners focus most of their attention on energy costs and hardware efficiency. Choosing the right hardware is one of the most important steps in setting up your Bitcoin mine.
How Difficulty Affects Miners
This is because choosing the right hardware can provide big long term efficiency. Bitcoin miners study relentlessly the efficiency of different GPUs and CPUs. Mainly in terms of power consumption and hash rate. The speed at which a computer can complete an operation in Bitcoin code is commonly designated as hash rate. Another variable to keep in mind is difficulty. Since Bitcoin blocks are assigned to miners randomly. The difficulty defines the average time between blocks of crypto.
Difficulty has been increasing exponentially, due to the reduction of blocks available to mine. Businesses with high operating margins are usually bound to face a lot of competition. As competitors see the profitability and jump onto the bandwagon. The same has been true for crypto mining. Not only have blocks diminished, but the increased competition has made it increasingly difficult to mine a single block.
The following simplified formula is the easiest way to calculate the expected profit of cryptocurrency miners:
The hashrate determines the processing power of the network. In essence it is the speed at which miners can solve the puzzles. It differentiates efficient and inefficient miners, and it is mainly driven by GPU, software and overclocking. Overclocking is simply a way to set up your hardware so it can extract the most performance possible.
There are a number of risks and factors miners and bitcoin buyers relying on the network need to consider:
On one hand, the increased competitiveness can hinder the profitability of most miners. As the number of blocks available to mine will eventually decrease even more in 2024. This in turn could pose a threat to the blockchain system. If the competition is too fierce, miners may not be able to mine the amount of Bitcoin needed to even break-even.
What if the price of Bitcoin decreases
Another factor to keep in mind is the price of Bitcoin. If Bitcoin prices decline to a certain threshold, mining may become an unprofitable activity. Given that the competition has increased tremendously over the years, Bitcoin miners see their margins shrink day by day. The only thing supporting and increasing their margins is the price at which Bitcoin trades.
What happens after 2140?
Another important question that nobody seems to be able to answer is what happens after 2140. In 2140 the last Bitcoin will be mined. When that happens independently of the price of Bitcoin, what will be incentive for miners to keep on processing transactions? Nobody seems to be able to understand the risk that this poses to the whole system. One of Bitcoin’s advantages is the fact that there are no transaction costs.
This happens because miners are able to mine Bitcoin as they process transactions. Possibly miners will only receive a transaction fee. When there is little incentive to miners what will happen to Bitcoin? Who wants to hold a cryptocurrency that you cannot transact with? Bitcoin fanatics usually use the argument that Bitcoin has a finite supply of 21 million. But in reality they never dig deep enough to realize that unless the supply increases, there will be no miners to process their transactions.
Cashless Transactions Worldwide
Another aspect that is usually overlooked is the fact that Bitcoin transactions are extremely inneficient. On one hand Bitcoin processes a fairly small number of transactions. Particularly when compared with regular electronic transactions processed by financial service companies, the likes of Visa (NYSE:V) and Mastercard (NYSE: MA). Cashless transactions worldwide are estimated at around 708.5 billion transactions per year. They are also expected to grow to over one trillion in 2023.
Source: World payment report
Bitcoin has an average of 300,000 transactions daily. Or 109.500 million transactions yearly. That represents only 0.022% of all of the transactions processed worldwide. For a comparison Visa processes 150 million transactions on a daily basis. Everyday around the world there are roughly one billion credit card transactions.
Blockchain seems to have a scalability problem. For the number of transactions to increase drastically it is required that the number of miners grow exponentially. This is one of Bitcoin’s biggest risks. If there are too many miners processing Bitcoin transactions, the fierce competition will increase difficulty. Increased difficulty for miners will translate into lower margins. As more miners try to chase the same amount of reward blocks. It is essential that miners are able to generate a profit, otherwise the whole blockchain system is compromised.
There seems to be a correlation between Bitcoin’s price and the number of transactions. When Bitcoin prices are higher, the number of transactions also seems to follow along.
Global electricity consumption is expected to grow faster than the population. China is the largest electricity consuming country, with 6,011 TWh consumed in 2018. It is followed by the US, India, Japan and Russia, with 3,901 TWh, 1201 TWh, 946 TWh and 760 TWh respectively.
Bitcoin’s electricity consumption is so high that it equals that of Switzerland. At 58.93 TWh per year it represented 0.21% of the energy consumed worldwide in 2019. At the same time Bitcoin transactions represent 0.015% of all the cashless transactions worldwide. Some estimates point to even larger numbers. Comparing Bitcoin’s energy consumption with countries like Chile.
Given that global consumption of energy is around 173,340 TWh. Bitcoin transactions represent 0.45% of all the energy consumed worldwide.
Digiconomist goes even further stating that a single transaction of bitcoin, is the equivalent of the power consumption of an average US household during 23.55 days.
If Bitcoin was to process Visa’s 54.75 billion transactions yearly. It would require 38,854 TWh. Or essentially 22.4% of all of the energy consumed worldwide. To power all of the 700 billion cashless transactions happening worldwide yearly using Bitcoin. It would require 480,900 TWh, nothing more than a 177% increase in the energy consumed worldwide in 2019.
Bitcoin advocates usually prompt the cryptocurrency as the solution for all of mankind’s financial problems. They assume Bitcoin would be able to process most of the transactions worldwide if not all. If that was the case we would need to produce 177% more energy than what we do now. The energy inefficiency of Bitcoin transactions is its main acquiles heel.
Bitcoin’s Carbon Footprint
In 2019 roughly 43.1 billion tons of CO2 were emitted into the atmosphere. According to Joule, Bitcoin was responsible for 5.1% of the CO2 emissions in 2019. Using the estimated amount of CO2 Bitcoin produces annually according to Digiconomist – 36.95 MtCO2
If Bitcoin was to process the same amount of transactions as Visa – 150 million daily transactions. Taking into account Bitcoin’s 300,000 daily transactions it would generate roughly 18,475 Mt CO2 yearly. That would represent nearly 43% of all the CO2 emissions in 2019 around the world. According to Digiconomist, the carbon footprint of a single Bitcoin transaction is the equivalent of 717,673 Visa transactions.
Let’s say hypothetically, that Bitcoin would process all of the 700 billion transactions that are done worldwide in a year. That would result in a whopping 236,210 Mt CO2 emissions. An increase of nearly 450% compared with our emissions in 2019, of 43.1 billion tons of CO2. In essence Bitcoin can be extremely detrimental to our environment. As bitcoin transactions increase so will its carbon footprint. Since over 84% of the energy consumption worldwide comes from fossil fuels. Bitcoin’s increasing energy needs will continue to damage our environment. As Bitcoin miners are almost exclusively powered by fossil fuels.
Another consequence of the blockchain system is the amount of e-waste it produces. Given the fact that is highly dependent on state of the art hardware. So that the mines can run at the highest capacity possible. Bitcoin transactions end up creating a lot of e-waste related to hardware that is no longer efficient or desirable.
Bitcoin’s lack of efficiency when it comes to processing transactions, is clearly one of the biggest risks it faces. The blockchain is both energy inefficient and environmentally unfriendly. The increased energy we would have to produce. In order to process most of the transactions worldwide with Bitcoin is simply not feasible. While at the same time, the blockchain system does not seem to ever be able to process transactions at a certain speed.
Bitcoin is clearly not an investment vehicle nor is it a store of value as some tout. It is merely a sophisticated way of conducting transactions anonymously and in a decentralized way. Given its characteristics it is favoured by individuals engaged in illicit activities. As it protects them from exposure and conveys safety to transactions. For everyday investors it could be a speculative bet that can be profitable. Nonetheless, given the risks associated with it, it is wise to steer away from such speculative plays. The fact is that Bitcoin has no intrinsic value. Since there is no intrinsic value it is impossible to determine its value.
With no way of valuing such an asset, it is inconceivable that investors could attribute a price to such a currency. For those reasons, Bitcoin and as a matter of fact all cryptos are nothing more than speculative bets. We strongly believe that in order to consistently make money in markets investors need to buy assets below their intrinsic value. Since there is no way to accurately calculate the value of any crypto. There is no way to mathematically determine what kind of upside potential you can have, when you buy any cryptocurrency.
We have no position in Bitcoin. Read our disclosure.
Featured image source: BBC