February 5, 2013 By Ed Felten

Arvind wrote yesterday about the availability of chips that do super-fast Bitcoin mining. I want to follow up by unpacking the economics of Bitcoin mining, to see what the effect of the new chips will be, and more generally what the future of Bitcoin mining looks like.

For those unfamiliar with Bitcoin, here is a one-paragraph summary: Bitcoin is a digital currency that operates without any centralized issuer. It’s a “real” currency, in the sense that it can be converted readily into traditional currencies such as dollars. Logically, a Bitcoin has a serial number. You can give a coin to someone by adding an entry to the global Bitcoin log, saying that you gave them that coin. The clever part of Bitcoin’s design is how the global log works. The log consists of a chain of “blocks, ” each memorializing a bunch of transactions. To create a new block, you have to solve a difficult cryptographic puzzle which can only be done by randomly trying guesses until you find one that works. If you are the first person to solve a puzzle, you can create a new block in the log–and you are allowed to add to the block a special event that gives you a newly minted coin. Once somebody solves a puzzle and creates a block, a new puzzle-solving race begins. The activity of trying to solve puzzles, in order to create new blocks, in order to get the new coins that go to block creators, is called “mining”. Mining is optional: you can receive and spend Bitcoins without doing any mining. Increasingly, mining is a specialized activity.

The economics of mining are interesting. Suppose you are thinking about devoting resources to mining. Let’s assume it will cost you C dollars per second to mine (for equipment and electricity), and you will be able to try P puzzle guesses per second. Every time you solve a puzzle you will get a Bitcoin whose value in dollars is V. Is mining profitable?

The answer depends on how many guesses it takes to solve a puzzle. If it takes G guesses to solve a puzzle on average,

Source: freedom-to-tinker.com