Mining for Bitcoin: Ponzi Scheme, Future Reserve Currency or Something in Between?

Posted Jul 18 2013 by David Foulke in Turnkey Brainwave, Turnkey Research Note

As technology increasingly marginalizes the use of physical money, the rise of virtual currencies, as alternatives to national fiat currencies, is perhaps inevitable. And if you are not living under a rock, by now you have heard of the king of virtual currencies: Bitcoin, a form of electronic money that can be used to purchase goods and services from growing numbers of retailers, or even converted into cash.

When Bitcoin was first created back in 2009, there were 21 million Bitcoins that were digitally hidden in mathematical blocks that could be unlocked by solving algorithms through a CPU-intensive, repetitive trial-and-error process. In this sense, the digital “mining” of Bitcoins is quite similar to the extraction from the earth of physical commodities, such as gold, copper, ore, or coal.

In physical mining, miners always target the highest quality, most easily accessed reserves first, in order to maximize their profits. Over time, as the resource gets depleted, mining conditions become more challenging, margins get squeezed and the rate of production shrinks, as miners must go to ever greater lengths to obtain a given amount of the commodity. Eventually, the resource becomes fully depleted, and no further production is possible.

Bitcoin mining is similar: as the easy reserves are mined out, the rate of mining decreases geometrically , with an approximately 50% reduction every four years. The number of Bitcoins is set to reach a limit of 21mm Bitcoins somewhere around 2040.

Compare the graph above to the cumulative production curve for oil, another commodity that today is moving along a similar development/resource depletion curve:

Source: turnkeyanalyst.com