Saturday, January 06, 2018

China will kindly ask crypto-miners to smoothly evaporate

Czech mining pool somewhat likely to regain the global dominance

Half a century ago, on January 5th, 1968 Slovak-born Alexander Dubček was elected the new boss of the Czechoslovak Communist Party and "socialism with a human face" (Luke's hyperlink) officially began in our homeland. (It abruptly ended on August 21st with the help of fraternal tanks.)

Right now, the Chinese Communist Party is practicing its own "socialism with a human face". The comrades don't like the cryptocurrencies too much. They have disabled the China-based exchanges and banned the ICOs but China is still leading the "mining business". For a few months, the Chinese ban on the mining was discussed as a possibility.

Bloomberg reported that the Chinese government decided to pursue a compromise (see other outlets). It wants to suppress the Chinese miners while keeping a human face. The local governments will be asked to apply microaggressions and use environmental, electricity-based, and other regulatory harassment to persuade the miners to evaporate "in an orderly manner". ;-)

Well, will it be enough? The miners are just vaguely profit-making – and many of them are making a financial loss – but what may be underestimated is the fact that the Bitcoin is a religious cult and many people, including lots of the key folks in the mining pools, are religious fanatics. So they may want to continue their businesses despite the losses and harassment.

Let me remind you of basics of the economy of Bitcoin mining (Bitcoin mining accounts for some 90% of the cryptocurrency mining, Bitcoin Cash is probably the 2nd right now, the 51% attacks against any other cryptocurrency are probably very easy for bigger players).

OK, in the Bitcoin "monetary system", mining – the creation of new coins – is needed for the validation of transactions. Bitcoin miners calculate useless complicated tasks with their GPUs and the system is arranged so that once in 10 minutes in average, a new block is discovered. Some number is found that just "works" as the answer to a mathematical problem that depends on the whole pre-existing ledger of transactions (plus solutions of previous problems).

The miner is allowed to take 12.5 new Bitcoins for himself, along with the payment fees from the holders of Bitcoins who want their transactions to be validated. In total, a typical block today brings some 16 Bitcoins to the lucky miner (see for the profit from freshly mined blocks). This reward is needed as an incentive for miners to do the work, and for the transactions to be validated.

The number 12.5 is being halved every 4 years. So Satoshi Nakamoto was originally mining BTC 50 for a block, another halving to BTC 6.25 per block is expected in 2020 (yes, if the Bitcoin price is smooth, the halving of the reward also means the halving of the expected monthly profit of the miners! So whenever the rewards go down, some miners are expected to go out of business which also makes the hard life of the survivors a bit easier). Because of this exponential suppression of the rewards, the total number of Bitcoins remains convergent and, from the current BTC 16.8 million, is expected to reach BTC 21 million in the asymptotic future (in practice, due to the discreteness of the smallest unit, namely one Satoshi i.e. 10 nanoBitcoins, in 2140 – at that moment, those who assume that the Bitcoin will still exist plan the miners to fund themselves purely by the transaction fees).

OK, so every 10 minutes, some BTC 16 is being given to the miners. That's slightly over $250,000 or so according to the fresh exchange rates. Every ten minutes. The miners get this money in the form of the Bitcoins, may keep them as Bitcoins (a volatile worthless virtual commodity), or convert it to some real money. They use this money to cover the electricity expenses, plus some hardware they had to pay.

As I said, the average profit margin is almost certainly small. If it were easy to make profit by starting new mining pools, lots of people and companies would join the business. So they have probably joined it. So the average profit margin was probably pushed towards zero by the competition and some miners are very likely to be in red numbers.

On the other hand, those BTC 16 which are paid each 10 minutes are paid for the service of validating some 2,500 transactions in average – that's 360,000 transactions a day. The Bitcoin has basically saturated the maximum number of transactions. Its basic rules don't allow the daily number of transactions to be much more than 360,000, the current one. The SegWit (Segregated Witness) has been incorporated and has the chance of increasing the capacity by a factor of (less than) two. More radically, the "Lightning Network" is a proposed layer – which is already being tested – how to move much of the data outside the blockchain which could make many transactions easy.

The high transaction fees are discouraging the transactions, to keep them at those approximately 360,000 a day. The payers are competing for the slots in the blocks. If you want the transaction to be validated quickly and safely, you pay a higher fee than others.

By now, the mining has been transformed to a centralized industry that is dominated by the mining pools. Most of the rewards go primarily to these mining pools – organizations that merge lots of small people's hardware to act as unified entities (see for the percentages – choose "mobile site" at the bottom if you're redirected to the desktop
  1. AntPool: 21%
  2. 20%
  3. BTC.TOP: 15%
  4. ViaBTC: 11%
  5. SlushPool: 10%
  6. F2Pool: 5%
The numbers add to 82% – all the numbers are hugely oscillating, the discovery of new blocks is a random process. The remaining miners make some 18%.

A funny aspect of the table above is the top 4 mining pools are all located in China – they represent 67% of the Bitcoin mining power. Well, most of the smaller ones (F2Pool, BTCC, BWpool, Bixin) are also Chinese so the Chinese share is almost certainly significantly higher than 2/3.

The first non-Chinese mining pool is the fifth one, SlushPool, which is located in my Czech homeland. It's also the oldest mining pool in the world (founded in 2010). And it's the mining pool that is generally recommended as the best one in the world. So if you're getting started with mining, or if you're using some Chinese pools whose future is uncertain, you should jump on the SlushPool bandwagon, it's straightforward.

There are differences between the four big Chinese mining pools. AntPool is owned by BitMain, so it's basically private and closed. BTC.TOP is also closed. On the other hand, and the newer F2pool are open Chinese mining pools.

So the numbers so far indicate that the Bitcoin mining is currently a Chinese-Czech enterprise. It's mostly Chinese (the panda) but the biggest, 10% mining pool is run by Czechs (the little mole/krteczech). That doesn't mean that other nations are absent. In practice, the individual miners are located in many countries of the world (but China also has a majority if you count the location of individual members of the mining pools).

Among the mining pools, Bitclub.Network is a shady mining pool with headquarters in Iceland – where electricity isn't subsidized as in China but the cooling of the hardware is cheap, you know. BitFury is located in (the post-Soviet) Georgia, and some pools reside in Japan and India. That's (almost) it. If the Chinese government managed to successfully suppress most of the Chinese mining pools, it's reasonably likely that the Czech SlushPool, the oldest mining pool in the world, could become the #1 again. Just like I said that the Bitcoin was owned by the Chinese communists, the Bitcoin could suddenly be owned by Andrej Babiš, the new Czech prime minister. If he learned about his ability to 51% attack the Bitcoin, I am sure he would use the new powers more effectively than the Chinese! ;-)

The Czech mining pools could even gain a majority if the campaign against the Chinese miners were really successful. SlushPool is one of the mining pools of the true cultists – unlike most of the Chinese ones, they would never dare to mine for Bitcoin Cash, for example. This outcome is decided by a SlushPool vote and because the members are mostly globalist cultists from the whole world who came to SlushPool because of the purity of their beliefs ;-), the outcomes remain as pure as you can get.

SlushPool gets some 1% or 2% from its members' work – which is extremely acceptable for the individual miners.

If the Chinese local governments managed to stop the Chinese mining very quickly, it would have far-reaching consequences for the Bitcoin payments and probably the price, too. I have mentioned that the system is designed and adjusted so that each 10 minutes in average, a new block with those 2,500 transactions in average is discovered. How is it guaranteed that this average timescale stays at 10 minutes?

Well, the difficulty of the computational tasks is being adjusted. When the blocks were generated too quickly, the difficulty goes up. When they were generated more slowly than one block in 10 minutes, the difficulty goes down. Bitcoin Cash is already making some adjustments after every block. But the "original" Bitcoin is running on old mechanisms and it only makes the adjustment once in 2 weeks.

More precisely, every 2016 blocks, the difficulty is being calculated again. (2016 looks like a recent year but it is really 6 blocks per hour times 24 hours per day times 14 days, check it.) Next Saturday, there will be a new difficulty adjustment – it's expected that the difficulty will go 7% up again.

If the Chinese government hypothetically succeeded in turning off almost all the Chinese miners shortly after a difficulty adjustment, there would be 2016 blocks (unless some emergency measure were realized) which would be being discovered by a vastly smaller set of miners in the world. If you imagine that the Chinese government reduces the mining power by a factor of 3, there would only be 100,000 transactions per day.

And this situation wouldn't last just 2 weeks. It would last 2016 blocks but because the blocks would be discovered 3 times more slowly, this situation could last 6 weeks. And things could be getting worse if the Bitcoin price started to drop and additional miners were discouraged from mining in this way.

If there were just 100,000 slots for transactions per day, the transaction fees would grow dramatically. I am pretty sure that the growth would be more pronounced than indicated by indirect proportionality. So instead of $20 fees (now) multiplied by 3, you would get more than $100 fees per average transaction. And a vicious feedback loop could start to drive these numbers out of control. These crisis scenarios only help to emphasize that the Bitcoin's capacity has already been reached, it's crowded, and extremely vulnerable to any similar shocks.

The remaining miners could decide to "fight the crisis" and, for example, reduce the difficulty so that one block is expected in 5 minutes instead of 10 (so that an extra exodus of miners would bring it to 10 minutes). But any such irregularity would probably be rather harmful for the Bitcoin as well – not for technical but for religious reasons. The Bitcoin fanatics would probably complain that Satoshi Nakamoto's Holy Word has been twisted and bastardized and the heretics should be burned at stake.

Now I think it's more likely than not that Bitcoin's $20,000 price was already the historical peak. Of course it may be wrong. But if it's right, it had to happen at some moment. The $20,000 moment was reasonable because that's when the saturation of the Bitcoin capacity became obvious; and it's also when the futures began to be traded.

Lots of the money have flown to the "altcoins" (cryptocurrencies different and newer than the Bitcoin). The share of the Bitcoin in the total cryptocurrency capitalization has dropped from some 65% a few months ago to 36% now. (I have been saying for some time that the decrease of this percentage, of the "dominance", is virtually unavoidable.) The "altcoins" don't have urgent problems because their transaction capacity has not been reached yet. In this sense, the Bitcoin is really the most broken cryptocurrency among all of them.

But the replacement of the Bitcoin by "altcoins" has some other negative implications. It emphasizes the fact that the scarcity of the cryptocurrencies is just nonsense. The number of the Bitcoins may be believed to stay below 21 million but new "altcoins" may be created all the time. The numbers of Ripples, Ethereums, and Bitcoins Cash (among 1,400 others) may be individually limited but one may invent millions other names of such "altcoins" and the total number of the coins in all these systems is surely unlimited.

When people switch from Bitcoins to "altcoins", it becomes more obvious that they don't know what they're doing – except for gambling. If the first unbacked cryptocurrency dies or totally loses its dominance, it's very obvious that every other "altcoin" may follow the Bitcoin's example. Well, it's obvious to rational people. Most of the people playing with the cryptocurrencies aren't rational so the evolution may be irrational as well.

Also, the price of every "altcoin" is even more volatile than the price of the Bitcoin. An increase or decrease by more than 50% a day is really "very possible" for all of them. So the "investments" into all the cryptocurrencies are becoming an extreme form of gambling. A somewhat random one may suddenly "pop" and its price adds an order of magnitude (it may be Bitcoin Cash on one day, Ripple on another, Ethereum o the third day, or Monero, Dash, Iota... next week). But it may also collapse and on a sunny day in the future, which may be extremely close now, all of them may collapse.

I surely think it's right that Merrill Lynch, an investment branch of Bank of America, banned its clients from "investing" into cryptocurrencies. It's really not an "investment". The people who call the cryptocurrencies "currencies" or "investments" are just fraudsters – or morons.

One additional observation: In the Bitcoin cult, males are said to outnumber females 96-to-4 or so. This is quite a gender gap. It's actually even more extreme than in theoretical physics. For some reasons, the cryptocurrency nut jobs aren't being harassed by the feminists. No one demands the pictures of the Bitcoin to have lipstick on them, in order to be more attractive for women, and so on. (I realize that the feminists wage a war against the lipstick, too, but I don't know how to present their campaign in a way that is both articulate and accurate.)

Why is it so that the cryptocurrencies get an exemption from the harassment by the femi-Nazis? Let me tell you a possible explanation. It's because the cryptocurrencies are assumed to be "hip" in the sense of "far left" – they represent a war against the existing financial system. So unlike theoretical physics, they're considered "ideological allies", and in such cases, a 96-to-4 gender gap isn't a problem, is it?

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