Bitcoin Mining Q/A - 4/9/2021

We received a question from a reader this week about bitcoin mining. New readers might have a similar question, so we will take a minute here to discuss it.

Question

"I really don't understand the mining aspect of bitcoin. Doesn't it require a lot of power and isn't that why so much of it is done in China?"

Bitcoin mining is one of the least understood parts of bitcoin. We write a Mining section below each week about some of the news about the industry, but it would helpful to discuss the basics.

Bitcoin mining fulfills two functions, 1) it provides the way to move the network forward in a consistent, decentralized, and secure manner through Proof of Work; and 2) it is a way to distribute coins in a verifyable way, in a completely free and open market. Mining is absolutely necessary for a scalable, decentralized network.

Being decentralized means no one is in charge to keep everyone in sync, make the rules or confirm transactions. Bitcoin solved this problem with mining. Participants don't need to trust the ledger because they can verify it, and know it was updated through a random, expensive process. You can't fake burning energy, everything else can be gamed and corrupted.

The distribution of coins is also accomplished by the block reward claimed in the mining process. This keeps bitcoins circulating to pay for the energy needed to mine.

Power Consumption

Yes, bitcoin mining consumes a lot of energy. That fact has always been a criticism of bitcoin. Over the last 10 years though, the refutations have become very good.

First, is the fact that energy consumption is a measure of a civilization. Standard of living is directly correlated to energy consumption. If people want to have better lives they typically consume more energy. Even with gains in energy efficiency the total energy used goes up every year. Is consuming energy a bad thing? No.

Second, bitcoin replaces more wasteful uses of energy. Think of all the energy the current financial system uses, everything that is spent to maintain fiat's value and use is being replaced by more efficient bitcoin.

Third, bitcoin miners bid for energy against other uses, and the energy will go to the most productive use. Bitcoin mining is more efficient at turning energy into well-being than other things or else people wouldn't use the energy for bitcoin.

Specifics to Energy and Bitcoin

There are several specifics of the bitcoin mining industry and energy production/distribution industry that affect energy use.

Most importantly, energy is expensive to move. As oil or natural gas, energy has to be transported via pipeline, rail or ship to the place it is used. If electricity is produced in a hydroplant, it has to transit miles of powerlines that slowly lose that power over distance. Costs (and waste) would be drastically cut by living right next to the powerplant, but that isn't appealing for most people.

However, bitcoin miners are mobile, they can go to where energy is plentiful and cheap. Miners can go right out in the oil field or right next to the distant dam or dangerous nuclear powerplants.

No discussion of power production is complete without discussing peak hours. The demand for electricity is highest during a few short hours a day, however, the powerplant can't ramp up during those times and down at other times. Usually the plants provide a constant level of output. They are designed to meet the peak demand, and have excess capacity during the rest of the day. That energy was completely wasted, until bitcoin mining came along.

Now, bitcoin mining can consume that previously wasted excess power, and pay for it, making everyone's electricity cheaper.

For energy usage, we also must quickly mention unique places bitcoin mining can go that others uses can't. For example, bitcoin is now tapping into flares directly in the oil fields. One of the byproducts of oil drilling is natural gas which in many cases is uneconomical to capture and use, so oil companies simply burn it as it goes into the atmosphere. Bitcoin mining equipment can be installed directly next to the flare and use that energy to mine bitcoin. This is just one way bitcoin is driving clean energy usage.

Why China?

Lastly, we will discuss the political distribution of bitcoin mining. Some people have raised concerns that China controls bitcoin because they have a high percentage of bitcoin's hash rate (computer power). That is simply old news, often repeated by bitcoin critics.

Bitcoin is controlled by the nodes of the network, not the miners. This was confirmed in very public fashion in 2017 when a big majority of the hashing power was spanked during the User Activated Soft Fork (UASF).

Early in the history of bitcoin upwards of 90% of bitcoin mining took place in China for one reason, cheap energy. As a communist country, and a communist country building powerplants for ghost cities, energy is a public good there, and they have a massive amount of excess energy capacity all around the country. This was a recipe for very cheap energy and bitcoin miners took advantage.

Mining pools also make the current distribution of hash rate difficult to know. It's common practice for people to pool their hash power to increase the likelihood of finding a block, and then distribute the revenue proportionally. Many mining pools are headquartered in China, so people falsely assume all the hash rate in the pool is in China.

The global distribution of miners is evolving rapidly. The US has approximately 10-20% of the hash rate now, Russia and former Soviet Republics are coming on strong, too. The most recent estimates are that 65% of hash rate is in China today, but we'd put that closer to 50%, while still a lot, it is vastly different than 90%.

Lastly, mining power increases at a fast rate, though has been slower over the last 6 months due to a microchip shortage. The average increase in hash rate during 2019 was 3.37% every two weeks, 2020 was 1.62%, and 2021 YTD has been 3.23% every two weeks. At that pace, the 60% number in China could quickly be eroded.

We hope that helps everyone understand bitcoin's energy consumption a little better and arms them with some counterarguments when debating bitcoin haters.