Bitcoin Series 31: Cost of a 51% attack against Bitcoin vs. a Traditional Ledger

US Forever stamp, circa 2015.

In Bitcoin

• A lot of ink has been spilled on the cost of a 51% attack* on the current Bitcoin ledger.  
  
  * an attack that would allow parts of the ledger to be re-written
   
• Most attempts to do a pure calculation of the computing power needed come up with estimates in the range of a few hundred million dollars
   
• Others argue with those estimates
   
• Others say in a few years it will be billions of dollars
   
• Others say that if existing miners collude it might be cheaper
   
• Other say that miners aren't incented to attack the chain due to the diminished value of their Bitcoin future revenue stream
   
• And so on

I personally think the explicit or implicit cost is well above $100M and rising, but the debate will go on for a while.

In a traditional financial ledger:

By contrast, it is extremely easy to calculate the cost of a 51% attack on a traditional financial services ledger.  

In the United States, circa 2015, it is $0.49, or the cost of one 1st class stamp.

This stamp needs to be attached to a letter addressed to the CFO of a financial services firm and would have one of the following as the sender: 

• IRS
• Treasury
• OFAC
• Federal Reserve Board
• FDIC
• OCC
• SEC
• A variety of state regulators in your state of choice
• A variety of three letter agencies
• A federal court
• A state court
• An insurance commissioner

I am not judging one model vs. the other as they each have their uses.   But I am comfortable saying that subverting a traditional ledger is a few orders of magnitude less expensive than subverting a decentralized one.*

* What if a three letter agency sent letters to miners ordering them to collaborate to execute an attack on Bitcoin?  I don't know how realistic that is but, to the degree it is realistic, it is an excellent argument for them being distributed.  This is why I don't worry about stories of miners at the Mongolian border of China leaching electricity from state-owned enterprises and hurting the ROI of other miners. The more miners, the more dispersed the miners, the more jurisdictions that they operate in, the safer the Bitcoin ledger is.

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Bitcoin Series 30: Hashing Power and Difficulty

A short explainer

1. It is critical to understand that "the amount of effort needed to mine a block" is a variable that resets every 2016 blocks (about every two weeks).
    
2. Mining is effectively solving a computational puzzle.   The amount of "hashing power" in the Bitcoin mining system is effectively how many guesses per second exist to try to solve that puzzle
    
3. The "difficulty" is how hard it is to solve the puzzle.   Simplified, the puzzle is like a massive version of Powerball where the miners have to guess a very long number.  The puzzle is made harder by requiring the winning number to have more 0s at the beginning of the number and made easier by requiring the winning number to have fewer 0s at the beginning of the number
    
4. Because the puzzle is effectively a lottery, the algorithm can figure out approximately how much hashing power is in the system by seeing how often the puzzle is solved (aka how often a block is mined).   The target is every 10 minutes.   If the blocks are being mined sooner than every 10 minutes (on average) then the algorithm needs to raise the difficulty of the puzzle to get back to 10 minutes.   If the blocks are being mined longer than every 10 minutes (on average), the algorithm needs to reduce the difficulty of the puzzle to get back to 10 minutes
    
5. This auto-adjustment is why you can safely ignore any statement in this format: "it costs $xxx to mine a bitcoin and that is not profitable and so Bitcoin is in trouble."   If the cost to solve the puzzle is higher than the value of the bitcoins earned by solving the puzzle AND the miners have no incentives to wait it out, then miners/hashing power will drop out of the system and difficulty will drop and the system will come into balance*
   
   In other words, the system auto-adjusts for how much hashing power is in the system, whether it is 2 laptops' worth (as it was Day 1) or xxx,xxx supercomputers' worth (as it is now)
    
6. A more technical explanation can be found here.   Same story in tweetstorm format here and here.

* There is a known edge case that could cause an issue if there was a discontinuous drop in hashing power.

• Let's say we just started a 2016 block period at a new level of difficulty and then for some reason all miners dropped out simultaneously (imagine all data centers were blown up as I can't really envision where they all drop out voluntarily). 
   
• It is true that the difficulty will readjust in 2016 blocks to account for the lower hashing power but that might take months to get there with reduced mining power and in the interim blocks would be slow.  
   
• If this happened in real-life, I expect at least some miners with a long-term incentive to have a functioning Bitcoin network would stay on (just like they have done recently) or worst-case scenario, you would need a soft-update to the Bitcoin algorithm.    
   
• But, on the whole, long-term market incentives I think will handle this.  By analogy, if a steel manufacturer does not like the price of steel for a two week period, they usually would not put their customers out of business by not delivering steel until the price reset.
   
• In the longer-term, miners will just hedge their output using futures, just like with other commodities

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Bitcoin Series 29: Why Do We Mine Bitcoins?

Credit: Wikipedia

A lot of people seem to think that the purpose of mining is to create Bitcoins (as if there was something special about creating Bitcoins that requires lots of computation, electricity and datacenter).   This is not correct.  The purpose of mining is to provide transaction security for the Bitcoin network by creating a competitive environment for recording transactions so that no one bookkeeper controls the ledger.  The Bitcoin rewards for mining a block are an incentive to provide that transaction security and that is it.

So, with this in mind, we are in a position to figure out what it means when miners "overinvest" and lose money mining.  

The first order effects are simple:

• If miners overinvest and it costs them more to mine a block than they can earn from selling the Bitcoins earned all it means is that a user of the Bitcoin network gets extra security (extra protection from a 51% attack) for free.
   
• And the miner who made the CapEx investment in mining equipment based on an incorrect assessment of 'how many other miners will be in the market simultaneously" and "what the price of a Bitcoin will be" will have a poor return on the capital invested.

It might be useful to reason by analogy.  

• Let's say the strategic planning committees of all the world's steel producers see a bull market for steel and build out a lot of steel capacity (that would be profitable in isolation, but, in aggregate creates too much steel).  
   
• The price of steels falls and certain steel manufacturers lose money.
   
• This is bad for the steel producers but fantastic for steel customers.  When General Motors can buy cheaper steel procurement doesn't think "oh no, 'steel is dead' but hurrah I can get more steel for my money".    

The analogy in Bitcoin is that the Bitcoin user gets more transaction security than would logically be needed given the market capitalization of Bitcoin.   It is a boon to consumers of Bitcoin (network users) and a tough market for Bitcoin producers (miners).   That's all.

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