After yesterday’s talk on editable blockchains, the family comes back today to continue their conversation on blockchain and cryptocurrency mining. The conversation is mostly between Emily, who believes she is not good at technical details, and her parents.
Greg: I hope you all had the time to find something related to blockchain. Yesterday we talked about philosophical issues of absolute or relative immutabilities, today I think the issues may be more detailed and more technical.
Emily: I guess I’m not good at technical stuff. Can you help me with “Proof of Work?” versus “Proof of Stake?” I know one of the top cryptocurrencies, Ethereum I think its name is, is moving toward “Proof of Stake” while Bitcoin stays with “Proof of Work.”
Kimberly: That’s right. I read a report from the Fortune magazine that Ethereum is currently running both “Proof-of-Work” and “Proof-of-Stake.” But when they finish the highly expected upgrade, which we don’t have a set date yet, it will be “Proof of Stake” only.
Lily: And I read an article published by Bitcoin magazine that says Bitcoin will not, and could not, switch to “Proof of Stake” because Bitcoin code is immutable.
Joy: It’s important to remember that first of all, “Proof of Work” and “Proof of Stake” are different ways of doing cryptocurrency mining. Perhaps even more importantly they are both “Proofs of Resources” in the sense anyone possessing more resources has a better chance to become a winner in crypto mining.
Emily: You said “a winner” so there is just one winner? Also what is cryptocurrency mining? Why are so many people interested in mining?
Joy: Let’s begin from the last question, which is the easiest: People want to mine crypto for the same reason today as people came to California during the “gold rush” in the 19th century. They want to win something big.
Emily: How big is “big?” I mean the size of miner reward.
Joy: Let’s find out. Jason, could you Google today’s Bitcoin price for us please?
Jason: Sure. “Hey Google, what’s the price for Bitcoin today?” Here it is: $31,119.80 for one bitcoin on May 15, 2022.
Joy: Thank you! Just to be clear, a winning miner will get far more than $31,000 because she receives more than one bitcoin, 6.25 coins to be accurate for now, every time she successfully mined one block of crypto transactions. We multiply the unit Bitcoin price of $31,119.8 Jason just found for us by the number 6.25, which is $194,498.75.
Emily: You said, “for now.” So 6.25 coins are not constant all the time?
Joy: No, how many coins the winner gets are not constant but keep decreasing by half roughly every four years, until it goes to zero in 2140 when there will be 21 million Bitcoin in total.
Emily: How does the decreasing reward work?
Joy: It’s called “block halving event” and let’s show it with numbers. I will quote this website called bitcoinblockhalf.com that does a good teaching job. I have it downloaded to my phone. Here it is: “When Bitcoin first started, 50 Bitcoins per block were given as a reward to miners. After every 210,000 blocks are mined (approximately every 4 years), the block reward halves and will keep on halving until the block reward per block becomes 0 (approximately by year 2140). As of now, the block reward is 6.25 coins per block and will decrease to 3.125 coins per block post halving.”
Emily: I understand these numbers but why the decreasing rewards. That’s not fair to later miners don’t you think?
Joy: This is a good time to tell the entire crypto rewarding story, or why miners get rewarded in the first place. Let me ask a question first: Who do you think is authorized to issue the paper money?
Lily: The central banks. In the US that’s the Federal Reserve.
Joy: That’s right. Now, who has the authority to issue Bitcoin, Ethereum and other cryptocurrencies?
Lily: No one. They are decentralized currencies I believe.
Emily: Wait, what are “decentralized currencies” versus “centralized currencies?”
Lily: The dollar bills we use every day are centralized money because every dollar bill is issued and controlled by the Federal Reserve, nobody else can do that. That monopolistic and central control makes the dollar centralized currency.
Greg: Now that we are on the topic, centralized versus decentralized is not the same as distributed. I read an article talking about how the three systems differ. Briefly, centralization or decentralization refers to mode of control, while distribution is about location.
Joy: Yeah I heard about that, too. Bitcoin, or more accurately its blockchain, is decentralized but also distributed: “Decentralized” because decisions are made not by a central authority but by consensus; “distributed” because the nodes in a peer-to-peer computer network are all over the world.
Greg: Here is a picture of the three systems I found online. Centralized has all links pointing to a single center, kind of like the Chinese political system where everything is eventually determined by Beijing. Decentralized does not do that, although it may contain hubs of links, kind of like the federation system this country has, where hubs are different states. Distributed has neither a center nor hubs. It is like “direct” or “pure” democracy if you will, getting rid of the representatives altogether.
Lily: I don’t know you guys but if we were treating all three systems as modes of control for decision making, I will pick the one in the middle, the decentralized mode, although I understand the “distributed” system is for locations, not exactly for controlling.
Kimberly: I feel the same! Decentralized has advantages from both sides, just like “representative democracy” is better than centralized dictatorship and distributed “direct democracy.”
Greg: Going back to cryptocurrencies, they are all issued and controlled by algorithms, not by government agencies.
Emily: What are algorithms?
Greg: An algorithm is a predetermined set of rules for computing. In this country we have rule of law for governing human behaviors. Algorithms are the rule of law for governing computer behaviors.
Emily: Interesting. I did not realize how important algorithms are in our lives.
Greg: Bear in mind though algorithms are initially designed by humans. Once started, an algorithm can obtain its own life, or works by the designed logic until we decide to change the rules later.
Joy: I really want to comment on the algorithms in cryptocurrency, more specifically Bitcoin, has been well thought of. Let’s ask ourselves this question: Why was the algorithm designed to reward miners? This is highly relevant to Emily’s question of why the miner rewards are reduced by half every four years.
Lily: From what I have read, it’s all economics. When Bitcoin first started, it must compete with the monopoly power of central banks. The way it competes is through mobilizing as many people as possible, to get them involved in creating and owning cryptocurrencies. Offering reward in Bitcoin — not in dollars — is the best way to go, because miners would have their personal interests lined up with increased value of Bitcoin, or all cryptocurrencies for that matter.
Joy: That’s right! Decentralized power comes from having a large number of people all working for the same goal with shared interest. The economic reasoning behind cryptocurrency rewarding is to give higher reward at the beginning, when Bitcoin was a brand new “startup money” and not many people knew about it.
Lily: It also reflected the lower value of Bitcoin in terms of dollars back when it started in 2009.
Joy: Exactly! The priority back then was to attract more miners to join the digital “gold rush,” to make some “cryptocurrency noise,” to increase decentralized power, which all add up to benefit the value of Bitcoin or other cryptocurrencies.
Kimberly: I see the logic now: The algorithm assumes the value of Bitcoin will get higher and higher as time goes on, so there is no point in keeping the same number of rewarding Bitcoin for the winners.
Emily: I see it, too. Even though the number of Bitcoin rewarded goes down from 50 in 2009 to 6.25 today, the dollar value is perhaps higher than 2009 given the current Bitcoin price. The miners today can take home much more than earlier miners.
Greg: That’s exactly what happened. One thing I love about this country is that you can always find the information you want. I was searching for the price history of Bitcoin and came across this article from Investopedia called Bitcoin’s Price History. We can see Bitcoin had a price of zero when it was introduced in 2009. That changed on July 17, 2010, when its price jumped to $0.09. So indeed the 50 bitcoins received by the first miner meant nothing in 2009, while 6.25 bitcoins are enough to bring six digit income now, even with the recent cryptocurrency price crash.
Joy: This is why I had a hard time believing Warren Buffett actually said that he would not buy all the Bitcoin in the world for even $25, because he said he could not find any use of Bitcoin. He seems to have forgotten what he has been doing for all his life: investing in something for better returns. That’s exactly what one can do with Bitcoin. Let’s say someone sold Buffett 50 bitcoins back in 2010 at the historical price of $0.09 per coin, and he kept those until today, he would have gained how much? Jason, could you do the calculation for me?
Jason: No problem. 50 bitcoins times the unit price of bitcoin today at $31,119.8, that’s $1,555,990, more than $1.5 million! Let’s take out his historical cost of $4.5 in 2010, his net profit would still be $1,555,985.5!
Greg: Let’s calculate his rate of returns. Divide his gain of $1,555.985.5 by his cost of $4.5 and then multiply 100 to make it a percentage figure. What do we have, Jason?
Jason: Wow! That comes out to be 34,577,456%!
Greg: That was phenomenal, and I doubt if Buffett’s other investment records can beat that.
Emily: I still have a concern for miners after 2140, when the algorithms will stop paying reward as there won’t be new Bitcoin released once the algorithm reaches its goal of 21 million Bitcoins.
Joy: I won’t worry too much about that. Miners are still capable of charging fees against Bitcoin users because transactions will still need to be audited by miners. Miners have other privileges like voting for Bitcoin rule changes as well.
Greg: I think we’ve had an interesting discussion on things like decreasing mining reward, centralized versus decentralized currencies, distributed nodes and the value of cryptocurrencies as “investible assets.” But we have yet to answer Emily’s questions about what mining is in any details, about “Proof of Work” versus “Proof of Stake.” We’ll have to stop here as it gets late. Do I have everyone’s consensus to continue the talk tomorrow?
The answer is “yes” and that marks the end of conversation for today.
