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Bitcoin Mining: Converting Computing Power Into Cash Flow

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Bitcoin Mining: Converting Computing Power Into Cash Flow Bitcoin Mining: Converting Computing Power Into Cash Flow Yuen Lo∗, Francesca Medda QASER Laboratory, UCL, London Correspondence address: Room 213, Chadwick Building, Gower Street, London WC1 E6BT Declarations of interest: none Abstract Bitcoin is the world’s leading cryptocurrency, with a market capitalization briefly exceeding $300 billion. This hints at Bitcoin’s amorphous nature: is this a monetary or a corporate measure? Hard values become explicit in the processing of transactions and the digital mining of Bitcoins. Electricity is a primary input cost. Bitcoins earned are often used to circumvent local currency controls and acquire US dollars. For the period August 2010 to February 2018, we examine the components of Bitcoin mining revenues, their statistical contribution to daily changes, and to its variance. We provide evidence that Bitcoin transaction processing is capacity constrained. JEL D23 O31 Keywords: Bitcoin, Bitcoin mining, Blockchain, Distributed ledger, Proof of work, Highlights with transactions. It offset transaction growth with higher trans- actions per block. Blocks processed per day - and consequently • Bitcoin mining rewards transaction processing tasks with Bitcoin mining prize games - have been stable since 2011 (Ta- new Bitcoins. ble 1). More recently divergences occurred as Bitcoin reached • Changes in Bitcoin USD price is primary factor in changes its block size limit, which specifies how much data may be con- in Bitcoin mining revenues. tained in each block. These divergences include a peak in transactions, higher • Changes in Transactions (volumes) are also statistically transaction fees and a rise in mining revenues. The latter two significant. are a user cost and a system cost respectively. Mining revenues • Peak in transactions, spike in mining revenues and fees reached $50 million per day during December 2017. These indicate capacity constraints. divergences are now moderating with the adoption of SegWit, which reorganises data on and off blocks. 1. Introduction Bitcoin utilizes cryptographic digital signatures and proof of work computing tasks (Nakamoto, 2009). These form a The Bitcoin mining industry processes 300,000 transactions, pseudo public database, that transfers value without relying on a and generates $15 million dollars worth of Bitcoins and $500k trusted central party. Iansiti and Lakhani (2017) describes Bit- of fees daily (Figure 1). Historically, Bitcoin scaled efficiently coin as a narrow use case of blockchain, or distributed ledger ∗corresponding author technology, in an area with low coordination requirements. Email addresses: [email protected] (Yuen Lo), Parties move Bitcoins, a unique digital asset, between elec- [email protected] (Francesca Medda) Preprint submitted to Elsevier February 14, 2018 Figure 1: Daily Bitcoin mining revenues $m, and transactions ‘000s tronic addresses via transactions. Transactions are submitted to focuses on Bitcoin prices (Cheah and Fry, 2015), which our the mempool (temporary storage). Most processing is carried work confirms is central to changes in Bitcoin mining revenues. out by collective mining pools, that reduce individual reward Bitcoin mining rewards convert computing power into cash variance, and divides in two the task of transferring transac- flow. This incentivizes participation. Successful malicious ac- tions from the mempool to the blockchain (Gervais et al., 2014). tors must control a quarter of this compute (Eyal and Sirer, The pool administrator checks, selects and orders transactions. 2014). Nakamoto (2009) and Kroll et al. (2013) consider spend- Pool participants contribute computing to the resource intensive ing on Bitcoin mining as an attacker’s cost function. proof of work required to validate blocks. Blocks must contain This paper adds to the literature an empirical analysis of the a solution to a cryptographic puzzle related to its transactions components of Bitcoin mining revenues, plus their contribution and its place in the chain (Nakamoto, 2009). Block process- to log daily changes and variance. We find that the Bitcoin ing earns miners Bitcoin rewards and fees. Buterin (2013) de- USD price, and transactions, are statistically significant drivers scribes this as a first-to-file system: transactions are ordered by of revenues. Rolling regressions of the coefficient on changes in when they are processed. daily transactions suggests that despite SegWit scaling remains Although Vukolic´ (2016) suggests directions for addressing an issue. The results highlight the rising expense of censorship blockchain’s limitations, most Bitcoin mining literature focuses resistance within Bitcoin. Those who consider Bitcoin a low on game theory and incentives. Eyal and Sirer (2014) outlines cost financial network ignore that it is costly by design. The Bitcoin’s vulnerability to selfish mining strategies. Schrijvers results support research into longer term efforts to help Bitcoin et al. (2017) models mining pool reward functions. Kroll et al. scale. We do not suggest that costs are the only reason trans- (2013) suggests the optimal mining rewards level is equal to actions are declining, hash rates and the difficulty in finding the value of Bitcoin’s collapse to an attacker. Other literature new blocks have also accelerated. However, network issues im- 2 pacting supply may have contributed to the rise in the Bitcoin is the block reward rate, which does not have to be collected price. If holders cannot transact efficiently, this may amplify by the miner. Ut is blockchain.info’s benchmark exchange rate price corrections, and has relevance to economists and policy of US dollars per Bitcoin. Ft is the daily total of an optional makers. transaction fee. Our analysis is focused on Bitcoin mining revenue RXt ex- 2. Data cluding transaction fees, because fees and blocks are statisti- cally collinear with the other variables, particularly on a daily We source our Bitcoin mining data from blockchain.info via basis. We exclude C as effectively discrete. We assume that the Quandl platform. Effectively this outsources the creation of t miners behave optimally and collect coin rewards. We assume a single Bitcoin price index to the former, and the selection of that miners convert the Bitcoins they mine into USD the same time of day to the latter, which eases any effort to replicate our day. results. As a check of robustness, we also utilize daily pric- We take first differences, which reject the null of non-stationarity ing data from the Bitstamp exchange. Bitstamp’s Bitcoin index at the 99% significance level. We transform our ex fees nonlin- is indirectly regulated by the CFTC via being referenced by ear identity into a linear equation by taking logarithms. We the CME Future. This check highlights data quality issues in define a spread variable of the intraday High=Low = S . Baek the field: most exchanges have no defined regulator, the period t and Elbeck (2015) found a monthly spread variable to be a sta- available (beginning 28 November 2014) is significantly shorter tistically significant factor in monthly price changes. We follow than for the blockchain.info index, and the time of day when the literature and incorporate S . the data is acquired impacts the nature of the sample. We down- t load our Bitstamp data at 9:50am EST on the 12 February 2018. ∆(lnRXt) = α + β1∆(lnTt) + β2∆(lnUt) + β3∆(lnS t) + (2) These discrepancies can be particularly glaring when using live API data feeds. The high and low intraday prices are provided In addition to an analysis for the complete period, we calcu- by Cryptocompare, a data aggregator. Blockchain.info calcu- late 365 day rolling regressions, with overlapping time periods, lates mining revenues by tracking the number of blocks pro- to chart the coefficients on log daily difference in BTCUSD, cessed and the daily transaction fees. Table 1 shows a variety and log daily difference in Transactions, over time. of descriptive statistics. The time period under analysis covers We carry out two separate checks of our analysis, with re- 17 August 2010 to 12 February 2018. sults presented in (Appendix A). We perform a winsorization of the variables of the empirical model (Dixon, 1960), and com- 3. Empirical Model & Methodology pare the full and modified dataset results. Our winsorization compacts the top and bottom 5% of each series, replacing them The blockchain algorithm ensures that less than 21 million with the 95th and 5th percentile value respectively, to examine Bitcoins (BTC) are issued. As part of this, mining rewards the impact of tail values. We also carry out the analysis with halved to 25 BTC per block on 28 November 2012 and to 12.5 an alternate data source for the Bitcoin price - notably from the BTC on 9 July 2016. Total daily compensation, or Bitcoin min- Bitstamp exchange. ing revenues, follow an identity. Tt E(RIt) = × Ct × Ut + Ft (1) 4. Results & Analysis Bt RI Under this notation, t is the Bitcoin mining revenue for As we have taken logs of both sides, based on the empir- a given day, including fees. Tt is the number of the transac- ical model the coefficients βn are elasticities. Consequently a tions. Bt is the average number of transactions per block. Ct 3 N Mean Standard Deviation Min Max Bitcoin mining rev inc fees, USD ’000s 2,737 2,387.23 (5,886.94) 0.34 53,191.59 Bitcoin mining rev exc fees, USD ’000s 2,737 2,096.62 (4,626.25) 0.34 42,863.09 Transactions, ’000s 2,737 109.23 (103.81) 0.27 490.64 Bitcoin US Dollar (BTCUSD) price 2,737 924.48 (2,411.20) 0.06 19,498.68 Transaction fees, USD ’000s 2737 290.62 (1,418.29) 0.00 22,724.84 Blocks processed 2737 166.14 (82.54) 6.5 2,941.5 Log difference in mining rev ex fees USD 2,736 0.0038 (.14391) -1.03 .967785 Log difference in Transactions 2,736 0.0022 (.196634) -3.27 2.879949 Log difference in BTCUSD 2,736 0.0042 (.064605) -1.04 1.004342 Table 1: Descriptive statistics for Bitcoin Mining industry and log daily differences, 17 August 2010 to 12 February 2018 100% change in Transactions implies an 9% change in min- uary 2016 (Appendix B).
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