With everyone interested in crypto currency, we will examine the issues of profitability in relation to mining cryptocurrency.
The idea of mining is the foundation of a cryptocurrency because it entails the way new cryptocurrencies are produced. The value of a cryptocurrency increase as more and more people invest in mining it since the amount of cryptocurrencies that will ever be produced is finite (Goleman, 2018). Nevertheless, as more cryptocurrencies enter into circulation, it becomes challenging and requires extensive time to mine them, which makes them less profitable.
According to DeMartino (2016) mining cryptocurrency was initially considered as very profitable without any substantial investment. However, this has changed and today mining cryptocurrency is considered as the least profitable way to obtain and invest in cryptocurrencies. It is now an arms race with people now being forced to use designated chips or application-specific integrated circuits for mining purposes. These chips are expensive, which means that ordinary people with standard computers cannot gain from mining (Davidson, 2013). While practically any person can mine, it is unlikely to earn any profits even if an advanced computer is used because of the substantial amount of electricity consumed and possible damages to the computer due to overworking.
Due to the arms race, mining today requires a substantial investment if one hopes to earn any profits. According to Norman (2017), mining cryptocurrencies requires a tolerance for risk because one must first invest in the required equipment. Even if a person has the means to invest in the required hardware and software, the hope of earning any profits is negligible. The hope of profits further reduces when factors such as mishaps in the type of the hardware used, connectivity problems and power are included (DeMartino, 2016). The required investment to earn a profit from mining increases as the complexity of the block chain increases.
According to IntroBooks (2018), mining cryptocurrencies with a personal computer is no longer profitable because of its limited computational abilities. The expenses required to operate a personal computer for 24 hours including the cost of the consumed electricity is more than the created cryptocurrency through mining, which makes mining less profitable (Viilup, 2015). One way of investing to earn a profit is to acquire dedicated hardware and software to ensure fast hash function solving to yield a cryptocurrency coin. Luntovskyy and Spillner (2017, p.71) state that the value of a cryptocurrency coin created after solving a hash function relies on market dynamics, trust and perception. Earlier, there was a steady growth of profits, which was followed by an unpredictable growth (Narayanan, Bonneau, Felten, Miller and Goldfeder, 2016). The unpredictable growth was caused by the increasing cost of production for mining because of the blockchain nature that needs more hardware resources for each succeeding solution. The investment required to mine is not repaid through a possible gain from the cryptocurrency coins based on energy reasons (O’Dwyer & Malone, 2014). Nevertheless, many of the difficulties with mining are related with Bitcoin (IntroBooks, 2018). Currently, other cryptocurrencies have emerged that are not complex to mine with most of them designed to solve the challenges that people experienced with Bitcoin mining. Examples include Bytecoin, Litecoin, and Ethereum. However, to be profitable, miners must first acquire the latest tools that offer a high hash rate per unit cost (Ren, 2014). Manufacturers of mining equipment possess a strong financial incentive to use the tools they produce to mine first and ship to the user only after the profitability of mining reduces. In turn, this reduces the profits that actual users of the equipment can earn (Ren, 2014).
While there are many cryptocurrencies today, the same principles of production as applied to bitcoin are still used. For example, the main determinant of profits is the relative cost of producing a cryptocurrency through mining and electricity is the primary production cost. Other factors that affect the profitability of mining include the competition level that the network of producers present, the complexity of algorithms used to mine a cryptocurrency and the rate of unit production (Hayes, 2017). Variations exist for different cryptocurrencies regarding factors required to mine them with the newest cryptocurrencies being more profitable than Bitcoin. However, the fear of the entry of more advanced hardware threatens the profits of this new cryptocurrencies because the difficulty of their algorithm will also grow (Ren, 2014). Ren (2014) argues that mining can be profitable only if the mining operation is left to specialists with the required domain knowledge to achieve economy of scale, particularly for established cryptocurrencies like Bitcoin.
Ren (2014) states that miners can only make profits at a fixed cost if they mine the most profitable and less complex cryptocurrency and trade it fast to avoid being exposed to price risks, which can only occur through pooling together (Salimitari, Chatterjee, Yuksel, & Pasiliao, 2017). However, this creates problems, for instance, cryptocurrency prices may suffer due to a downward spiral as the cost of mining reduces due to advances in technology. Another issue is that since miners select cryptocurrencies with low complexity and mine it until it becomes more complex, this can compel cryptocurrencies to deal with immediate interests instead of dealing with lasting development and improvement (Ren, 2014).
It is challenging to earn profits from mining, especially for established cryptocurrencies like Bitcoin. Miners can still make profits from other cryptocurrencies even though they must first invest in the right equipment and focus on the most profitable and less complex cryptocurrency.
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Ren, L. (2014). Proof of stake velocity: Building the social currency of the digital age. Self- published white paper.
Salimitari, M., Chatterjee, M., Yuksel, M., & Pasiliao, E. (2017, October). Profit Maximization for Bitcoin Pool Mining: A Prospect Theoretic Approach. In 2017 IEEE 3rd International Conference on Collaboration and Internet Computing (CIC)(pp. 267-274). IEEE.
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