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Why People Still Mine Bitcoins

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Background on the Halving

“The Halving” describes the 50% reduction in subsidy for Bitcoin miners for every block that is mined and sealed. To simplify, the reward that Bitcoin miners receive for their work is cut in half. “The Halving” occurs every four years, built into Satoshi Nakamoto’s Bitcoin model to control the total output of currency. The first halving of Bitcoin occurred in the early stages of growth for the currency. On July 9th 2016, the second halving of Bitcoin occurred. Since Bitcoin is more established in 2016 than it was in 2012, it may be easier to separate the effects of “The Halving” from the fluctuations of a less mature currency.

Halving’s Impact on Bitcoin mining

To date, Bitcoin has generally avoided drastic effects from the second halving. To the surprise of industry experts, Bitcoin value and hash rate have not noticeably deviated from their previous levels. Most surprisingly, the hash rate, which is a measure of computing power dedicated to mining, has not responded to the change in reward. As a brief overview, Bitcoin miners dedicate computing power to unlocking blocks. Miners are rewarded in Bitcoins for each block they unlock. Logically, since the reward for mining has decreased, it is a puzzle as to why mining levels remain similar to those prior to the halving.

hash-rate-for-why-people-mine-bitcoins
Hash rate chart for past year.  Sourced from Blockchain Info.

Economic Theory

Although the mining levels are initially puzzling, economic theory offers a possible explanation.

I begin with the assumption that prior to the second halving, the Bitcoin market was in equilibrium. In other words, it would not be profitable for new miners to enter the market, since the cost to a new miner would exceed the benefit from mining. This assumption makes rough sense, because it assumes that if opportunity existed, people would take advantage of it.

Miners require a tremendous amount of infrastructure, in particular, computers. These computers are a fixed cost. Once miners have purchased computers, they have a different set of costs to compare with benefits. Fixed costs aside, they consider variable costs. Variable costs are typically related to power usage, operating space, etc. Variable costs alone are less than variable and fixed costs together.

fixed-and-variable-costs

Now consider the second halving. While it may be to expensive to become a miner and create infrastructure, especially given the reduced mining reward, existing mining operations can still function with their Bitcoin rewards exceeding their costs. For readers familiar with first-mover advantage (cite Wikipedia), this describes the explanation of hash rate levels. This phenomenon is common to industries with high fixed costs to entry.

Accordingly, it makes sense that the hash rate will remain constant, or decrease, as Bitcoin subsidy reduces every four years, holding other factors constant. People with mining operations will continue to mine at current levels, until the operational costs exceed benefits.

If other factors change, this could impact the hash rate. If costs, fixed or variable, are reduced, the hash rate could increase. For instance, if the cost of purchasing computing power decreases, the hash rate could increase, since miners would be motivated to create new infrastructure. If the variable costs, such as power, increase, this could reduce hash rate as costs outweigh benefits.

Images from Blockchain Info and Prelounge.

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