The Future of Bitcoin: Corporate Mines and Network Peering?

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At the Inside Bitcoins Conference in Las Vegas in December, Josh Zerlan of Butterfly Labs spoke about the future of Bitcoin mining and transaction fees. (Photo: Rich Miller)

This is the second in a two-part series on the boom in Bitcoin computing infrastructure, and what it means for the data center industry. See Part One, Mining Heads to the Data Center

LAS VEGAS - What’s the end game of the Bitcoin mining arms race? Miners are building ever-more powerful hardware and larger data centers, trying to stay a step ahead of their rivals and keep pace with “the difficulty” – algorithm changes that make it progressively harder to earn new bitcoins.

Some Bitcoin watchers believe the network will ultimately shift from mining for new coins to a model based on transaction fees, which could accelerate a shift of Bitcoin hardware into data centers and the creation of peering networks to manage fees, just as current peering agreements seek to reduce network transit costs.

The long-term outlook for Bitcoin is important for the data center industry, where some leases can run from three to 10 years. The emergence of Bitcoin has seen the cryptocurrency soar in value, accompanied by rapid advances in the hardware required to successfully capture new coins. The Bitcoin protocol is designed so that these rewards will become harder to earn and will shrink over time. That means that the economics and business models of bitcoin could shift over the life of a data center lease.

Fees and the Future

The Bitcoin economy is supported by a global network of computers that use processing power to verify transactions between Bitcoin owners. Those who participate can benefit in two ways:

  • The issuance of new bitcoins, which happens about every nine minutes with a “block reward” of new bitcoins to the miner that processes that transaction. The block reward diminishes over time. It was initially 50 bitcoins, but is currently 25 bitcoins, or about $23,000. In 2016 it will be reduced to 12.5 Bitcoins.
  • Miners earn transaction fees, which can be awarded in every bitcoin purchase or transaction, and have historically been a tiny amount (often less than a cent) left as a gratuity for the miner. Slightly larger fees can be offered for transactions that require more data crunching, to ensure that the transactions are processed without delay.

Over the past two years, gaining block rewards has become progressively more difficult, forcing miners to upgrade their hardware from CPUs to GPUs and then FPGAs (Field Programmable Gate Arrays) and finally specialized ASICs (Application Specific Integrated Circuits) optimized for bitcoin data-crunching. As the hardware has become more expensive, many enthusiasts have been priced out of the mining market.

Princeton University computer science researchers Ed Felten, Joshua Kroll and Ian Davey have studied the bitcoin reward system and foresee a shift ahead.

“At present, the mining reward seems to be large enough, but under the current rules of Bitcoin the reward for mining will fall exponentially with time,” the Princeton team wrote in a recent paper on Bitcoin economics. “Transaction fees, which are voluntary under the current rules, cannot make up the difference. The only way to preserve the system’s health will be to change the rules, most likely by either maintaining mining rewards at a higher level than originally envisioned, or making transaction fees mandatory. The choice is likely to drive political disputes within the Bitcoin community.”

Researchers from Microsoft and Cornell have also explored this scenario and outlined refinements that would be needed to make incentives work in a shift to transaction fees.

The bitcoin community is “debating that (shift),” said Emmanuel Obiodun, founder and CEO of Cloudhashing, which leases computing power to customers. “It’s becoming more expensive to mine coins. But transaction fees are very low right now, and have very small profit margins. For now, there’s still a lot of upside in bitcoin mining.”

One Vision of a Fee-Based Future

The future of mining was a hot topic at the Inside Bitcoins conference in Las Vegas in December, where Josh Zerlan, Chief Operating Officer of Butterfly Labs, gave a presentation on the future role of transaction fees.

“In the future, there will not be much incentive to mine (for block rewards),” said Zerlan. As rewards become harder to achieve and the growth of bitcoin leads to more transactions, Zerlan says that fees will need to increase to ensure that miners continue to support the network. As this happens, miners will gravitate towards transactions with higher fees attached to them, which will be processed before those with smaller rewards.

If bitcoin gains wide acceptance as a payment platform or even as a currency, the growth of fees will present several challenges, Zerlan said.

“If you’re a large company, you have a problem (with paying transaction fees),” he said. “The solution is to maintain a large mining farm in your data center to process your own transactions for free, and your customers’ transactions for free. You can also earn extra income to processing others transactions.”

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3 Comments

  1. eddie

    Bitcoin will replace fiat currency very soon. Earn bitcoins from your laptop today here http://MyBitcoinJob.com/?id=eddie321

  2. Alex

    "The only way to preserve the system’s health will be to change the rules" I don't understand this bit, but maybe I am just ignorant on this part. I thought that the Bitcoin system is healthy, no matter if there are a few hundred miners in the world, or like now, an army of industrial miners with thousands and thousands of ASICs. That's the point of the self adjusting difficulty, isn't it? Do the researcher mix up the health of the Bitcoin network and the "healthy income" of miners? If mining ever becomes unprofitable, miners will switch of their gear, the network will adjust the difficulty downwards automatically, and a few hundred or thousand people with notebooks will again be enough to do the dirty work. For reference, the value of voluntary transactions fees included in the last few blocks: $ 26.26 $ 14.01 $ 6.63 $ 5.13 $ 7.30 $ 42.84 Assuming that the number of transactions in each block would be significantly higher in the future, and mining would become unprofitable for the industry, that's not so bad for a few guys with notebooks in my opinion. There is a new block every few minutes. Just trying to put this in perspective. Not sure why a shift would be required. The gold rush has to be over one day. In the early days of Bitcoin, every client automatically was a miner. This has been disabled nowadays, since mining on a CPU makes no sense. But bringing this back seems to be a no-brainer if all industrial miners would stop tomorrow.

  3. Andrew

    Once the 10 minute blocks are 20MB in size the transaction fees could easily exceed the block reward if even they averaged 10 cents each. The researcher's concerns are overblown.