I have heard that the bitcoin mining process was created in a way that purposefully required the expenditure of resources (energy/money) in order to add real value to bitcoins. In this way, when more miners join, the value of bitcoins would rise because there would be additional resources that would be used to process the transactions. However, the way I see it, it is the opposite. In other words, it seems that the value of a bitcoin is based on supply and demand from buyers/sellers, and the degree of mining interest is based on this pre-established value. My reasoning is that people do not suddenly decide to buy or sell bitcoin because "oh there is more mining power going into validating the blockchain so it must be worth more." On the contrary, miners enter or leave the mining process based on whether the potential reward for successfully mining a block is "worth" the work, with the value of the reward being strictly based off the current market value of a bitcoin. Would anyone like to confirm or refute the latter hypothesis?
2 Answers
I have heard that [...] when more miners join, the value of bitcoins would rise because there would be additional resources that would be used to process the transactions.
I do not see why more validation power would make the currency unit more valuable. But before this discussion, lets clarify the technical side.
In general, the idea behind the Bitcoin protocol is to achieve a consensus view on the common transaction ledger in a decentralised way, i.e. no third-party intermediary to act as a clearing agency etc. To avoid double-spending of coins, transactions need to be verified by miners before insertion into the blockchain - also, all nodes will synchronise with the longest chain available, so effectively the system works on a majority-based consensus system (majority of the miners determine the global chain).
Now, this would open up to security problems - one example is the Sybil attack, where an adversary simply creates countless virtual identities who all vote for his (potentially false) chain.
This is where the Proof-of-Work (PoW) scheme used in Bitcoin's mining protocol comes in. It is purposefully made computationally difficult for miners to verify blocks. Because of this, miners need to invest resources (energy, money) in order to participate - the rationale is that it is much harder to fake computational power in the network than simple identities, preventing a Sybil attack.
Back to the value of Bitcoin: Note that the following is rather subjective, and highly controversial.
I argue that it is simply determined by market supply and demand. Following this basic logic, the value of 1 BTC must increase in the number of users to join the network, since the monetary base of Bitcoin is limited by design. Because this is unrealistic in the long run, this argument can not be final.
On top of this, we can see extreme levels of speculation on cryptocurrency exchanges, driven by developments such as
- adaptation (e.g. recognising Bitcoin as legal tender in some countries, more vendors' acceptance...)
- news flow on upcoming updates, increasing awareness of cryptocurrencies and the resulting interest by the public and corporations
- negative economic/political activity in some economies might lead to more demand for bitcoin
On the contrary, miners enter or leave the mining process based on whether the potential reward for successfully mining a block is "worth" the work, with the value of the reward being strictly based off the current market value of a bitcoin.
Yes, this is correct. A causality between hashing power and the market value of 1 BTC is not apparent, other than that new miners will likely participate in the system themselves, increasing demand. Rather, as the market value increases, mining becomes more attractive in the short run. Note that after each 2,016 blocks, mining difficulty is adjusted to maintain a fixed mining rate, so then it becomes more expensive and miners will have to decide if they continue participating.
-
Great answer, thank you. Also, I would like to point out that I agree with your hypothesis on the valuing of BTC. Jan 5, 2018 at 19:00
You are correct as to what influences the price of bitcoin, but the significance of mining and Proof of Work and why it costs time/ energy and money is due to fact that the number of valid blocks produced needs to be limited over a period of time and to ensure that it is difficult to rewrite the blockchain.
If it was easy to produce blocks, the network would be flooded with blocks and various chains. It would be very difficult to agree which blockchain is authoritative. Further, if it were not for the difficulty of producing a new block, it would cost nothing to rewrite the blockchain and produce an alternative view of the history of transactions.
-
Okay I now understand your point that "if it was easy to produce blocks, the network would be flooded with blocks and various chains." So if I am understanding correctly, the expenditure of valuable resources (energy/money) is simply a side effect of the necessity to make the verification process "difficult"? Therefore in an ideal world–however implausible–the mining process should be as inexpensive as possible while still maintaining the appropriate threshold of difficulty? Jan 5, 2018 at 18:51
-
I'd say the other way around, being that mining should be as expensive as possible. The problem we encounter, however, is that if mining is to hard the rate at which blocks are produced is too slow. It's important that mining is expensive as it is the expensiveness of mining which ensures the blockchain can't easily be replaced by an alternative. Jan 5, 2018 at 21:23