Introduction to Komodo KMD. Part 3

Reasons for popularity and problems with proof-of-work.

Other reasons for the popularity of proof-of-work have to do with what is known in the science of economics as “network effects.” On the Bitcoin network, the difficulty parameter of its proof-of-work algorithm changes every 2016 blocks. The parameter goes up or down based on the laws of supply and demand. If there are more active miners, the parameter goes up. If the number of miners goes down for some reason, the parameter goes down. In practical terms, this means that as more users and miners join the network, the more secure it becomes. The more secure the network, the more attractive it is for new miners and users and the more both the miners and the users trust the network, which means that more of them will be joining it and so on. The more users the network has and the more popular the currency of the network, the higher the price of the currency, which, again, attracts more miners and the cycle continues.

This is the same “network effect” that applies to social network, ride-sharing platforms, online dating sites and so on. If Facebook had only a few users, then there is very little incentive for new users to join the platform because there won’t be a lot of new and interesting content. However, as the number of users increases, the amount of content also increases. When a platform does have a lot of users, then people are also not likely to stop using it because all their friends are on it. For example, if everyone in your social circle is on Facebook and uses Facebook messenger to communicate, then it is highly unlikely that you will stop using Facebook. It works with Bitcoin and other cryptocurrencies in the exact same way. If all your friends and business partners were using Bitcoin to send payments, you would also be more likely to use Bitcoin than if no one in your social circle was using it.


Problems with proof-of-work in its current form

While the Bitcoin network is a testimony to the fact that proof-of-work algorithms can be very effective, the algorithms do have a number of issues.

The first issue is that the algorithms are extremely energy ineffective. On the Bitcoin network, miners burn a lot of electricity to run the computers that create hashes.

According to an article in Forbes magazine, in 2017 miners just on the Bitcoin network used up to 20,000 gigawatt hours of electricity, which is about 0.1% of global usage of electricity. For comparison, this is the amount that the entire country of Ireland uses in a year. Mining equipment, such as, for example, Antminer S9, that you can buy at Wal-Mart for $8,250, uses the same amount of electricity as two refrigerators and one large TV set.

Essentially, mining coins on proof-of-work networks is like playing a lottery. The system works because blockchain networks are transparent, honest, and the chances of winning are significant.

Most people do not realize that in regular lotteries it is almost impossible to win. For example, chances of winning a Powerball jackpot have gone from one in 175 million in 2015 to one in 292 million in 2017. This happened because the total number of balls that players can choose went up from 59 to 69.

When looking at the numbers 59 and 69 and thinking about choosing 5 balls, people start intuitively dividing 59 or 69 by 5 and think that the chances are someone between one out of ten and one out of twenty. In reality, the chances have to do with choosing a subset of numbers from a set of numbers and involve not simple division, but doing factorial math. A factorial, described with an exclamation point, for example, “5!” is equal to a product of all the positive integers up to five, including five, so 5!=1 x 2 x 3 x 4 x 5 = 120. This number is important when calculating chances because in a set of N objects the number of ways to arrange these objects into a sequence equals N!. This means that there are 120 ways to arrange numbers (1, 2, 3, 4, 5) into a sequence. They would be (1, 2, 3, 4, 5), (1, 2, 4, 3, 5), (2, 1, 3, 4, 5) and so on. Even with a set this small, there are more combinations that people realize.

In practical terms, this means that winning a regular lottery such as Powerball is roughly the same as being chosen out of all living residents of the United States. This chance is actually smaller than a chance of being hit by a plane randomly dropping from the sky (chances of this happening are 1 out of 10 million), crushed by a vending machine (1 out of 112 million) or being hit by a lightning (1 out of 10 million).

While on the Bitcoin network and other cryptocurrency networks winning is possible and attainable (otherwise, no one would be investing in mining equipment), it is also all about math. For example, as of the beginning of 2018, running one Antminer S9 for a year would allow you to mine approximately 0.85 bitcoins. In addition to buying Antminer S9, you will need to pay for electricity. At 3 cents per Kwh, running Antminer for a year will cost USD$600. At 9 cents, the price will be 3x that, or USD$1,800, which is still profitable at the price of bitcoin fluctuating around USD$10,000 – USD$11,000.

The problem will all of the above is that while individual miners and miner pools are turning a profit, buying equipment and burning energy do not add any value to society, which is something that many of the visionaries in the cryptocurrency space are not comfortable with.