Bitcoin is an interesting beast. It seems like something out of a William Gibson cyberpunk novel. It was created by a shadowy figure that could be an individual or a cartel. It's infinitely traceable but ownership is completely anonymous. It has value; at the moment I write this, each "coin" is worth $869.61 and the total dollar value of existing bitcoins worldwide is almost $11 billion.
Unlike traditional currency, it exists outside of national control. Like precious metals, it can be mined, but unlike precious metals, you can't hold it in your hand.
It's real, in that some merchants and services will accept bitcoin as payment. It's virtual, in that it exists only as a series of entries in a global data structure.
And it's become the new best friend of criminals the world over.
You can gain ownership of bitcoin in three primary ways: you can buy them, you can get paid in them in return for a product or service, or you can make them through a process called bitcoin mining.
The first two approaches: buying bitcoin and getting paid in bitcoin are interesting, in that any item that can be bought and sold is interesting. Bitcoins might be, to quote Paul Krugman, storehouses of value, or they could someday go "poof" and simply be bits worth less than two bits.
The bitcoin system is set up to limit the total number of bitcoins that will ever be available in the world pool. That limit in total availability artificially forces value on each coin because the resource is designed to have scarcity built into its DNA.
What's propping up the value of bitcoin is both buzz and the limited availability, combined with a decidedly libertarian political flavor and, well, its almost perfect fit with the needs of illicit and illegal transactions. And that brings us to both bitcoin mining and crime.
Bitcoins come into existence as the result of increasingly complex calculations that incur both computing hardware and energy cost. The bitcoin system requires that each new bitcoin is incrementally harder to "mine" than the preceding coin. What this means is that each new bitcoin requires more and more calculation power than the coins that came before.
When bitcoins first blinked into existence, they could be mined by a few spare computers, just left to crank away. Now that there are so many more bitcoins in circulation, those computers can barely mine a fragment of a bitcoin in anything resembling a reasonable amount of time.
Given that bitcoin mining is designed to always need more computing power thrown at it, a market sprang up for custom bitcoin mining computers, machines built with custom ASIC (application-specific semiconductor) chips designed to optimize the processing of bitcoin mining algorithms.
As more and more bitcoins are born into the world, more and more processing power is required. The custom bitcoin mining machines have become increasingly expensive to purchase, and — also very important — increasingly expensive to operate as they eat raw electical power at a phenomenal rate.
All of this makes a sort of elegant sense. They take more work to create, so the rate of supply of new bitcoins slows down over time as the cost to produce them goes up along with — at least in theory — the overall value of each coin.
That means that each coin has a cost of production. The profit attributable to each coin, therefore, can be calculated as the net selling price of the coin, minus the cost to produce.
At least that's the case for people and companies who mine bitcoins and who are unwilling to break the law. The game (and the profit structure) is completely different for criminals.
All your coin are belong to us
Think about what it takes to produce bitcoins, the means of production: processing power. Law-abiding bitcoin miners spin up this processing power either using ever more powerful, special purpose computers or -- in a relatively new trend -- rent bitcoin processing time from service providers who sell timeslices of their processing power plants.
Now think about the cost items. You have the cost of the mining computers, storage space, and energy for cooling and powering the mining machines. The profit in bitcoin mining is all about making sure that the selling price (or stored trading value) of the mined bitcoins is greater than the cost to mine them in the first place.
As the Bitcoin mining profitability calculator shows, profitability is all about getting the hash rate (speed of calculation) high enough, while the cost of hardware and energy is low enough. Even so, because bitcoins become more difficult to create, the existing hardware (no matter how large its current hash rate) will quickly obsolete.
This means that a law-abiding miner will have to constantly upgrade and discard hardware, simply to keep up with the ever-increasing difficulty rate inherent in bitcoin mining.
Breakin' the law, breakin' the law
But what if you're willing to break the law (which, for the record, I do not advocate)? Do the production cost ratios for bitcoins change?
That's what we'll discuss on the next page...