The market had a mini-crash yesterday after the Elon Musk tweets. He claimed that Tesla won't be accepting BTC for payments, and in the same tweet, he says Tesla will not sell its BTC.
Stressing environmental concerns, he expressed his interest in cryptocurrencies once again, but he also recommended everyone to change our PoW ways into something less energy-consuming.
Yes, we know already the BTC network is severely inefficient. Also, the carbon footprint it leaves is becoming quite important.
But I'm not going to bother with anything Musk said in his tweet. He doesn't actually care for the environment, what is more, important is to explain Proof of Work (PoW).
Proof of Work (PoW)
Energy consumption for Bitcoin is high, however, it is probably not something that pollutes so much to be discussed as the main drawback.
Bitcoin uses a modified version of hashcash, which was a system created by Adam Back (Blockstream). Hashcash was created to combat e-mail spamming and DoS attacks.
Very important to begin by explaining what hashrate means:
“Hashrate” refers to the total combined computational power that is being used to mine and process transactions on a Proof-of-Work blockchain.
Mining and PoW work like this:
Miners create a block that contains transactions. This block had a limit of 1MB 1MB introduced by Satoshi Nakamoto, but it was expected to increase to cover mass adoption for Bitcoin.
After miners create their blocks containing the transactions they enter a race between them to mine this block and propagate it to the network for validation.
Miners in this race are using their computational power to solve an algorithm.
This algorithm is SHA256 (or SHA-2). Miners are solving this algorithm, and the first one that solves it, propagates the block to the network for validation.
This procedure requires calculations performed by a CPU, which requires electricity to run. The higher the speed of the CPU the most likely the block will be found before other competing miners.
But there is more. The difficulty of solving the SHA256 algorithm Bitcoin uses is adjusted according to the hashpower.
Bitcoin blocks are set to a 10-minute average interval. On average each block needs to have this time gap.
The difficulty of the SHA256 algorithm adjusts every 2016 mined blocks. This is also a consensus rule set by Satoshi, to stabilize the average block mining time to 10 minutes.
As more miners join and more CPUs are running, the blocks are mined faster and the average block time drops. In the time between these 2016 blocks (called an "epoch"), the difficulty adjustment rule calculates the difficulty required for the SHA256 algorithm to keep the blocks on an average of 10 minutes.
Difficulty is a number. The current difficulty is 25046487590083.27.
The higher the difficulty the more CPU power is required to keep with the competition. If a miner doesn't invest in new equipment and increase the hashrate produced, then the miner will lag behind the competition and since hashrate keeps increasing this miner will eventually be unable to mine a single block. Mining pools are a solution for small miners.
Mining initially was performed using desktop computers. One Pentium or AMD CPU was enough to mine thousands of Bitcoins since the early coinbase reward (new mined BTC) was very higher than today. (50BTC).
Era of ASICs
After the first few years and by the moment Bitcoin was found to hold real value, ASIC hardware was created to specifically mine Bitcoin.
ASIC stands for Application-specific integrated circuit. Knowing the initials is important as it explains exactly what this system does.
ASIC is specific hardware that has only one function. To solve SHA256 algorithm. It is extremely efficient in doing so and the hardware manufacturers are releasing better models every few months.
These circuits are very demanding in electricity. Hashpower is increasing with new models coming out and miners increasing their operations. Also increasing with new mining companies finding a profitable enterprise.
For miners Bitcoin and any other PoW cryptocurrency is about profitability. The rules are not the same as for us, the simple cryptocurrency enthusiasts. Businesses work differently and only see possible profit as a reason to enter a field.
So this is the whole procedure. There is a lot more which is very technical, but the important part of how mining is performed and the explanation of PoW is this.
A better representation of all the above for the BTC network is given in this website: diff.cryptothis.
Bitcoin BTC difficulty adjusts every 2016 blocks which is roughly 2 weeks time.
Retarget means adjustment of proof of work. How much more is being produced during this epoch compared to the previous one.
Understanding how Bitcoin works give us some more insight into power consumption and how this expands over the 12 years of Bitcoin's existence.
The hashrate is counted in hashes. Currently, for BTC the hashrate is 195 Exahash.
The higher the hash power the more secure the network is. It is a fact that most mining is performed in China and a previously forced shutdown of mining in the Xingjiang area caused a hashrate drop of 25%. The concentration of mining in one location means concerns for decentralization. China is currently producing more than 60% of the total Bitcoin hashrate.
While hashrate is rising on average, there are lengthy times where it drops. In 2018 when the bear market was at full effect, miners were quitting, shutting down their ASICs and there were even events of mining farms going out of business, under the inability to cover their loans and make a profit.
PoW Secures the Blockchain
Hash rate, while it secures the network, it does that by transforming electricity, solving the SHA256 algorithm, and securing the network.
The blockchain is a series of blocks, connected between them. It is permissionless, uncensorable, decentralized. But most importantly it is secure.
The idea is that nobody can tamper with the previous blocks. Everything is permanently recorded and public.
Nobody can challenge the blockchain data, unless one party reaches 51% of the total hashpower, performs what is called a 51% attack, and a reorg. But for top blockchain networks like BTC, Bitcoin Cash, Ethereum, and Litecoin, the resources required for one entity to perform this attack would require combined power that will be impossible to reach.
Bitcoin having the highest hash rate means it is practically impossible to be attacked. However, since more than 60% of hashrate is located in a country run by an authoritarian government, China, there are many concerns and discussions about whether this government decides one day to take control of the network.
How is Electricity Consumption of BTC connected with Tesla
Bitcoin ($BTC) electricity consumption is very high. It is compared to the annual electricity consumption of the country of Norway.
Source: University of Cambridge
I have no intention to back BTC but what I saw from Musk was far from telling the truth and the motives behind his decisions are clear.
There is a lot of discussion about the carbon footprint of Bitcoin and many environmental concerns. And these concerns affected Tesla directly. Funds don't like companies disrespecting environmental laws.
Elon Musk didn't suddenly grow ecological conscience after finding out that the BTC network has been increasing carbon emissions and miners are using coal plants. It is all about the price of the Tesla stock.
Musk went into Bitcoin, and not just because of environmental concerns, funds pulled out.
Critics say electric-car firm Tesla's decision to invest heavily in Bitcoin undermines its environmental image.
-BBC (February, 10th, 2021)
Source: Yahoo Finance
After the explosive growth of the Tesla stock and the top of $900 Elon Musk decided it was about time to invest in Bitcoin and accept it for payments in his company.
The stockholders disapproval of this decision is visible in the Tesla stock price action.
Musk, after Tesla losing close to 50% from the recent ATH in January, is now trying with PR stunts on Twitter to ease the tension and please the Tesla investors.
It is common knowledge that accepting Bitcoin wasn't going to help his company. I haven't heard of anyone buying a Tesla using Bitcoin, and nobody was expecting Bitcoin to boost sales.
What could happen next, is Tesla (Musk) dumping BTC. It could be done even at a loss. Tesla bought at 30k. Musk discusses negatively his own investment but without prior selling it. Meaning he didn't take profits knowing his Twitter power will send the price down. This is unreasonable unless there are other reasons for Musk to not want to have a profit when the season ends. (It could be taxation reasons, I am keeping this thought for a later reference if I find more information).
Elon Musk seems right now he is just trying to control the development of cryptocurrencies and push them into what he thinks is best.
He wants to be part of anything revolutionary, but it impresses me how he didn't calculate the damage beforehand.
The brand name Bitcoin is notorious. It is connected to crime, unlawful markets and its high electricity consumption has always sparked environmental concerns.
For a company like Microstrategy that has learned to game the system for decades, it has worked well so far. However, the Microstrategy stock also started dropping and will eventually return where it started.
For Tesla though, which is growing in a market cap above any expectations, this was a huge mistake to make and Musk is currently trying to reduce the effect of this mistake.
Elon Musk can keep playing with Doge, as nobody accuses Dogecoin of anything yet and there had been no concerns expressed so far.
Suggested related articles:
→ Bitcoin Whitepaper: a beginner's guide (by Bitcoin.com)
→Bitcoin consumes 'more electricity than Argentina' (BBC)
→Tesla Stock Just Can’t Seem to Break Out of Its Slump. Here’s Why. (Barrons)
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