Ethereum meltdown symptomatic of a cryptocurrency out of balance

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The recent Ethereum meltdown indicates that the profitability of mining is putting pressure on the blockchain to find a scaling solution – and soon.

For all too many years the PC industry in Thailand, and indeed the world, has been in the doldrums. Mobile First has become the norm and even laptops are becoming sidelined for tablets and phones.

Until now.

Bangkok’s annual Commart computer market this year saw people queuing up in the wee hours of the morning to get their hands on GPUs … for cryptocurrency mining.

Yes, despite all the naysaying (and the tiny detail that the Bank of Thailand’s currency control rules effectively make all decentralized tokens legally questionable), Bitcoin has finally become mainstream in the country, and people have woken up to it, albeit not quite from a freedom-and-liberty-from-central-bank-oppression point of view.

Hence the sudden surge in demand for GPUs.

Which may sound like a good thing for the cryptocurrency movement. The problem is that the cost of mining cryptocurrencies is becoming increasingly out of balance with their market prices. Put another way, cryptocurrencies are becoming so popular, and hence profitable, that it’s causing scalability problems that are already threatening to overwhelm blockchains like Ethereum

Lack of equilibrium

A quick backgrounder for the newbies: most cryptocurrencies are secured through a technique called mining. At the risk of oversimplification, mining is like signing off accounts. It involves the expenditure of resources (electricity and computing power – in this case, GPUs) to guess a number that – when hashed (put into a complex calculation) with the carry-forward from the previous page of accounts (previous block) and all the transactions in this block – is lower than a certain number. If this number is found, the finder gets a reward and the block is made part of the blockchain. Changing the past (i.e. cheating the system) would be straightforward but would require huge amounts of energy to recalculate everything from that point onwards, making it infeasible and unprofitable. The attacker would gain more by using his resources to help secure the blockchain and compete for the reward rather than attack it.

During normal market periods, mining income and price move to equilibrium – that is to say, the cost of mining a new coin is usually around the same as buying one on the open market. If there is profit to be had, more people will mine them instead, and difficulty will rise. If miners mine at a loss, they would do better to turn off their mining rigs and buy coins on the open market with the money they would otherwise pay for electricity. This would in turn lead to difficulty levels becoming easier to maintain equilibrium.

But the recent explosion in various cryptocurrency prices means that equilibrium is not there. That’s why there is silly money to be had for anyone who can get their hands on GPUs to mine Ethereum or Zerocash (the two most profitable coins), or variants thereof, at this moment in time.

How silly? An AMD Radeon RX 580 can break even in 70 days, and anything beyond that is pure profit. An nVidia 1080 Ti graphics card will break even in 90 days.

Needless to say, GPU prices and markups are exorbitant right now. Local Thai media is full of pictures of the lucky ones getting their hands on graphics cards as if they had won a lottery. Which is pretty much the case.

Ethereum’s fall from grace

Ethereum has been head and shoulders above the rest in terms of profitability. Yes, the algorithms automatically adjust, but the meteoric rise in its price has meant that profitability has remained – until a few days ago, when most exchanges suddenly stopped sending or accepting Ethereum transactions until the network backlog had been cleared.

Put simply, Ethereum’s blocks were full, and it did not fail gracefully.

The reason for the rise of Ethereum and its subsequent network meltdown is the growing number of initial coin offerings (ICOs) – in particular, the Status ICO that raised $64 million in one day.

Nearly every recent ICO has been made on the Ethereum blockchain for the simple reason that it’s infeasible to starting a new cryptocurrency from these days. Young blockchains with only a little hashing power to secure them can easily be attacked. The only practical way is to piggyback on established blockchains, and Ethereum has made this especially easy – if you can do cut-and-paste, you can launch your own ICO.

However, this has driven up fees and pushed the network to breaking point – hence the price crash that saw Ethereum drop from $350 to around $300. It will be interesting to see how Ethereum founder Vitalik Buterin and his band of merry men address this scaling issue. Without a scaling solution, the dream of Ethereum as an unstoppable, uncensorable global computer might come crashing down – and soon.

From a mining perspective, the big winner is Zerocash. Bitcoin and indeed most cryptocurrencies are not fungible – that is, one Bitcoin is not the same as another and their entire history can be traced in the public ledger that is the blockchain. Zerocash offers a completely anonymous mode. Consequently, many are pouring their investment into it as potentially the next big thing once authorities get serious about cracking down on Bitcoin-based tax evasion.

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