If you want a bitcoin, you have three ways to acquire it: You can buy it, you can receive it as payment, or you can – well, just go get it.
The first two methods are self-explanatory, and they’re the usual subjects of the debate around bitcoin: its value as an investment and as a currency. As for the third method, bitcoins are created through a process called mining, in which computer power (hashing power) is used to solve a puzzle in pursuit of a number called a nonce. In theory, these puzzles could be done with a pen and paper. They aren’t mathematically challenging, they just require a lot of number-crunching and guesswork.
So why buy a bitcoin for Monday morning’s price of roughly $43,000 when you can just solve one of these puzzles and get one on your own? To answer that question, it helps to think of the traits bitcoin shares not with other currencies or investments, but with something else – commodities.
Not your typical commodity
The U.S. Commodity Futures Trading Commission characterizes bitcoin as a commodity so that derivative contracts like futures and options can be traded based on its underlying value. This makes a certain amount of sense. What’s considered a commodity has changed over time, but from goats to gold, commodities all have something in common: They’re fungible, meaning interchangeable. There may be different types of tea and grades of motor oil. But a gallon of unleaded gasoline is more or less the same no matter where you get it.
In most commodity-dependent industries, when the price of the underlying commodity goes up, supply starts to increase, as well. When prices of gold or copper go up, miners respond by ramping up production. It’s the same with oil. Higher supply eventually causes prices to go down, and the cycle repeats. But something strange is happening with bitcoin: Its price is near its all-time high, but supply is increasing at its slowest pace ever. There are several reasons for this.
Tesla buys $1.5 billion in bitcoin:as Elon Musk jumps on board with cryptocurrency
Is this the year to buy bitcoin?:The smartest investors are doing, here’s why.
In the early days, the puzzles that bitcoin miners had to solve were relatively easy and didn’t require a lot of hashing power. A dusty old central processing unit (CPU) would do the trick. But the puzzles have gotten exponentially harder over time. This is because bitcoin’s founders decided each block of bitcoin should take about 10 minutes to mine, in an effort to keep a lid on supply. As computing power surged, so did the difficulty. The difficulty is adjusted every 2,016 blocks – which is roughly every two weeks if it takes 10 minutes to mine a block. In theory, you could take the average hash rate and the time per block of the prior 2,016 blocks to estimate what the next difficulty number will be. But it’s not a perfect science (since sometimes a block is mined in far less than 10 minutes by pure luck).
In January of 2009, the difficultly was 1.0 and the network’s hash rate was 4.21 million hashes per second. Today, the network’s difficulty is closing in on 20 trillion, and the hash rate is around 150 million terra hashes per second (TH/s), with a terra hash equalling 1 trillion hashes. This is one reason behind the surging demand for NVIDIA’s (NASDAQ: NVDA) top-of-the-line graphics processing units (GPUs).
So there’s one part of our answer: the computing power required to mine one block of bitcoin is exponentially higher now than it was 12 years ago, even if the time it takes to mine one block is still around 10 minutes.
If the time to mine a block is relatively constant over time, why is bitcoin supply increasing at a slowing rate? The answer is due to bitcoin “halvings.”
The first bitcoin block, known as the “genesis block,” yielded 50 bitcoin. But after every 210,000 blocks are mined (about every four years), the reward is cut in half. The first halving occurred on Nov. 28, 2012. The second was on July 9, 2016. And…