As we reported yesterday, Cryptocurrencies like LiteCoin are causing certain GPU vendors like AMD to have shortages of supply due to cryptocurrency mining. When we look at the fundamentals of cryptocurrencies, the primary question that keeps getting asked time and time again is whether or not mining these currencies is worth it. The next question that is usually posed therafter is what are these cryptocurrencies worth, since that determines whether or not mining the currencies is worth it.
First, we look at BitCoin, arguably the most valuable of the cryptocurrencies and the one that carries the rest of the cryptocurrencies along for the ride. BitCoin is a currency that is completely de-centralized and are purely peer to peer without needing a central bank or clearing house to verify the transaction. Because BitCoins are also secure and anonymous, they are generally considered an alternative to paying with ‘real’ money. You can also pay people with BitCoins without having to pay any fees (until you use an exchange to convert it to an actual currency like USD or GBP). In order to obtain a BitCoin, you must mine the currency using some sort of computer and hash the algorithm until you have broken down the block of code needed to unlock a single BitCoin. However, the way BitCoins work, you don’t necessarily have to have a full BitCoin in order to earn money, you can earn a fraction of a BitCoin and trade it for cash or goods as well.
One of the features of BitCoin and many other cryptocurrencies is that they have a limited amount of currency and cannot be inflated by the creation of more currency, instantaneously devaluing the other peoples’ currency. As such, this appears to be a more attractive alternative to governmentally controlled currencies which generally inflate and devalue at a rapid pace on a daily basis. As BitCoins become more and more difficult to generate (as they already are) the cost of generating a single BitCoin in terms of hardware purchased and electricity consumed will go up. Many people will argue that BitCoins are an artificially inflated currency who’s price is being manipulated by speculators. While this may be true, and likely does account for BitCoin’s high price, it doesn’t take away from the fact that BitCoin and LiteCoin and many other cryptocurrencies still have underlying value propositions.
All of the currencies require you to spend money on hardware to generate the currency through mining. Generally speaking, a full computer with proper graphics cards to do some cryptomining will likely cost in the price range of about $1000. Sure, you can build cheaper mining machines, but you will be vastly underpowered in terms of GPU horsepower. Not to mention, BitCoins are not even profitable to mine via GPU and are almost universally mined using custom ASICs like the TerraMiner and Butterfly Labs ASICs. Those ASIC miners cost thousands of dollars and promise to generate BitCoins at a vastly faster rate versus GPUs and promise a certain payback rate based on a certain BitCoin price. LiteCoins and many other ‘altcoins’ have recently become more attractive to the general populous due to their lower barrier to entry and overall lower cost to generate a coin. Additionally, many people are mining these coins to then trade up for a BTC, which explains why recently LTC and BTC have shared similar pricing fates.
One of the biggest flaws in any cryptocurrency’s payback is the fluctuating value of the currency. BitCoin has crashed before and many miners abandoned their efforts because the cost of electricity outweighed the payout that BitCoin offered. Admittedly, BitCoin right now is around $1,000 per BTC and LiteCoin is around $33 per LTC and each of them clearly has a different payback rate and cost associated with generating a coin. This payback rate eventually determines whether or not it is worth mining coins or not, some people are willing to mine for weeks if not months to pay back their initial investment assuming that the price will remain stable, which it really hasn’t. The truth is that the hardware investment necessary to mine BitCoins is so great at this point that it doesn’t make sense in terms of risk to actually mine any BitCoins unless you are already doing so. As such, this is why I suspect we have so many BitCoin speculators buying BitCoins and driving up the price while the rest flock to ‘altcoins’.
There is also the lack of centralized banking or security or even accountability. As a result, users are basically responsible for their own banking, security and accountability. If something goes awry, like hard drive failing, then the user is responsible for recovering those cryptocoins. There have already been multiple documented cases of BitCoin theft and hacking, and because the currencies are anonymous it is virtually impossible to track any sort of theft. As such, many people will likely shy away from such a potentially dangerous currency. Not to mention that governments like the US consider BitCoin to be one of the currencies used for criminal activities, even though most crime is still done in cold hard cash. China also argues that they will not allow for banks to exchange BTC because of the money laundering potential, but the likelihood that this will happen is very narrow and even so isn’t a very valid reason to ban their exchange altogether.
Looking at the overall volatility of cryptocurrencies is another problem. Since little legislation and governmental policies have been decided regarding cryptocurrencies, there is still quite a bit of uncertainty left within the markets. As a result these currencies fluctuate wildly, like with bitcoin, swinging $300 in each direction in a matter of days.
If you take the security, anonymity, cost of hardware and cost of electricity it is simply impossible to argue that cryptocurrencies are worthless. Yes, there are flaws, but it is clear that many people believe that the benefits outweight the flaws and there is an underlying value in the benefits that cryptocurrencies provide. The real question is, what is the true value of a cryptocurrency once all of the speculation has died down and the dust settles? After all, there is no denying that much of the BitCoin’s value is purely based on speculation of future value much like many other publicly traded securities. We don’t think anyone really knows yet.