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Risks in bitcoin mining urge for privatization of protection, industry trend reveals

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I had a very productive time at Bitcoin 2022. It’s the first time I’ve gone to a conference like this, and I met and shared drinks with a lot of very forward-thinking individuals. This space attracts a lot of different talent, and I think the diversity is the reason it’s so much fun. I had a chance to speak to some folks in the traditional finance and energy industry, and gather their opinion on Bitcoin. It was really interesting to see how these worlds are converging.

Kevin O’Leary has a hypothesis on this. He’s stated that this space will eventually become the 12th sector of the economy, the DeFi space. I don’t know if I buy into it. Not in the long run at least. It seems to me that the cryptocurrency is merging industries together more than it is creating something new. Stranded energy is being turned to something valuable. The grid is being stabilized. An energy currency is being made, one with a very predictable supply.

I see the space as on its way to becoming this energy currency, but few people tend to view it this way. Bitcoiners do, but we’re not everyone by a pretty large margin. Michael Saylor’s faith is not representative of his class. The power-industry people think they’re supporting some one-off use case to profit from natural gas byproducts. The finance-industry people think they’re supporting an internet-based P2P payment rail that’ll disrupt point of sale systems. Both of these things might be right individually, but I believe their industrial biases are forcing their viewpoint through a myopic filter.

Cheap Energy and Political Turmoil`

Bitcoin miners are incentivized to go where the energy is the cheapest. Cheap energy and political stability are not often co-located. Cheap can be pretty relative. There’s lots of miners in the U.S. using $0.06/kWh energy to mine Bitcoin. That’s pretty good compared to your residential rate, if I had to guess, but it’s definitely not where energy is the cheapest in the world.

As the industry continues to grow, and if profit margins become increasingly dependent on cost of energy price differentials from location to location, Bitcoin mining could see itself performing best in some questionable locales. I heard explicitly from miners at the conference that the best locations to mine would be places like sub-Saharan Africa or even Venezuela, if it weren’t for the security problems associated with the area. Miners consider the risk of losing their assets too high to seriously consider these areas.

Compass Mining, a popular MaaS (mining as a service) provider, recently experienced the implications of a tumultuous political climate. Customers of Compass Mining can buy ASIC hardware, but keep it hosted at a Compass Mining site, where it’ll benefit from professional care and low energy costs. Their customers mine directly into their wallets, so using a hosting service makes a lot of sense if you live in an area with expensive energy or if the local political climate around crypto is questionable.

When I thought about buying an ASIC and hosting it with Compass Mining, I considered placing one in Russia. With the outbreak of the war in Russia, I noticed this was no longer an option within their site. At the conference, when pressed, an insider told me that their miners remain operational in Russia. They’re still in the control of Compass Mining and their investors, but they will no longer be placing additional miners into the site. Apparently, there were even Russian threats to nationalize the Bitcoin mining site. I haven’t found any proof of this, but given the turmoil in the region, I wouldn’t doubt it.

Crypto is just beginning to enter the political consciousness. There’s a lot of different theories on which way currencies will go in the 2020s (123, etc.). One thing’s certain: currencies are going to be weaponized between countries in order to maintain power. If your economy goes to shit because of policy, you might just seize whatever hard asset you can. If Bitcoin is the hardest asset of all, well- that makes miners pretty big targets, doesn’t it?

Enforcement of Physical Custody

For one reason or another, Russia did not seize these Bitcoin mining sites. At least, not yet. If the currency/commodity wars continue to escalate, I’m not sure if I trust any country’s government to respect the property rights of the miners, including my own. It may become too valuable to a government to not seize them from the government’s viewpoint. A sovereign has a monopoly on violence within their own borders by definition, so there’s little to stop them from at least trying this in the future.

These miners need physical security of their property. The distributed ledger may protect us from financial governmental overreach, but there’s nothing securing the physical layer except for whatever force is internal to the miner’s site and the sovereign state in which the site resides. When a sovereign state is faced with an existential threat, such as the collapse of their currency, their hand will be forced to make world-changing moves. Stealing one’s property is a regular occurrence in the most free of the free market countries. This is a precedent one could expect moving forward.

Miners must begin to act collectively for their own interests. This includes assembling security teams and enforcing custody at their sites. Jason Lowery is an incredibly bright individual, but I think we’re a decade away from a Hash Force if we’re lucky. How many years away are we from a site being secured by a nation state? Days? Are we not obligated to ensure our network is used ethically?

I theorize this will lead to the rise of the layer 1 network stateMiners can not rely on a solution from the nation state to support solely their interests. The solution must come from within a network state. A sovereign nation state can not enforce custody against another sovereign nation state without the decision becoming besmirched in political quagmire. Custody of ASICs must be enforced by a state-agnostic solution. This network state could negotiate the initial terms with the nation state in which it resides, and revoke the nation state’s access to the network’s benefits upon provocation.

I believe this is necessary to ensure the integrity of the network, is it not? Assume otherwise, and we allow the hash power to be stolen. Sorry, Charlie- might makes right, at least for now. In this world, the physical component of the network experiences a free-rider problem, and a thieving nation-state gets taken along the ride to the top. Now, perhaps, our little garden has become tainted. Perhaps this isn’t a problem when it is only one nation state like Venezuela, but what if they were to collude for their survival? Could this not align incentives between unlikely nations?

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