Category Archives: Understanding

Brainwallets and Why You Shouldn’t.

One of the most complicated aspects of Bitcoin and cryptocurrency security is that of maintaining your wallet security. Sadly, there is a lot of conflicting and non-intuitive information out there and it can be difficult to find information about what to do and how to remain safe.

One way of handling wallet security is through a method called brainwallets. In short, these are wallets that use a memorized word, phrase, or sentence to generate a secure key for an address.

Unfortunately, it’s not as easy as just coming up with a good phrase. To understand why, you need to understand a bit about wallets, addresses, and keys. Don’t worry, it won’t be very complex, and I’ll write a more extensive article later on deeper details.

Wallet and Key Primer

The first thing you need to know is that a wallet, in cryptocurrency terminology, is more like a collection of addresses than a store of money. It is the addresses that store the coins, not the wallet. The wallet is really little more than a list of the private keys for those addresses.

Each address is a unique string of characters that is derived from a public key. It is not the public key as such, but rather the result of some mathematical juggling.

At this point, you may be wondering what these private and public keys are, so let me give you a brief overview.

Modern cryptography often utilizes a private and public key pair. Each of these private and public keys in a pair are linked so that a certain public key always corresponds to a certain private key, but in such a way that knowing one part of the pair does not give you the other part.

For example, and very simplified, let’s say you have a public key ABC that corresponds to the private key DEF. You can validate that the key DEF corresponds to ABC and the other way around, but you cannot find DEF simply by looking at ABC.

In fact, you want people to have your public key in many situations. You can share the public key with anyone as long as you keep your private key, well, private. This is essentially what you are doing when you publish your cryptocurrency address, although it’s technically difficult to get from a Bitcoin or Dogecoin address to a public key.

By sharing your public key, or really the address derived from your public key, you accomplish two things. First, you allow people to send coins to your address, which at least in my book is a very compelling goal. Second, you create the ability to sign messages using your private key so that anyone can verify that you control the address. This allows you to send coins as well.

Note: You can even use this in reverse to create encrypted messages that only whoever has the private key can open, but that’s for another article.

Having the the private key part of a public/private key pair means that you can use the key DEF to sign a message, and anyone seeing that message can, knowing the ABC public key verify that it was indeed signed with the corresponding DEF key without knowing what the DEF key really is.

Note: Signing a message is really just creating a unique sequence of numbers or signature as it is usually called, using the private key and the message. Because the private key DEF always corresponds to the public key ABC, anyone who knows the ABC key can verify that it was indeed signed with the DEF key, again without knowing the DEF key.

Cryptocurrencies utilize this key pair method too by creating a unique address derived from the public key ABC. The private key DEF remains in your care, and this is what you need to guard to care for your wallet security. Your wallet essentially contains the private keys for any address (and thus public key) you have added to your wallet.

Anyone can verify that any message, such as a transaction, derived from a public key is indeed signed by the private key that corresponds to the public key. So, as long as you control the private key corresponding to the public key used to generate the coin address, nobody but you can sign a message that sends money elsewhere using that address.

So, with that primer out of the way, let’s look at brainwallets and why they are a bad idea.

Brainwallets: Just Say No!

Every transaction in Bitcoin, Dogecoin, Litecoin, or any cryptocurrency rely on two keys only; the public key, used to generate a coin address, and the private key, used to sign messages to control the coins held by that address.

This is what creates the semi-anonymous nature of cryptocurrencies. Nobody knows who controls the private keys, and whoever controls the private keys control the money. There is no other identifying properties such as address names, usernames, passwords, or anything like that. If you have the private key, you have everything you need.

However, remembering a private key can be very difficult. Here’s an example of a private key:

5KJvsngHeMpm884wtkJNzQGaCErckhHJBGFsvd3VyK5qMZXj3hS

This key corresponds to the address 1JwSSubhmg6iPtRjtyqhUYYH7bZg3Lfy1T, which is a fairly well-known and quite insecure address used as an example for a brain wallet.

Instead of trying to remember the private key, or having to keep it secret and possibly losing the medium used to store it, a brainwallet instead uses a phrase or sentence that is much easier for people to remember.

The above example is the brainwallet key for the phrase “correct horse battery staple” which is from a well-known XKCD comic that explains an aspect of passphrase security called entropy.

A brainwallet uses similar cryptographic number crunching to turn that phrase into a private key for a cryptocurrency address. Seems genius, right? You don’t need to memorize any cryptic strings and you don’t even need to store your wallet or private keys anywhere. Simply remember the passphrase and you’re golden; you can always recreate the private key from the passphrase.

But there’s a problem.

A Brilliant Idea Tainted

Because the only thing you need to get access to funds is the private key, and the passphrase can be used to recreate the private key, you end up with a situation in which anyone who uses the same passphrase as you will get the same private key.

The above example, using “correct horse battery staple” is an example of this. It is a common phrase that, while easy to remember, is also known to everyone and also fairly easy to guess.

In short, you end up with a security solution that relies solely on a passphrase that must be globally unique and extremely difficult to guess to have any meaning.

The XKCD comic is still right, but not in the case of cryptocurrency and wallet security. In a website login, a passphrase may work fine because you can add a bit of difficulty by having to combine the username and the passphrase, but also because you cannot simply brute force a billion attempts every second to try to log in using every conceivable combination of words. The server would either overload or there would likely be some kind of lockout after a few failed attempts.

With cryptocurrencies, however, you can try combinations of words as many times as you want. You don’t log in anywhere; you simply create a private key from the combination of words.

To create a secure brainwallet, then, you need to have a passphrase that is guaranteed to be unique and very difficult to guess.

You may think you can outsmart the system by using something that is unique to you. For example, add your spouse’s middle name to your phrase to create something like “correct horse denise battery staple”. However, you’d fail on the ‘difficult to guess’ part, and you’d fail in the globally unique part because, well, other people have spouses named Denise too.

You may use a longer passphrase but again, with the power available to modern computers these days, trying billions of combinations take seconds at most and if the attacker knows even basic information about you, such as the languages you use, your family names, your birthdates, and so on, it wouldn’t take very long to outsmart you by simple brute force.

Even if you managed to find a unique and difficult to guess pass phrase, you’re still stuck with a couple of problems.

One such problem is that you also need to remember the passphrase. The longer the passphrase, the more difficulty you’ll have remembering it.

Note: Writing it down is… not good.

“Great, “ you think, “I’ll use the first paragraph of the national anthem” and you’d fail in the difficult to guess and globally unique aspects again. “So, what about the combined names of all my kids, my parents, and my own, in random order?” For a password, it would be great, but for a brainwallet, it is not sufficient.

But let’s give you the benefit of the doubt and hope you remember your 28 word passphrase perfectly, and that it is both difficult to guess and globally unique.

Now you need to remember such a passphrase for every unique address you control. in cryptocurrencies, new addresses are cheap and used extensively. I’ve had hundreds if not thousands of unique addresses in just the year or so I’ve been involved with cryptocurrencies and remembering a passphrase for even a fraction of these would be impossible. And I do have great memory.

So, Any Good News?

You may think that based on what you’ve read so far, brainwallets have no use at all. That’s not entirely true, but like any tool, you need to know in which situation it makes sense to use it, and not try to force the situation to fit the tool you want to use.

For example, in cold wallet strategies, having a brainwallet may work great. Rather than storing the private keys in clear text, you can store a passphrase as part of something else. For example, you can put a book in a safe, and remember that the passphrase is the second paragraph on page 238. Whoever breaks into the safe won’t know the secret to finding the passphrase, and you just need to remember a few items of data. It isn’t practical for every day use, but then again, the purpose of cold wallets is to be long-term storage, not day-to-day payments.

Note: I’ll write about cold wallets and cold wallet strategies in a later article

For most normal uses, however, brainwallets aren’t as cool as they initially sound, and you need to be very careful before you rely on them for your security. With the knowledge you’ve gained here, though, you may be better able to determine when to avoid them and how they may be used as part of an overall security strategy.

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MtGox Bankruptcy: The Bad and the Good News

MtGox filed for bankruptcy protection on February 28, 2014, after losing control of almost 6% of all ‪‎Bitcoin‬ in existence at the time. You should be worried and excited at the same time.

Bitcoin is inherently a fixed supply currency. If a coin is lost, it cannot be reprinted ever. It is not mathematically possible so it’s not just a matter of attitude either. When you give someone a coin to hold for you and they lose that coin, there is no way to recover it. It is lost forever and you can jump up and down from anger as much as you want.

In essence, unless you can make 2+2 equal something else than 4 in traditional math, it won’t matter.

So, the loss of those coins, if they are indeed actually lost, is quite a blow to MtGox users. Even if you go to court and get a ruling saying you should get your money back, the money, for all intents and purposes, do not exist anymore. It would be like getting a ruling saying that you are entitled to be part of a historical event that happened centuries ago; it’s just not possible to enforce the judgment.

That’s the “why you should worry” part of this.

There’s good news, though, especially if you have followed the advice from virtually everyone who know how to tie their own shoelaces, and have kept coins in different accounts.

Imagine this: Tomorrow, the US government (or your local government) announces that 6% of the entire money supply is gone, and it’s not coming back. The money printer burned down, taking the only templates with them, and for some odd reason, it’s not possible to create a new template. You may think that this is a disaster, but it can be quite the opposite.

You see, the economy isn’t measured in number of coins, dollars, euros, or whatever. The economy is still exactly the same. You still buy the exact same amount of food, gas, electricity, and midget porn.

The means that, because there are fewer dollars in circulation, each dollar is worth more than it was prior to the accident. 6% more, actually. That means prices measured in US dollars will drop, so the money you have will last longer.
In a perfectly balanced world, where everyone kept an equal amount of money in MtGox, cold wallets, hot wallets, and other storage services, the loss of one of these services will not in any way affect the purchasing power of each individual. You can wipe out MtGox and it won’t mean a thing to Bitcoin, in the grand scheme of things.

To understand how this works, again imagine that every dollar in the world, except one, was gone in some freak accident. Suddenly, that dollar now represented the entire US economy, so it would be worth the entire supply of food, gas, electricity that the US consumes. And midget porn. A cent would suddenly be worth 1% of the entire US economy.

Similar to Bitcoin, of course, that won’t matter for those who lost all their money and it will make whoever holds that remaining dollar very rich. For those who did not lose anything on MtGox, their remaining coins are worth more. If you held a perfect balance across all your accounts, it won’t matter much.

So, it’s not all bad news, unless, you know, you just lost your entire life savings in which case… Well, you should have listened to the hundreds and thousands of community people that warned you against keeping all your eggs in one basket.

And you’ve learned.

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Understanding Bitcoin Malleability

Here’s an explanation of the malleability issue of Bitcoin and what it really means for you.

Let’s say you hire Jane Plumber to fix your sink for $100. After Jane completes her work, you write a check for $100, sign it, and send to Jane, thinking nothing of it.

CheckOriginal

Upon receiving the check, Jane annotates the check in some insignificant manner, for example by stamping it or writing a note that it has been received. She then sends the check to the bank to get the $100 deposited.

 CheckNew2

In Bitcoin, the check is analogous to a transaction. It is a signed statement from you that you want to transfer an amount to someone else. To declare that you intend to do so, you publish a cryptographically unique signature, or in this analogy a unique image, so that anyone can see that you intend to pay Jane $100.

All of these images or transactions are stored in the Bitcoin blockchain which is a public ledger of all transactions made by anyone. In this analogy each transaction is a picture of a check, a check signed by you, but that can be published to the public ledger by anyone who has that check.

BlockChainOriginal

As such, when Jane annotates the check, she can also publish the annotated image of the check. The annotated check does exactly the same thing; it withdraws $100 from your account and transfers to Jane. However, because of the annotations, the image that Jane publishes is different from the one you publish.

Although there are two check images published, only one of the images will be accepted by the bank or in this case the Bitcoin network. The details of how this happens is beyond the scope of this explanation, but involves a transaction history which ensures that you cannot give away the same dollar twice.

However, a malicious attacker can exploit this if you are a bit naive. If Jane’s image is the one accepted, Jane can call you and say that she never received the check. When you then go into the public ledger and search for your original image, it is nowhere to be found because it was Jane’s image that got accepted.

BlockChainHighlight2

If you are naive, you may then write Jane a new check, and she can withdraw your $100 twice, once for each check you sent her.

If this happened outside of Bitcoin, it would be very simple to check whether Jane was telling the truth. You can simply check your bank statement and see whether the charge for the personal check has been posted to your account. If so, Jane is lying and you can simply ignore her request.

BankStatementHighlight

In fact, even in Bitcoin, if someone claims that they have not received the funds you sent, it would be easy to check the balance of your address to see whether the funds are gone and thus have been sent. You may not find your original transaction, but you will find the transaction that sent the money and you could present that to Jane as evidence that the money has left your account and has been received in her account.

The malleability component of Bitcoin is the protocol’s ability to interpret the intent of the check, so to speak, even if it has been annotated with certain pieces of information or decoration. It is still the same check designed to do the same thing, but it looks a bit different than when you originally signed it.

Please also note that although you can make simple changes to a check or Bitcoin transaction, any change that is of importance, such as the sum you want to pay or to whom you send the money, can not be changed. If you attempt this, Bitcoin requires a new signature from you, and it’s not as easy as just copying the signature from a paper check.

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Why Altcoins Show the Future of Cryptocurrencies

I have previously written about how I think alternative coins like Litecoin, Namecoin, and Primecoin are important to the cryptocurrency community and to Bitcoin itself. My argument is that evolution is awesome and we should embrace it. A multitude of coins can keep cryptocurrencies from falling prey to the single point of failure.

Don’t get me wrong; Bitcoin is awesome on its own. For serving its purpose, it is almost perfect and there is no realistic alternative right now. If all we wanted to do with Bitcoin is what we currently do, alternative coins are a waste of time.

However, alternative cryptocoins, or altcoins as they are often called, have completely different uses too, and uses that Bitcoin cannot possibly expect to cover. In fact, although these uses  are incredibly useful (and I start to realize the overuse of the word use), adopting them into Bitcoin would be a huge mistake.

Let me show you some examples.

Litecoin

The biggest altcoin by far, Litecoin has been argued as being nothing but Bitcoin with a few minor changes and thus not adding anything of value. In fact, where some coins actually have useful features, the argument goes, Litecoin is simply Bitcoin with a slightly different algorithm. Faster transaction times isn’t really required and it isn’t really that much more secure, if at all. Nothing new to see here, move on.

However, look at what’s happening with the community. Over the previous few months, the Litecoin developers have given Bitcoin a completely new wallet program. The Bitcoin developers probably couldn’t have done this without inciting confusion, but Litecoin has been experimenting with this for a while and gave the result to Bitcoin for use as it sees fit.

In fact, being so close to Bitcoin in terms of features allow Litecoin to be the perfect test bed for new features for Bitcoin. Not only that, but other coins can also learn a lot from what Litecoin does, which may in turn yield even better alternatives than this current more-or-less replica.

Still, Litecoin is probably the coin that is easiest to just write off as a nice idea but not really required. Let’s move on, though.

Namecoin

Believe it or not, but a big problem today is the control that the US has over the domain name system. By court order, the US government can shut down or take over a .com domain, and because .com is operated by a US entity, that is a concern for those most paranoid about privacy and liberty.

It doesn’t even affect .com domains either; pretty much any country in the world has similar laws that allow someone to take over the operation of their domain names. This is one reason why you see a lot of ‘weird’ domain extensions; it is often an attempt of someone to gain some kind of protection from the scrutiny of governments.

Namecoin proposes to change all that by decentralizing the distribution of domain name management.

It has failed so far, but the potential to completely revolutionize and democratize the internet is there. Namecoin may be the first version of something that will eventually take domain names out of the control of government or ‘big corporations’ to democratize the process of managing domain names.

Primecoin

If you’ve read my articles on understanding Bitcoin mining difficulty, you may know that what Bitcoin and Litecoin miners generate is essentially thrown out the window. You may say that they are turning electricity into money, but for absolutely no other benefit beyond heating the room.

Primecoin is another example of how cryptocurrencies can have real life impact. If you don’t know, Primecoin is an attempt to turn the power generated by mining into something useful. In the case of Primecoin, it is generating chains of prime numbers, which is way beyond what I currently understand about math, but is potentially useful.

So far, Primecoin is only potentially useful, though, but it shows how cryptocurrencies can have the potential to yield real scientific benefit. Distributed computing, like the Folding at Home or SETI at Home projects, could be completely revolutionized by efforts like Primecoin.

Bitmessage, Colored Coins, and Mastercoin

Don’t like alternative coins at all? Fine, Bitcoin itself can also be utilized for other purposes than just as a store of value.

Three examples are Bitmessage, Colored Coins, and Mastercoin. Bitmessage is, or was, an attempt at building a messaging framework on top of Bitcoin. Colored coins can be used to make special Bitcoins that represent a different value like stock in a company, a car loan, or other valuables. Mastercoin can potentially allow anyone to create their own currency that is propagated through the Bitcoin block chain.

Bitmessage failed, or at least haven’t succeeded yet, because it simply doesn’t scale well, but imagine a messaging system where all messages are seen by everyone but encrypted so that only the intended recipient can decode the message. It may not replace email, but it could serve as a public verification and records of things like contracts, bids, agreements, and so on; an open and free notary public if you will.

Colored coins hasn’t been implemented by anyone yet, but imagine a system where a special Bitcoin could represent the shares in a company. Suddenly, you have an ability to trade that coin, or fractions of that coin, just like you trade shares in a company at a stock exchange today, except it would be open and transparent and not controlled by anyone.

Mastercoin is a new undertaking that seeks to build a protocol on top of Bitcoin to create custom currencies. Imagine a chain like Wal-Mart or Trader Joe’s issuing their own currency that you can buy and trade and use in their stores only. Governments could give custom coins for social welfare for use at a certain store only to prevent recipients from using them for drugs or gambling. Parents could give allowance money to kids without fear that they would use them for nefarious purposes. Airlines could give bonuses in terms of tradable currencies rather than ‘points’.

Version 0.1

At this point, cryptocurrencies are in its most basic infancy. We think of Bitcoin as just another form of money, albeit issued through mining rather than by a central bank.

However, this is akin to looking at the web in 1994. It was extremely basic and rudimentary. The ability to submit a form via a web page was considered a major breakthrough. Animating GIFs were considered the multimedia of its day. You could easily wait a minute or two while your browser loaded a web page. Much of the web was just text. It was awkward for most normal people and a niche thing for geeks and crazy people.

Today, we can barely imagine a world without the web. Not just did it pave the way for awesome communication across web pages, but it brought the internet to all those normal people, spawning a range of additional services, like online games, real-time video conferencing, secure communication for the masses, YouTube, and all the other things we now can barely live without.

Imagine, if you will, what the world can look like in a few years, the equivalent of the web in 2000, when cryptocurrencies have been around long enough for the mainstream to adopt them and build awesome services, products, and features.

Embrace the Future.

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New Bitcoin Client – From the Litecoin Developers

A few months ago, I wrote about why I believe Litecoin has a place in the cryptocurrency community. In short, one of the main reasons is that diversity strengthens a community, and Litecoin certainly offers a contribution to that diversity.

To show this, the Litecoin developers, lead by Warren Togami, just announced they have released a Bitcoin client called Bitcoin OMG. Yup, that’s right, the Litecoin team working for the “enemy”, making Bitcoin a better coin.

The new client introduces several interesting features that are sure to make an impact. For example, the new client allows watch-only addresses. What this means is that you can monitor any address and see it’s account movements as if it were your own address. Obviously you can’t do anything with the money in those remote wallets, but due to Bitcoin transactions being public, you can see what goes on in any address.

Another interesting feature for those managing multiple addresses (like myself) is coin control. If you don’t know how a wallet works, it is essentially a collection of Bitcoin or Litecoin addresses. Although your wallet will show the complete balance for all those addresses (including watch-only addresses with the new client), each address actually was its own balance independent of each other.

Let’s say you have ten addresses where you’ve received 1BTC each. Your wallet balance now shows 10BTC and you want to send 3.5BTC to someone.

The default client will “kinda randomly” chose from which of those 10 addresses funds will come. This may be a problem if you are managing addresses for multiple entities, for example if you have an address for a company, your spouse, or perhaps set aside for a specific purpose.

With coin control, the new Litecoin-based Bitcoin client allows you to control from which addresses you send money so you can keep certain addresses completely out of touch if you like.

A final feature worth mentioning is for miners; you can now disable the wallet functionality completely and use the client as a relaying or mining station only. This reduces RAM usage considerably and makes the impact of running a client much smaller.

There seems to have been a hitch with the first release of Bitcoin OMG, though, so the developers have pulled it for now, but you can follow its progress in the Bitcoin OMG thread over on Bitcointalk.org.

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Understanding DMS

Disclaimer: This article contains information about investments in cryptocurrency assets. Investments such as these are extremely risky and you should carefully read and understand all aspects of investment and what makes cryptocurrency investments even more risky. Also, the author is an issuer of a cryptocurrency asset and may (or probably does) have vested interests.

So, you’ve become interested in the Deprived Mining Speculation, or DMS, securities have you? DMS.Purchase, DMS.Selling, and DMS.Mining seem to get a lot of attention these days, but can you quickly tell me which asset does what?

Well, you’ll be forgiven for not fully understanding how it all works because this is a very complex set of assets that confuse seasoned investors to no end. Add to the situation that a lot of community participants have very wrong ideas about what these assets do, and you’re pretty close to a guarantee of misunderstanding what you’re actually buying.

Note: Please read the update at the end of the article as it reveals how deceptive these assets can be.

Don’t worry, though, because in this article, I’ll explain it as easy as I can. I’ll take some shortcuts around the math as usual by using some silly numbers, while maintaining the integrity of the idea behind this security. Also, I’m assuming you have a fairly good understanding of what Bitcoin mining is, so I’ll skip the basics of explaining that.

An Executive Overview

DMS is a set of three correlating assets that works most of all like a bet. The three assets are DMS.Purchase, DMS, Selling, and DMS.Mining, and each work as a separate investment opportunity.

The bet is on whether mining investments will ever make money at all. The buyers or holders of DMS.Selling believes mining investments will never make back what their buyers have paid. The buyers or holders of DMS.Mining believes that mining investments will be profitable.

DMS.Purchase is a bit different because it is the entry point of each of these bets. Buyers of DMS.Purchase gets one share of each of DMS.Selling and DMS.Mining and would be smart so sell the share against which they bet.

However, unlike what many people seem to think, though, there’s no Bitcoin mining involved. The confusion stems from the fact that under certain conditions, DMS.Mining may appear to act like a mining bond and people seem to want to compare it to other mining bonds and contracts based on this fact. Doing so, however, is at best a bit naïve and at worst deceptive; there’s no mining involved, simply a dividend payment that mimics that of a bond under certain conditions. In fact, as I’ll show you later, there’s no way you can reap the benefits of being right in your bet on DMS.Mining.

What’s more confusing is that DMS.Selling, which is the bet against DMS.Mining ever making more than 100% return-on-investment, only pays out if the situation is such that DMS.Mining keeps acting like a mining bond. If that situation stops, DMS.Selling won’t get any more money and shortly thereafter DMS.Mining will shut down.

Confused yet? Let me see if I can clarify, one asset at a time.

DMS.Purchase

The DMS.Purchase asset is by far the easiest to explain because it is simply the way new shares are issued onto the market.

The purpose of a DMS.Purchase share is to give you one share of DMS.Selling and one share of DMS.Mining. In other words, the price of DMS.Purchase should always be the sum of one DMS.Mining and one DMS.Selling.

For the sake of the example, and silly numbers, let’s say that DMS.Selling and DMS.Mining both sell for 1BTC each. The price of DMS.Purchase will thus be 2BTC.

You can exchange one DMS.Purchase into one DMS.Mining and one DMS.Selling at any time, and really, this is usually the only thing that makes sense. The funds received will be invested in a very conservative way with just a few investment options being on the approved list. Considering the low-risk returns from investment and the management fee of 3%, the return from holding DMS.Purchase would be lower than simply investing in the underlying investment options directly.

DMS.Purchase receives dividends equivalent to what both DMS.Mining and DMS.Selling gets. However, because the price and thus resale value of DMS.Purchase options are defined by the price of DMS.Mining and DMS.Selling, which in turn is designed to go down as dividends are paid out, the price of DMS.Purchase will not rise.

DMS.Mining

Contrary to what many seem to believe, DMS.Mining is not a mining asset. However, it does represent a bet that Bitcoin mining assets will make money.

The way this bet works is that DMs.Mining pays dividend as if it were a mining bond with 5mhs hashing power, at least based on a formula for what an average of mining output would be, sans transaction fees, miners luck, and pool fees.

Note: This isn’t the same as a 5mhs mining contract or operation. Read more in my comparison of PMB and mining contracts.

The first question you should ask yourself is this; if there is no mining going on, from where do the funds come to pay the dividends?

The answer to this, as I eluded previously, is that the money comes from people buying DMS.Purchase, which may mean you if you got your DMS.Mining shares from swapping in a DMS.Purchase.

This may sound a bit sneaky, but it works as a way to speculate. After all, you pay 2BTC, get one share of DMS.Mining and one share of DMS.Selling. If you want the mining equivalent income, you can just sell your DMS.Selling for 1BTC.

You can, of course, also buy 1 DMS.Mining directly from the market and skip the DMS.Purchase route; the effective price you pay is the same. Regardless of which path you choose, DMS.Purchase has received the funds from someone and those funds will later be used to pay out dividends.

DMS.Selling

So now that we’ve explored DMS.Purchase and DMS.Mining, the rest should be easy, right?

Sorry to disappoint, but there is a major twist on the last leg of our exploration, and that is DMS.Selling.

You see, the entire DMS portfolio is a bet on whether Bitcoin mining assets will ever make money. Those that buy DMS.Selling believe that this will not be the case, so they should get some for of reward if they are correct, right?

Well, they do, and here is how it works.

The dividends paid to DMS.Mining goes down as Bitcoin mining difficulty goes up. That means that the price paid for DMS.Purchase may never be exhausted if the mining difficulty goes far enough up. In other words, if difficulty rises so much that a DMS.Mining share will never get back more than you paid for it plus what someone paid for DMS.Selling, then those excess funds will be paid out as dividends to DMS.Selling share holders.

In theory, this makes payments very difficult because who can say whether DMS.Mining will ever get paid enough to get all the funds paid in? After all, eternity is a very long time.

In practice, DMS solves this by introducing several steps of coverage. This coverage is determined by how many days of DMS.Mining dividends are available.

For DMS.Selling dividends, as long as the funds from sales of DMS.Purchase exceeds 400 days of dividends to DMS.Mining, any excess funds are paid out as dividends to DMS.Selling.

To understand how this calculation works, let’s imagine that 500 people buys DMS.Purchase for 0.4BTC each for a total of 200BTC and the immediately converts those DMS.Purchase shares to DMS.Mining and DMS.Selling shares.

If each DMS.Mining should get 0.001BTC per day, for 400 days, this amounts to a funding requirement of exactly 200BTC (500 shares x 0.001/share x 400 days). Because this is the same amount paid for buying the DMS.Purchase shares, no dividends are paid.

However, if difficulty then rises so that the payments drop by 10% to 0.0009 per day, the funding requirement for DMS.Mining is now just 180BTC. The excess 20BTC are thus paid out to DMS.Selling share holders, for a total dividend of 0.05/share.

The numbers aren’t quite so easy to understand, though, because the funds available obviously goes down as DMS.Mining dividends are paid out. Also, dividends to DMS.Selling won’t be paid out until there is more than 410 days of DMS.Mining dividends available.

In short, however, as long as difficulty goes up and does so by a certain amount, DMS.Selling will get dividends.

Now that we’ve explored the assets, let me explain why this becomes a very tricky investment.

Where’s The Catch?

You may have several questions at this point, and if you don’t, you have either cheated and read the contract already or you’re far smarter than me.

For the rest of us mortals, however, let’s consider some of the consequences of this bet. I’ll also show you why DMS.Mining isn’t a mining asset and is doomed to lose, regardless of whether you are right in betting that the difficulty rise will slow down.

First, what happens if difficulty doesn’t go up or even goes down? After a relatively short time, the 400 days will expire, especially if difficult goes down because this will increase the dividends to DMS.Mining.

Well, if the funds available in DMS.Purchase at any point gets below 100 days worth of dividends to DMS.Mining, all the funds will close immediately and DMS.Mining gets whatever remains in a lump sum payment. In other words, you won’t get any more dividends but you get just over three months of dividends paid out right away.

This may sound generous but there’s a catch. You see, if you buy or keep DMS.Mining, it is likely because you believe mining will be profitable. If DMS.Mining closes, and it would do so because mining has become too profitable, you’ll probably want to move your funds into a different asset.

However, the situation that may make mining profitable is a stop in the rise of mining difficulty. If that happens, all mining assets suddenly becomes vastly more profitable and thus prices will rise rapidly.

At the same time, everyone will know that DMS.Mining will stop operating and pay out a lump sum but will have no chance of reaping the potential huge rewards that a stop in rise or even a drop in mining difficulty will cause.

There’s no reason for anyone to pay more than dividends for whatever time remains until DMS.Mining closes plus 100 days, so prices for DMS.Mining will not rise. Thus, the funds you get from selling or liquidating DMS.Mining will certainly not be enough to buy an equal share of hashing power in a different asset, which by then will have risen dramatically because they can reap rewards from lower difficulty forever.

Let’s run a thought experiment again, where the funds in DMS.Purchase is now 1BTC and only one DMS.Selling and DMS.Mining exists. Dividend payment for DMS.Mining is 0.0025 so the DMS.Purchase funds are enough to secure 400 days of dividends. The price of a DMS.Mining share is 1BTC and a competing asset ACME Mines also cost 1BTC and pays exactly the same dividends.

Then, disaster strikes. Godzilla lays waste to Tokyo and several Chinese cities and takes out 50% of the Bitcoin mining network. This means that the profitability of mining for the remaining network doubles immediately and in a rational market, that would also double the prices. Of course, if ACME Mines is backed by hardware located in Tokyo, the hardware will also be lost, but that is a risk of any hardware based mining.

However, because the funds in DMS.Purchase are limited to 400 days (and now 200 days due to the drop in difficulty) a buyer knows that there is no possible way to get more than 200 days worth of dividends out of a DMS.Mining share. Even if dividends are paid out immediately, the maximum that can be paid is 1BTC.

For ACME Mines, however, the drop in difficulty means that long-term profitability will skyrocket. In fact, the return on investment (ROI) of ACME Mines bought for 1BTC is now 91.25%, which is an insane return for any investment (NASDAQ Composite usually does 4-7% per year).

In two years, someone buying an ACME Mines share will not just have gotten back everything they invest but a healthy 82.5% interest on their investments on top of that, and they can keep reaping that reward until they retire. Prices on shares like that go through the roof and probably double overnight.

Why DMS.Mining Will Always Lose

For DMS.Mining, however, well, there’s no such future. In just three months, the fund will forcibly close and you’d get another three months and a bit worth  of dividends plus probably a pat on the back and a ‘thanks for playing’ from Deprived. You’ll at most get 200 days or just over six months of dividends, representing just 1 BTC.

ACME Mines shares on the other hand, and assuming its hardware is not residing in the bowels of Godzilla, now cost 2BTC. Effectively, you’ve lost 50% of your mining investment even if you were right in your bet.

Note: Keep in mind, I’m using silly numbers to exaggerate the example to show how DMS.Mining is not a mining asset and only behaves that way if you are wrong in your bet on mining profitability.

The idea behind the DMS assets is that DMS.Selling should represent a bet that difficulty will go up and that DMS.Mining should represent a bet that difficulty will not rise by too much. Both assets reward investors who are right. In other words, if you believe mining to be a profitable undertaking, you’ll want to buy DMS.Mining shares.

This is correct, as long as you only consider DMS and not what happens in the rest of the Bitcoin investment world. If you believe in mining profitability and you’re right, you’ll want to reap the rewards.

However, as I’ve just explained, this won’t happen. If you are right, you’ll get a fairly small amount in payment from DMS.Mining and may even be stuck the shares because nobody will want to pay a dollar now for a dollar in the future so you’ll probably need to sell for less than you’ll get in dividends and lump sum over the next months.

Other mining assets will rise, though, so your ability to cash out and earn from being right is limited at best and completely gone at worst.

So, the brutal result is this: If mining difficulty keeps going up, DMS.Mining will lose the bet. However, if mining difficulty goes down or even flattens out, DMS.Mining will also lose the bet. There’s actually no way that DMS.Mining can win this game.

It is very important to understand this catch. DMS.Selling is the only asset that in reality can actually make money in DMS. If DMS were the only assets available in the world, then yes, DMS.Mining could earn money, but in a world where other mining assets exist, the loss in rising prices of those other assets will quickly and brutally cancel out any earnings from DMS.Mining.

So, DMS.Mining is not a mining asset and doesn’t behave like one, except when you are slowly losing money by holding it due to difficulty increases. If difficult slows down, you’ll only lose money faster.

Sounds harsh? Indeed it may be, but now at least you know. You also know why I really don’t consider DMS.Mining a mining asset and thus don’t want to compare it to BFMines.

Update August 10, 2013:

Deprived, the issuer of DMS, was apparently being less than completely honest about the outlook of his assets and in several drunken posts on Bitcointalk admitted that there is no way that DMS.Mining would ever make money and anyone investing in DMS.Mining were idiots. Interestingly, his claim is that there was no way DMS.Mining would make money until now so if you believe him this time, you should definitely run over and buy.

If you believe this article, of course, you wouldn’t.

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What is the Halving Effect in Bitcoin Mining Investments?

Disclaimer: Please do not take this as investment advice. I am not a lawyer or financial analyst. Do your own research, consider every source as potentially having vested interests, and do not invest more money, especially in cryptocurrencies, than you can afford to lose.

When analyzing a Bitcoin mining investment, it is vital to understand one key factor; the halving effect. In short, the halving effect is the effect that the periodic block reward halving has on the potential long-term revenue of a mining operation.

I have mentioned the halving effect in my analysis of the 100TH mine, but it seems that there is still some confusion about how or even if this effect will influence pricing. I’m here to tell you how this effect works and what, how mining operations are affected, and in a fair market, the effects should be.

Block Reward and Transaction Fees

The income from mining operations is defined by the current block reward plus any transaction fees levied on transactions since the previous block. The block reward is currently 25BTC and the transaction fees are currently around 45BTC per day, which means a transaction reward per block of around 0,32BTC for a total mining reward of 25,32BTC.

This mining reward will be distributed for every block that is solved by the miners and thus represent an upper boundary for how much a mining operation can earn.

However, this mining reward isn’t fixed. First, the transaction reward varies depending on how many transactions are performed, which in turn depends largely on Bitcoin adoption but also on miners’ willingness to process transactions.

Note: Miners are free to set policies on how much they want for each transaction and reject transactions for any reason they see fit.

The bigger impact, however, comes from a built-in halving of the block reward. The current block reward is 25BTC per block, but this hasn’t always been the case, nor will it be. In fact, initially, the block reward was 50BTC and it dropped to half in November 2012.

This halving is due to Bitcoin’s built-in anti-inflation policy. To control the production of new money and make Bitcoins more and more scarce, the block reward halves roughly every four years. The next time this happens is in late 2016, at which point the block reward will be 12.5BTC per block.

You may be excused for thinking this is far into the future. After all, Bitcoin mining moves at an incredible rate and we’ve only just seen the first doubling ever a few months ago. Who cares about what happens in 2016?

Well, the problem is, it affects the price you pay today, and it lowers your value very day.

A Bit about Mining Asset Valuation

As with any security traded anywhere in the world, investors expect to get a return on their investments (ROI). This isn’t even limited to securities, it applies to anything we do. We want to do something because it gives us more in return, whether that is more money, a loving spouse, better health, or a good conscience.

With mining investments, the return is quite simple. Assuming you don’t buy shares, contracts, or hardware for the sentimental value, your ability to receive a return is based on how many Bitcoins, Litecoins, or other cryptocurrencies your investment produces. You invest because you evaluate that the ability of the company allows for a return higher than your goal.

However, what happens if that ability is suddenly reduced by 50%? Obviously, your ability to get an ROI is also cut in half.

If a company produces 100 dollars in dividends per a year, you may wish to invest 1000 dollars, knowing that each year, you get a return on investment of 10%, a fair number if a reasonably safe investment.

However, if the company suddenly loses half the ability to produce dividends, your investment of 1000 will now yield only 5%. Of course, other investors looking to get 10% too will only pay $500 for your stake, so effectively you’ve lost $500 on your shares’ value unless you decide to hold the shares and be satisfied with the lower return.

If you knew in advance, however, when the yield would drop, you could calculate the drop in share price along the lines of (Y/X)2 per year, where Y is the price of your shares and X is the number of years until the drop happens. For example, if you know that the rate of return drops by 50% in 5 years and you paid 1000 for your shares, the formula would be (1000/5)/2, or $100 per year.

The problem, of course, is that now those $100 per year doesn’t really give you any ROI yield at all. You get $100 per year in return but your shares fall $100 in value too. Effectively, you are lending money to the company with no interest or chance of return. Obviously, you need a much higher return rate than 10% if these were the numbers.

In Bitcoin and cryptocurrency mining investments, you face this exact situation every four years. At that interval, the block reward halves and thus the bulk of the income for miners goes down.

See how the halving effect effectively reduces the value of your asset over time? this is the halving effect that affects all mining assets, whether it is mining contracts, ASICMiner shares, or hardware you purchase.

Your Questions, Please

I’m guessing you have questions. That’s fine, I’ll be proactive and answer some of them right now.

But Four Years is a Long Time!

Well, not really, but the time doesn’t matter. The effect happens every year. In fact, with Bitcoin investments, you can even calculate this per week or day if you want and you’ll see the expected drop in value every day.

You may, of course, gamble that the market doesn’t know about this effect (or doesn’t find this article) or that they don’t take it into account. However, if the market doesn’t take this into account now, it will definitely do so closer to the next halving when calculating ROI over even one year  means including the profit drop.

If the market ignores this effect until then, the drop will just be that much higher at once. Rather than drop $100 per year, it will drop $500 in one year, but the drop will still be the same.

But it Didn’t Happen Last Time!

When the first halving in Bitcoin history happened in November 2012, several mining assets were operating already. However, there wasn’t a massive drop in prices just when the halving reduced potential profits by 50%.

There may be several reasons for this. Most mining assets at the time was either issued and purchased within a year of the halving so people may have been aware of the effect and priced that into their calculations. Another reason may be that a lot of mining operations were growing at the time, so the halving effect would be cancelled out by increasing market share.

The simple fact, though, is that as long as market share remains steady, the halving effect will reduce a mining operation’s ability to generate revenue.

But the Transaction Fee Will Counter That!

Well, if it does, it actually only makes the situation worse.

You see, the transaction fee doesn’t follow the block halving, it follows Bitcoin adoption. The transaction fee is simply a mechanism to control supply and demand; miners are already free to charge whatever fee they like so they could easily charge 25BTC per block if they so desires. They won’t because there are simply nobody willing to pay that amount to transmit Bitcoins, so adoption isn’t nearly high enough to make demand for transaction processing expensive.

If it comes to that, however, the situation doesn’t improve. Transaction fee increases happen gradually unless all miners come together and decide at the same time to increase transaction fees, and it takes only one of them to disagree to cause cheaper transactions to just slow down and not stop completely.

Of course, if Bitcoin transactions became very expensive or slow, people would look to other coins for transactions, such as Litecoin. In effect, Bitcoin demand would again drop to a level where demand was lower and transaction fees could no longer be levied at the same level.

Back to the transaction fee increase; it will most likely happen over time and thus will either begin before the halving (making return on mining increase artificially just before the halving, or it will start after the halving, in which case revenue will drop due to halving before recovering later.

Either case will cause a substantial loss in mining revenue at the halving time in late 2016. No matter how you look at it; unless demand skyrockets to a point where the bloc reward is insignificant, transaction fees will not counter the effect of the block reward dropping.

But You’re Selling a Mining Asset!

Yes I am. BFMines is indeed a mining contract. And I am acutely aware of the halving effect, which is the main reason I sold out of ASICMiner a couple of months ago.

However, when I do my calculations for BFMines, I’m using a time frame shorter than the next halving. This is for two reasons

  1. In all likelihood, the future earnings of BFMines will have dropped to a level where calculating profitability isn’t really important. In fact, I may have shut down and bought out the contracts by then.
  2. Even if profitability remains at a reasonable level, speculating about the difficulty changes (which is the key factor in mining contract value) so far into the future is futile.

As such, I’m am very aware of the halving effect and that it does indeed affect my asset too. However, by focusing on achieving a good return on investment before the next halving, the effect will be less important.

All long-term assets, however, for example ASICMiner, and mining contracts or equipment bought closer to the date of the block reward halving will need to take this effect into account or be very surprised about their profitability a few years down the line.

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Feathercoin – There’s a New Kid on the Block!

A couple of weeks ago, a new cryptocurrency popped up over on Bitcointalk. The new coin, dubbed Feathercoin, initially looks extremely like Litecoin with the major difference being the amount of coin in potential circulation. Block rewards are set to 200 FTC as opposed to LTC’s current 50.

So, if Feathercoin is just a straight Litecoin clone, and Litecoin already struggles with getting the traction that Bitcoin has, what chance does Feathercoin stand in the world of cryptocurrencies?

FTC versus LTC

The similarities between these coins are fare more than their differences, but there are some key aspects that may turn people towards Feathercoin.

First, there’s the freshness of the coin, and the initial surge of enthusiasm from early adopters drive the ecosystem of Feathercoin forward at an astonishing pace. Already, several exchanges like BTC-E and Vircurex have taken Feathercoin on board, and there are mining pools popping up everywhere.

The lack of adoption presents an opportunity for miners as well. People have mined the established coins for a long time, and with ASICs coming online, graphic card miners move from Bitcoin to Litecoin and drive the difficulty through the roof. Profitability of mining Litecoins has dropped almost 80% since early April (at the time of this writing, a month ago) due to the difficulty rise.

From a non-technical perspective, Feathercoin offers few differences for most people at this time. Beyond the name, which is actually quite funny if you’re into the community jargon, the main difference is that there will be four times as many Feathercoin than Litecoins.

Note: The name, Feathercoin, both indicates something lighter than Litecoin, but also plays on the Trollbox nickname of Alt-coins in general and Litecoins specifically, chickun. In other words, we have both feather and chickuns.

This may have a psychological impact more than a practical one, as a price will need to be four time higher, which again means discounts can be four time higher, in absolute values.

“I love this car, but I can’t afford the 200,000 FTC to buy it!” says the customer. “No worries, I’ll drop 20,000 off the price for you” says the car salesman. 20,000 sounds like a much higher discount than 5,000, although the price of 200,000 also sounds a lot more than 50,000. I guess the benefit or drawback depends on whether you’re offering a discount or selling at a low price, and we’ll have to let the market decide what’s best.

That actually brings me to the next point, which is something that I believe goes for any cryptocurrency that pops up.

It’s a Rip-Off!

Actually, no.

Cryptocurrencies need diversity! Granted, the coins may look exactly the same at this point, but as the market matures, people will favor different characteristics of the coins.

The coins themselves may evolve and add new features or behavior, which may spawn further ideas that can bring about the next cryptocurrency revolution.

For Bitcoin, the big brother in this family, there are already a number of similar coins that have added different characteristics that the world is now evaluating.

Note: You may also want read my take on the different cryptocurrencies and why they are unique.

For Litecoin, however, which differs from Bitcoin in that it uses scrypt as its mining algorithm, there haven’t been a plethora of alternatives to help Litecoin evolve.

Feathercoin, and indeed some other coins that have appeared recently, also uses scrypt for mining and can thus be to Litecoin what Namecoin, Devcoin, Terracoin, PPCoin and the other SHA-based cryptocoins are to Bitcoin; helpful in evolution, but not in themselves and alone the future of cryptocurrencies.

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Why Litecoin has a Place in the Cryptocurrency Community

Litecoin is the second largest cryptocurrency today, and has around 2-3% of the total cryptocurrency market. It seems to bother some people to no end that Litecoin even exists, so I thought it would make sense to look closer at what Litecoin does that Bitcoin may not.

Diversity

I have previously argued that the diversity of cryptocoins is good for the overall cryptocurrency community. In short, the existence of cryptocurrencies other than Bitcoin serves to provide the community and the world with alternatives.

Note: Refer to my article Bitcoin, Litecoin, Whatcoin? Oh My! for the full article.

Why are alternatives important? Well, as in biology, the features that best provides survival for a species tend to survive from generation to generation, while features that are pointless tend to die out. To some extent, this can be said for alternative coins too; those that have features that make them competitive are those that society will adopt.

One argument I hear often is that Bitcoin can implement any of the features that alternative cryptocoins have. That may be, although it may certainly call for severe changes in Bitcoin, but the big question remains: Which features should Bitcoin adopt?

Litecoin has features that society seems to like. Even if the coin itself may not survive, it can provide Bitcoin or other cryptocoins with important information about what society wants.

This is not necessarily an argument for Litecoins specifically, but Litecoins success compared to other coins may tell the cryptocurrency community that Litecoin has features society wants.

Another argument against Litecoin is that it isn’t innovative enough; that it is too similar to Bitcoin and thus offer no additional value.

I’m not sure I agree with this argument in the first place, but the state of a currency at its beginning is not necessarily an indication of how it will evolve. This is, in fact, the whole idea of innovation and evolution. You start out with one idea and evolve that as time moves on.

Litecoin may evolve in completely separate directions from Bitcoin, and may thus be a completely different coin months or years from now. This further strengthens the cryptocoin community, and even Bitcoin may choose to pick up features that have evolved from other coins.

Speed

One feature that separates Litecoin from Bitcoin is transaction speed. Where Bitcoin has a 10 minute block time on average, Litecoins have a 2.5 minute block time.

Note: For those that do not know, block time determines how fast a transaction is confirmed.

This increased block speed makes Litecoin a faster currency. For vendors looking to process transactions rapidly, this may be a benefit.

The change in block speed isn’t necessarily the benefit that stores and other rapid transaction processors want, though. Even with Bitcoin’s 10 minute blocks, once a transaction is distributed to the network, essentially immediately after sending, it is virtually impossible and certainly uneconomical for someone to try to exploit the unconfirmed status.

For smaller transactions, say less than $100, a store owner can relatively safely assume that a transaction will not be at risk as soon as they see the payment received on their end.

However, for larger transactions, vendors may want to wait for a certain time or for a certain number of confirmations before sending the goods.

This is where Litecoin can provide a benefit. If you are buying a car, you want to get into your new vehicle as quickly as possible, but the vendor is unlikely to give you the keys before the customary 6 confirmations have happened. This takes an hour with Bitcoin and about 15 minutes with Litecoin.

Note: The number of transactions does not necessarily equate to more security. In other words, 6 Litecoin transactions may not equate to 6 Bitcoin transactions in terms of security.

Of course, if you’re standing in line at the grocery store, waiting around for 2.5 minutes for your payment to verify at least once is still too long. If stores require at least one verification, however, 2.5 minutes is better than 10 minutes.

Security

Speaking of security, Litecoin may offer some interesting features to help make it more secure.

First, the most fatal security issue with Bitcoin-derived cryptocurrencies is what is known as a 51% attach. In short, this means that someone who controls 51% of the total network mining power can effectively double-spend money. Double-spend means that money can be spent twice, for example to send money first to a merchant, but then resend the money back to the attacker, essentially cheating the merchant of the money.

Litecoin, although much smaller than Bitcoin, uses a different algorithm for mining called Scrypt (where Bitcoin uses SHA-256). This is important because Scrypt is much more expensive in terms of computing power and it is currently infeasible to create specialized hardware that mines Litecoins much faster than current technology.

For Bitcoin, ASIC equipment is very effective at achieving massive hashing power. As such, the network itself is very powerful and growing in power every day. However, this also cuts the other way; because Bitcoin blocks can be easily mined with specialized hardware, it makes it cheaper to produce hardware to attack the network.

Note: To read more about ASICs and what they are, check out the article called What Are ASIC Miners and Why Are They So Important?

For Litecoin, the most effective hardware today are graphics cards with GPU processors and massive memory bandwidth. This means that an attacker today would need to gain control over a huge amount of graphics cards, which are very expensive, in order to conduct a 51% attack.

Another factor in the 51% attack is that for the attack to be successful, the attacker needs to control the network for a certain amount of time. Even if the attacker had 51% of the network, the power cost of running such a network would quickly outweigh the benefit of double-spending money. 

Right now, though, the Litecoin network is much smaller than the Bitcoin network, so that means an attack today may be feasible, especially if the attacker could get control over one of the mining pools.

Well, maybe, but we still have one more feature to discuss.

Mining

As mentioned, Litecoin uses a different mining protocol from Bitcoin. This protocol, called Scrypt, requires memory bandwidth in addition to raw processing power. The algorithm was designed to be resistant to specialized cryptographic hardware that could otherwise be used to crack strong encryption.

Until ASICs came along in 2013, the most efficient way to mine Bitcoins was using graphics cards, and especially AMD Radeon cards. These cards, however, are not match for ASIC miners, so with the introduction of ASICs, a lot of Bitcoin mining graphics cards will become less profitable.

However, Litecoin mining with graphics cards and their GPUs and massive memory bandwidth is still feasible. In fact, today, GPUs are the most efficient way to mine Litecoins. Combine that with the fact that Litecoin is resistant to current ASIC technology, and existing Bitcoin miners will quickly find that moving their resources to mine Litecoins yields far more profit.

This means that the Litecoin network is far more distributed than Bitcoin. In the case of Bitcoin, large ASIC mining farms can quickly take 25-40% of the total network capacity. This can make Bitcoin more susceptible to a 51% attack because an attacker would need to control just one of two of the large mining pools in order to control more than 51% of the network.

Of course, the mining profitability of Litecoin also means that people that bought special mining rigs for Litecoin still has a place to earn money from their investments, which in turn means that the network will continue to exist as long as people are using Litecoins are willing to part with other types of currency to get it.

Conclusion

To summarize, Litecoin is an important part of the cryptocurrency experiment because it offers diversity, speed, security, and a chance for miners to continue earning from their investments.

Whether Litecoin, Bitcoin, or any currency survives, well, that all depends on you, as a part of the society that has to adopt these coins as a new way of thinking money.

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What are ASIC Miners and Why Are They So Important?

ASIC, or Application Specific Integrated Circuit, entered the Bitcoin mining market with full force in 2013. Shrouded in mystery for most and being almost mythical creatures, these mining beasts of burdens reached staggering prices in April 2013.

What are these beasts and why are they destined to change the face of Bitcoin for a long time to come? Why is are ASIC Bitcoin mining massive benefit for Litecoin?

Built for One Thing

ASIC stands for Application Specific Integrated Circuit, and essentially means a computer chip that has one purpose and one purpose only. In the case of ASIC Bitcoin miners, the sole purpose of the ASIC chip is to generate billions of hash values every second, 24 hours a day, all year round.

The obvious purpose of an ASIC miner is to generate Bitcoins through the reward system built into the system. An ASIC miner does this by generating SHA-256 hash values for a Bitcoin block at tremendous speeds, far out-performing any other technology at present.

Note: To understand more about hashes and mining in general, check out my article on Understanding Mining Difficulty

The race to get ASIC miners into production stems from a beautiful balancing aspect of Bitcoin, namely that the total rate of Bitcoin generation remains constant at a steady pace of 25 Bitcoins per 10 minutes. This means that whoever holds the most hashing power gets a bigger piece of the reward cake.

That cake, however, is always the same size, and even though there is a new cake every 10 minutes, the cake doesn’t get bigger even if more people want to eat from it. In fact, after 2016, the cake gets smaller because the reward per block goes down to 12.5 BTC per 10 minutes. This is determined by Bitcoin’s built-in controlled supply of coins.

Note: Due to the transaction fee system in Bitcoin, blocks will continue to reward miners, so even if the block generation reward will eventually go down to zero, the block transaction fees will still yield rewards to miners. This, however, is simply coin circulation; no new coins will be minted after the block generation reward goes down to zero in 2140.

Because ASIC miners perform so much better than other technology, whoever manages to get ASIC miners into production first will yield massive rewards. It doesn’t increase the total number of coins in circulation, it only means that the first movers have a huge advantage over those that arrive later.

At some point, when everyone has an ASIC miner at home (or at least has the opportunity to have one), the advantage of ASIC miners become much less. In fact, if everyone had an ASIC miner, the advantage of having one would simply disappear completely and the ASIC miners would even less valuable than the previous graphics card based technology, because the ASICs cannot be used for anything else.

As such, what we are seeing now is an arms race, to get new technology to the market first and thus reap the financial reward of being ahead of the crowd for a while.

However, the block reward is just one of the reasons why ASIC miners are destined to change the face of Bitcoin.

Attack! Attack!

One major concern with the Bitcoin system is that it is susceptible to what is known as a 51% attack. This means that if a malicious entity were to control more than 51% of the total network hashing power, they could control transactions to some extent. Although there are defense mechanisms against this situation, and the fear of such an attack is believed to be largely overrated, ASIC miners play an important role in stabilizing Bitcoin.

With the current Bitcoin network hashing power, largely based on GPU and to a lesser extent CPU mining, it is feasible that someone with enough resources could take over the Bitcoin network.

However, with the introduction and distribution of ASIC based hashing, the total network hashing power will skyrocket, making the chances of a 51% attack much less feasible. The more people get their hands on and start deploying ASIC miners, the more secure the Bitcoin network becomes against a 51% attack.

What About Litecoins?

Litecoins are currently not very interesting for ASIC miners, largely because Litecoin uses a different mining algorithm called Scrypt (whereas Bitcoin uses SHA-256). Scrypt requires far more memory than Bitcoin, and ASICs do not have a lot of memory. In fact, to build an ASIC based miner that could do Litecoin mining would be so expensive that nobody could possibly hope to make any profit from it.

This may lead you to think that Litecoin does not reap any benefit from the protection that ASIC miners give Bitcoin. You would be wrong in assuming that, though, and there’s a very good reason for this.

Up until ASICs become widely distributed, most of the hashing power in Bitcoin comes from normal users that have graphics cards mining for Bitcoin.

However, as ASICs take over, those users will not longer be able to reap rewards from Bitcoin mining and may want to move over to mining Litecoin. This means that the introduction of ASIC miners for Bitcoin moves a lot of computational power to Litecoin, thus making the Litecoin network more resilient against 51% attacks.

Of course, a massive shift in home mining will lead to increased difficulty in Litecoin mining, so whether the migrating users will actually get any sensible rewards remains to be seen.

Note: To understand the factors that determine mining profitability, check out my Litecoin Mining Profitability Guide.

As you can probably understand, ASIC miners are changing the cryptocurrency world, not just for Bitcoin, but also for related coins such as Litecoin.

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