Tim Swanson is an educator, researcher and the author of ‘Great
Wall of Numbers: Business Opportunities and Challenges in China’. Here,
he explores the mining systems of dogecoin and litecoin to show how the
dogecoin economy can thrive.
key ingredient to the success of any decentralized public ledger, such
as bitcoin, is incentivizing its transactional network to simultaneously
secure the network from attackers and process transactions.
the case of bitcoin
, and in the case of virtually all other
cryptocurrencies, this incentivization process is handled through
seigniorage. Every 10 minutes (or 2.5 minutes for litecoin
, or one
minute for dogecoin
) a fixed amount of bitcoins is paid to the labor
force called “miners.” These miners are computational systems that
perform never-ending mathematical calculations dubbed hashing. This
hashing in turn creates security for the network; so as long as more
than 50% of the hashrate is maintained by “good” systems, bad actors are
prevented from manipulating the ledger.
The other key role these
miners also fill is processing and including transactions into packages
called blocks. Every 10 minutes, one miner is rewarded for processing
these blocks with fixed income. Last month David Evans published a good
of how this process looks from a labor input and supply output perspective.
some advocates, one of the purported advantages of cryptocurrencies is
that their money supply creation rate is actually deflationary (or
contractionary) in the long run – in the short run, bitcoin’s
expansionary rate is quite high, with inflation at 11.1% this year
alone. That is to say, it is a hardcoded asymptote, tapering off over a
known time period. In the case of bitcoin, the wage for the labor
force (miners) is split in half roughly every four years (every 210,000
blocks), for approximately the next 100 years – until its money supply
is exhausted at a final 21 million bitcoins.
Roughly 12.7 million
bitcoins have already been paid to miners. With dogecoin’s 100 billion
dogecoins, this process is accelerated, with the mining income dividing
in half every two months. While it took about five and a half years for
about 60% of bitcoin’s total monetary base to be distributed, as of
today 78% of dogecoin’s reward
(income) has already been divvied out to its workforce in less than six months.
What now for the workforce?
this frenetically fast money supply has provided a psychological
motivation for early adopters to partake in the dogecoin ecosystem,
economic law suggests that this network will probably cease to exist in
its current form within the next six months probably through a 51% attack
reason is simple: with every block reward halving, also called
“halvingday”, the labor force is faced with a 50% pay cut. The
contractors (laborers) incapable of profitably providing
hashrate at this level can and will leave the work force for greener
pastures. This same issue has impacted other altcoins in the past, such
as MemoryCoin, which died after nine months due to a combination of
factors including diminished block rewards (it attempted to divvy out
its entire monetary supply in two years).
Early advocates of dogecoin like to point to outlier events such as the Doge bobsled team
or sponsored NASCAR driver at Talladega
or even a vaunted tipping economy (which is actually just faucet
redistribution) as goal posts for growth and popularity, yet after two
halvingdays the actual dogecoin block chain has lost transactional
volume each month over the past four months and the labor force has also
left for new employment elsewhere.
This is visualized in the following two graphs.
first chart shows dogecoin’s collective hashrate. The black lines
indicate when the “halvingday” or rather “income-halvingday” occurred.
Because the price level of a dogecoin remained relatively constant
during this time frame, there was less incentive for miners to stay and
provide labor for the network. If token values increased once again,
then there may be incentives in the short-term for laborers to rejoin
the network. Yet based on this diagram, roughly 20-30% of the labor
force left after each pay cut.
The second chart shows on-chain
transactional activity. The first three months are erratic because of
how mining pools (similar to lottery pools) paid their workforce
(miners). Following the first halving day in February, the network
transaction rate fell to roughly 40,000 transactions per day and then
leveled off to around 20,000 until 28th April 2014, when another
halvingday occurred and the subsequent transactional volume remained
relatively flat to negative. It is currently at 12,850 transaction per
day, or roughly the same level it was during the first week of its
launch five months ago.
Dogecoin’s falling hashrate
some readers may claim that a lot of the transactional volume such as
tip services and tip bots are being conducted off-chain and thus the
total number of transactions is likely higher. And they would be
correct. But that would completely defeat the purpose of having a
block chain in the first place – a trustless mechanism for bilateral
exchange that negates the need for “trust-me” silos (as Austin Hill
Also, while this topic deserves its own series of
articles, there is little literature that suggests that tipping can grow
an economy; it is not
a particularly good signaling mechanism
or way to grow a developing economy (i.e., “China, you need more tipping activity to grow and prosper”).
the key issue is this: if the trend continues and the network hashrate
continues to fall 20-30% after each halvingday, then within the next two
to four months it will be increasingly inexpensive for competing
mining pools on other ledgers to conduct a 51% attack on dogecoin’s
network, destroying its credibility and utility.
For instance, the
chart below is the litecoin hashrate over the past six months.
is dogecoin’s largest competitor based on its proof of work
(PoW) mechanism called scrypt
of the reasons the litecoin
hashrate is not rising or falling at a
constant rate but is instead jumping up and down erratically is that
miners as a whole are economically rational actors. When the cost of
producing security is more than the reward (block reward income), the
labor force turns towards a more profitable process
such as another alternative scrypt-based “coin” (note: bitcoin’s
hashing method uses SHA256d whereas litecoin and dogecoin use scrypt).
The same phenomenon of hashrate jumping up and down occurs with the
For the sake of simplicity, the litecoin network
can be viewed as roughly 200 GH/s versus the dogecoin network which is
roughly 50 GH/s. To conduct a 51% attack on dogecoin today, an entity
would need to control roughly 25-26 GH/s which is roughly one eighth the
processing power of the litecoin network. The current ‘market cap’ for
dogecoin is $35 million, assuming marginal value equals marginal cost
, ceteris parebus
on paper it could cost $17.5 million in capital and operating expenses to successfully attack the dogecoin network.
chart above shows both the hashrate of litecoin (in red) and dogecoin
with the vertical black lines representing the dogecoin
“halvingday.” What this shows is that while dogecoin, for roughly one
month in early 2014 was more profitable to mine than litecoin, the
halvingday led to an exodus of labor.
If current prices and trends
continue, which they may not, in two months the litecoin collective
hashrate may hit 240 GH/s and dogecoins hashrate could shrink due to
halvingday by another 20% to 40 GH/s. At this rate a successful 51%
attack on dogecoin would require just one twelfth of the hashing power
which at the same prices levels would entail less than $10
million in capital and operating expenses to do.
Will dogecoin survive?
While the development team could theoretically switch its proof of work algorithm (to X11 as used in Dash
), the doge community is really faced with six options:
- Merge mine. Namecoin
was (and is) an independent block chain, but since block 19,200 about
80-85% of its network hashrate (and block rewards) are tied to bitcoin
mining pools through a process called “merged mining.” The new sidechains project from Blockstream is attempting the same process. Charlie Lee, creator of litecoin explained how dogecoin could be “merged mined” with litecoin in a series of posts last month.
fees. Both the development team and mining community could agree to
float or raise transaction fees on the doge network, similar to what
Mike Hearn has been discussing
for bitcoin. In practice however, even if approved, very little actual
commerce, and therefore transactions, is conducted on the dogecoin
network. Thus it is unlikely that this will compensate the large drop in
mining income. Similarly, as Gavin Andresen pointed out in Amsterdam
this past Friday, increased transaction fees reduces the participation rate. It is important to note the actual transaction costs are much higher than stated – block rewards (token dilution) are usually not factored in.
of stake. There are several variations of proof of stake. Whereas
bitcoin, litecoin, dogecoin and most other cryptocurrency experiments
use a “proof of work” mechanism to protect the network from malicious
entities, a proof of stake system, such as that used in NXT, will
randomly assign a “mining node” called a “forger”
– a poor marketing term for sure – to process all the blocks for the
next minute. Because all of the other nodes in the network know which
miner to trust, this lowers the amount of infrastructure needed to
protect the network. In theory this sounds amazing. In practice
however, most proof of stake systems end up almost immediately
centralized in one manner or the other. Andrew Miller, Andrew Poelstra
and Nicolas Houy call it “proof of nothing”. Perhaps Stephen Reed’s version can work in the future.
in market price. This would incentivize the labor force to continue
providing security of the network with the expectation that the tokens
they are given in return for their labor will continually appreciate in
value. This is betting on hope. Charlie Lee pointed out the uphill
task this would require beginning next year when rewards fall to less
than one tenth what they are today, stating
last month, “At dogecoin block 600,000, only 10,000 coins will be
created per block. So in order for dogecoin to keep the same amount of
security as today, dogecoin price would need to go up by 25 times. And
dogecoin price would need to gain on litecoin by 50 times in order to
catch up on litecoin’s security. And assuming everything stays the same,
the market cap of dogecoin needs to reach $1.5 billion by January of
next year.” For comparison, the ‘market cap’ of dogecoin today is
roughly $35 million (note: it is probably not accurate to call it a
‘market cap,’ see Jonathan Levin’s explanation).
- Migration. Dogecoin could also migrate to a platform like Counterparty and become a fully secured altcoin with a dash of proof of transaction
thrown in to inflate the coin with ongoing usage that this particular
community likes to embrace. It could be fully protected by the bitcoin
hashrate with no further need to try to acquire miners to protect it.
experimentation. While it is unlikely the dogecoin has the resources
to create secure production code in the shortened time frame, Robert
Sams “growthcoin” and Ferdinando Ametrano’s “stablecoin” could provide a mechanism that enables the network to live on in a different manner.
any or all of these may be tried out, it may be too little, too late.
With that said, stranger things have happened. A rising tide lifts all
boats and thus in the event that “bitlicense” approved exchanges on Wall
Street come online this summer and new capital actually flows into
bitcoin and other alternative ledgers, perhaps similar speculative
funding will flow into dogecoin as well. However, this is not something
that can be known a priori.
I contacted Jackson Palmer, creator of dogecoin for his thoughts on the situation. In his view:
is definitely a challenge that dogecoin (and all current-gen crypto
currencies) will face in the future. As we discussed recently, it’s kind
of a sad reality that people are purely profit driven and these
decentralized networks we’ve built are reliant on profit-mongers to
power and secure their viability. I’m very concerned about the impact of
centralized mining and reliance on transaction fees could hold for
bitcoin as it becomes less enticing to mine – really, the network can be
held at ransom to attach hefty transaction fees if the mining pools are
cherry picking as they create blocks.
At the end of the day, I
think the viability of cryptocurrency really hinges on a move away from
PoW-based mining to something new and innovative that doesn’t just
stimulate an arms race and put all the power back into the hands of the
fiat-wealthy. I don’t have a solution unfortunately, but hopefully
someone will find one and bring about a new generation of digital
currencies in the coming five to ten years.
That being said,
cryptocurrency as a space is very unpredictable so it wouldn’t surprise
me at all if dogecoin beats the odds and overcomes these challenges in
some weird, wacky way. It’s in the community’s hands, and they’re
certainly passionate about seeing it reach the moon, as am I.”
Can this happen to bitcoin?
To be balanced, below is the network hashrate for the Bitcoin network following its first halvingday on November 28, 2012:
The following two months, from December 2012 through January 2013, the hashrate stayed flat and in some weeks even declined.
There were three reasons why the network did not decline precipitously like dogecoin:
the fact that very little real commerce actually takes place on the
bitcoin network, there was some amount that did in 2012 and does today
(primarily gambling and illicit trading of wares). Thus there was
external demand for the tokens beyond miners and tippers.
- The token prices rose creating appreciation expectations. The price rose from $12.35 on 28th November 2012 to $20.41 on 31st January 2012. If miners believe and expect the price to increase in value, they may be willing to operate at a short-term loss.
- The first batch of ASICs from Avalon shipped and arrived
to their customers at the very end of January. These provided roughly
two to four orders of magnitude per watt in performance than the top
competing FPGAs and GPUs. This is equivalent of miners being given
sticks of dynamite instead of pick axes to tunnel through mountains.
more research will be conducted and published in the following months
and years before the next bitcoin halvingday (estimated to occur probably before August 2016
the bitcoin network faces a similar existential hurdle, though perhaps
less stark once more ASIC processes hit similar node fabrication
limitations. That is to say, in the next couple of years there will no
longer be performance gains measured in orders of magnitude. They will
likely compete on energy costs
Since most participants do not like paying transaction fees,
incentivizing miners to stay and provide security will likely be
problematic for the same income reduction issues. This scenario will
likely be revisited by many others in the coming months and years.
a marketing perspective Dogecoin has done more to bring fun and
excitement to this sub-segment of digital currencies than most other
efforts – remember, USD can also be digitized and encrypted. In turn it
brought in a new diverse demographic base to block chain technology,
namely women. While some of the more outlandish gimmicks will likely
not be enough to on-ramp the necessary token demand which in turn leads
to token appreciation, this project has not gone unnoticed.
instance, two weeks ago I had coffee with a bank manager in the San
Francisco financial district. As we were wrapping up he asked me to
explain dogecoin. I mentioned that what sets doge apart from the rest
was its community was much more open towards self-ridicule, self-parody,
less elitist and most importantly, women actually attended meetups.
quickly surmised, “Oh, so it’s the wingman currency. It’s the friend
you bring to the bar who is willing to look goofy to help you out.”
That is probably a fair enough assessment and it will likely need a wingman to survive.
Open your free digital wallet here to store your cryptocurrencies in a safe place.