Crypto Mining: How coin value is protected over time

Crypto Mining: How coin value is protected over time

Every cryptocurrency on the market relies on some method of gradually releasing coins into circulation. One of the most popular methods is something known as 'mining'. Coin mining is the process of verifying transaction data and adding it to the ledger by building new blocks that get attached to the end of the chain. Mining requires both computer hardware and software.

The people and/or companies that perform this work are known as miners. As you might have guessed, they do not work for free; they are paid in coins. Rewarding miners with coins creates a very nice incentive, but it also creates a problem. Coin value tends to go down as supply increases. So how do you protect the value of a coin, over time, so that miners still have incentive to mine?

Supply and demand economics

The single greatest influence on the price of an asset is supply and demand. When demand is high and supply is low, the price goes up. Price falls when supply is high and demand low. Supply and demand economics apply as much to crypto as it does property, securities, and consumer goods.

Where crypto is concerned, mining naturally increases coin supply. Making matters worse is the fact that the supply of coins is artificially limited for most cryptos. Limits have to be built-in if crypto developers hope to keep their coins from being so prolific as to be worthless.

Limiting supply to a fixed number would, under most circumstances, sharply increase coin value with every coin mined. It would also allow miners to build wealth disproportionately. This is where protecting a coin's value becomes so important. You cannot necessarily stop the price from going up or down based on supply and demand, but you can control how mining occurs.

Mining gets harder over time

Most of the major crypto platforms, like Bitcoin and Bitcoin Cash, have a system in place whereby mining is made more difficult as time passes. Let us use Bitcoin mining as an example. To add a new block of data, a miner must verify and finalize a number of transactions that will make up that block. Each transaction contains encrypted data that has to be dealt with.

Miner software must first decrypt the data. It must then read the data and work out a complex mathematical equation. If it returns the correct answer, the transaction is finalized. Now, here's the thing: that equation gets more complex with each new transaction. So the longer the blockchain gets, the more work goes into building each new block.

This accomplishes two things. First, it slows down the pace at which coins are released into circulation. For example, let's say miners received one full bitcoin for each new block processed back in 2009. Today, that same miner might only receive one-tenth of a coin per block. Getting a full coin takes more work and time, thus reducing the rate of release.

Controlling release rate reduces the risk of price collapse due to market saturation. But that is just half the story. The second thing more difficult mining does is make obtaining new coins more difficult. That makes them more valuable. This brings a measure of stability to a coin by keeping miners in the game. Otherwise, the mining pool would shrink. This would concentrate mining into fewer and fewer hands, allowing a small number of miners to manipulate prices.

When supply dries up

Everything described thus far has been proven true by the biggest cryptocurrencies on the market. In other words, the mining system works. Still, there will come a day when mining stops, right? There has to be a day when a crypto's supply dries up. That is the day when the very last coin is mined. Then what?

No cryptocurrency has yet reached this point, so how it should be addressed is a matter of theory right now. One theory says let supply dry up and let market forces take over. This theory works if the coin in question actually has a use. The way a coin is used is known as its utility.

XRP offers a good example we can study. You may not know it, but XRP is a digital coin created by the Ripple payment network. Ripple existed before there was such a thing as crypto, so their system is set up to operate whether XRP exists or not. Likewise, XRP doesn't require the Ripple network for utility.

As XRP nears the point of releasing its last coin, Ripple could offer some kind of incentive to motivate customers to transact business using XRP. If successful, they could build demand into the coin even though supply is about to be cut off. The price of XRP would never again go through the roof, but it probably wouldn't collapse either.

If you do not like this approach, there are two other theories to consider:

Mining lost coins

Did you know that if you lose access to a digital wallet you also lose access to the coins it contains, forever? It's true. This is why experts recommend things like cold storage and wallet backups. However, the reality is that most casual crypto owners store their coins in hot storage (online) with no backups.

The end result is that people lose coins more often than you might think. This could work to the advantage of a crypto network reaching the end of its supply. It is theoretically possible to track how frequently owners access their coins. Thanks to how blockchains work it is also possible to track the location of every released coin. This creates a way to address end of supply.

By writing certain rules into the blockchain, a crypto platform could establish a standard for determining that dormant coins have been lost or abandoned. Said coins could be eliminated from the supply and replaced by new coins. This would give miners something else to do. It would keep the incentive to mine intact.

Create more coins

The third theory for addressing end of supply is to simply create more coins. This is the least attractive because it allows whoever controls the blockchain complete control over coin supply. The result could be market saturation or constriction, neither of which would be good.

Creating new coins could be tied to utility, though. By doing so, it is also possible to continually adjust the number of coins in circulation by tying supply to utility. To illustrate, imagine a crypto with an initial supply of 1 million coins. Once the last coin is mined, future supply could be linked to the coin's activity. During periods of high activity, new coins could be created and released. Coins could be taken out of circulation as activity slows.

In theory, this would work to control supply. But it may not protect value inasmuch as miners only have incentive to mine when activity is high. If they do not mine during periods of low activity, the entire network slows down. This could have a cascading affect that further reduces activity.

Uncharted territory

At the end of the day this is all speculation. No one really knows what happens when end of supply arrives. It is uncharted territory because it has never happened before. The one thing we do know is that time will eventually run out on some cryptos. Bitcoin is one of them. When that day arrives, we will see if any of the theories for addressing end of supply hold any water.

In the meantime, there's no need to let fear of the unknown keep you from using your favorite digital coins. Are you a slots player with a preference for Bitcoin casinos? Bitcoin still has a long way to go before reaching end of supply. So keep playing. If you are still in the market five years from now, check to see how close Bitcoin is to end of supply. Sell if you get nervous.

Though no one knows what will happen when that last coin is mined, we have the dual advantages of time and warning. End of supply does not have to trigger the crypto version of the 1929 stock market collapse. If everyone just pays attention and makes wise decisions, all should be well.

The systems already built into crypto to protect coin value over time are working exactly as intended. Bitcoin and its competitors are enjoying a healthy market controlled largely by market forces and without government intervention. That is the way it should be.

One of the natural strengths of crypto is that it is responsive to market forces. Thus, all of the speculation over end of supply could end up being moot. Market forces at that time could be such that users ultimately decide what happens next. As long as they all agree their chosen coins have value, that value will exist.

So, what have we learned? We have learned that mining practices are what control cryptocurrency coin value over time. It is the miners that keep the crypto network running, and the value of the work they do is represented in coin prices.

Byline: This article was published by Henry.
About: I'm a bitcoin advocate and admin of Coinbet.com.