The bitcoin mining market is the first actualization of a perfectly competitive market.
In a theoretical microeconomic model, perfect competition consists of several attributes. Notably, a firm's ability to extract profits decreases over time, ultimately benefiting consumers and society more than itself.
Future miners who understand the long-term microeconomic forces will be more competitive and successful in the long term. This article will define and explain perfect competition, reframe the original model, examine how the bitcoin mining market satisfies the definition of perfect competition and draw conclusions based on the arguments presented.
Defining the market
Perfect market competition consists of several criteria, all of which must be met.
- Buyers and sellers have perfect information on the price and quality of the product
- All firms produce homogeneous/identical products
- All firms are price takers and cannot influence the market price of the product
- There are no transaction costs for participating in the market. Firms can freely enter and exit the market (exclusive permits, prohibitive start costs)
- Each firm is unable to influence or impose on other firms
- Each firm’s output is perfectly divisible
Bitcoin mining
Bitcoin mining fits into this model when we think of bitcoin miners as “firms” or “sellers” and hashing as the “product.” The more abstract idea within this article is that the bitcoin network, as an entity, is the consumer of the “product.”
The assumptions only carry, however, if a miner participates in a mining pool. Participating in a pool is necessary to project long-term, sustainable revenue for all miners within a pool. Thus, solo bitcoin miners do not classify as firms because the probability of solving a block (achieving revenue) for a solo miner is near zero.
Let’s go through each condition as it applies to Bitcoin mining.
All miners have perfectly equal access to bitcoin’s open-source code.
The bitcoin network perfectly analyzes all incoming hashes and “purchases” the one with the correct quality.
All bitcoin miners produce perfectly identical correct hashes.
A “correct hash” satisfies the criteria needed to be “purchased” by the bitcoin network in exchange for the block subsidy + fees for that block. All bitcoin miners within mining pools are exposed to the block rewards and proportional costs of production, and thus they all contribute to producing the “correct hash.”
All miners are price takers insofar as they are unable to influence the price of bitcoin.
The revenue for the “firms” is generated through a mining pool, or a large collection of miners. However, selling of revenue is done by the individual miner, not the “firm.” Thus, mining pools are fundamentally unable to influence the price.
Bitcoin miners face zero transaction costs for participating in the market and can freely enter and exit the market.
Bitcoin miners do not require exclusive government permits (fishing/forestry), nor do they require extensive capital funding and regulatory approval for environmentally destructive projects (commodity mining/extraction or infrastructure construction).
Bitcoin miners have perhaps the highest level of freedom to exit and enter a market compared to all other industries. Bitcoin miners can turn off and turn on their machines at will, thus entering and exiting the bitcoin mining market instantaneously with no cost of altering the state of production. Unlike a typical customer base, there is no negative effect on future income by avoiding present market participation. Compare this to a bakery – if a baker closes their shop multiple times a day, they will likely lose customers. On the other end of the spectrum, extensive mining operations typically are unable to alter their production state until the project is completed.
Further, bitcoin miners are increasingly able to buy and sell ASICs on a secondary market, increasing a miner’s ability to enter and exit the market. Other barriers to entry, such as transactional fees, hardware costs and electrical configuration, are trending toward becoming more accessible and are likely to continue to do so. For example, Lightning can enable the smallest of miners who participate in a pool to profitably collect micropayments; ASIC-backed loans make it easier to acquire hardware; and ASIC hosting enables miners to plug their ASIC into a top-tier mining facility while paying their share of the bill.
Each firm is unable to impose on or influence others.
The only way a mining pool can influence another mining pool is by joining it. Even if two pools join together, they are still unable to influence the rest of the pools as bitcoin mining. Pools cannot influence one another because bitcoin mining has zero economies of scale; a miner’s hashrate is perfectly proportional to their long-term revenue. A possible form of influence is one where a pool grows beyond 50% of the network and interferes with the revenue of other firms by selecting particular transactions over others. However, it is worth assuming that the game theory dynamics in bitcoin mining prevent such an imposition from occurring.
Each miner’s hash contribution is perfectly divisible and proportional to their reward.
Bitcoin is highly divisible; therefore, small miners can profitably participate in mining pools and receive miniscule earnings through the Lightning Network. For every other industry, outputs and inputs are not easily divisible. Unlike small bitcoin miners, a baker, for example, cannot join a bakery pool, they cannot contribute a fraction of oven heat necessary for good procurement, they cannot sell a fraction of a croissant and they definitely cannot earn a fraction of a penny per payment. Bitcoin mining plus the invention of pools and micropayments facilitated by Lightning allow the smallest miner to join a pool. Importantly, the small bitcoin miner will have an equally proportional reward relative to their contribution when compared to very large miners. This is because bitcoin mining does not offer economies of scale – there are no advantages for scaling up one’s operations. One’s hashrate is directly proportional to their revenue, with zero increasing to scale.
Consequences
Understanding the market structure of bitcoin mining is very important to a firm’s long-term success.
A consequence of the perfect competition market structure’s highly competitive nature is that all firms' long-term profits trend toward zero. Firms that minimize their operational and marginal costs will have the greatest likelihood of long-term profitability. As a result, miners are incentivized to pursue renewable or free energy to realize lower operational costs in the search of greater profitability.
