Blogs/Vlogs

Cryptocurrencies. What you need to know (part two)

7 February 2020

The workings of cryptocurrencies remain a mystery to most people, which may well be a barrier to their growth and wider acceptance. But the time will come when your business is asked to accept payment in bitcoin. Are you ready to deal positively with such a request?

Mining revived

Those of us who were born and raised in the coalfields of South Yorkshire will treat the term ‘mining’ with great reverence and some regret. The new mining, however, involves little physical effort and next to no risk to health and safety. The term is used to describe the method by which new Bitcoins (or other cryptocurrencies) are created. In my previous blog, I mentioned that currencies are generally vulnerable to mismanagement, and that one sort of mismanagement is creating too much new currency, thereby diluting the value of the currency already in circulation and causing inflation, in some cases even hyperinflation. So how do cryptocurrencies, and in particular Bitcoin, deal with this threat?

In theory, anyone with a computer can be a miner, and help to create (or mine) new Bitcoins, thereby earning the right to be a participator in updating the blockchain, or ledger. On average, the Bitcoin computer creates a new block of pending transactions every 10 minutes. At the same time, a random number is generated, and those wishing to ‘mine’ Bitcoin compete to be the first to guess the random number. The winner gets the privilege of recording the block of transactions and sharing the information with all the other participators (i.e. updating the distributed ledger). He, she or it (!) is rewarded by receiving a fixed number of Bitcoins, and a transaction fee.

Mining is not easy

The system is ingeniously self-regulating by means of a concept known as ‘mining difficulty’. Initially, it was possible to guess the random number by using a PC, but technology has since escalated through various phases and now miners use a dedicated piece of hardware known as an ASIC. This is thousands of times faster than any previous technology but is expensive to acquire and set up, and uses a great deal of power. So much power, in fact, that some professional miners have relocated their equipment to places that have cheap electricity, for example Iceland. The Bitcoin algorithms automatically increase the difficulty in guessing the random number, in parallel with the increase in the number of miners and the sophistication of the available hardware.

At the same time, the offered reward, in terms of the number of Bitcoins issued for being the first to guess the number, halves for every 210,000 blocks created. So the cost of mining keeps going up, while the rewards keep going down.

If you were considering becoming a Bitcoin miner, you should take into account the price of the hardware, the cost of the large amount of power needed to keep it cool, the fact that the numbers become harder to guess year by year, the continuously reducing size of the rewards, and the fact that the market value or exchange rate of Bitcoin is very volatile. You can share these risks by joining a mining pool, to which you pay a subscription but also share the rewards. It could be an interesting sideline, but not a reason for giving up the day job.

So, what should you consider?

We’ll assume that for most individuals Bitcoin mining is not worth the risk (or the relocation to Iceland) but that as a business dealing with the public you cannot afford to deny your customers the opportunity of paying you in Bitcoin. Therefore, you need to know how to set up a system for buying, selling and doing transactions in cryptocurrencies. That will be the focus of my next blog.

If in the meantime you need to know more about how the increased use of cryptocurrencies may affect your business, or if your accounting software needs updating to deal with them, contact me at a.hulse@uhy-uk.com , or use our contact form.

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