ANZ Finance blog | Let’s Hash It Out

Let’s Hash it Out!

Published 23 November 2022

By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland

Let's Hash it out -- McGraw Hill Ideas In Finance

The crypto markets had a tumultuous start to November 2022. The collapse of FTX is the biggest story but since there are lots of unknowns, we’ll cover it in the next post, once more facts become available. For now, we’ll go ahead with our planned story about a technical aspect of cryptocurrency, the “hashrate”.

Crypto markets are statistics rich. A lot of technical information is discussed in crypto blogs, newsletters, crypto Twitter, and podcasts. Finance. Engineering. Computer science. Software engineering. If you follow the crypto industry news, you’ll be bombarded with lots of these stats. One statistic that gets mentioned often is the hashrate.

The hashrate is relevant to proof-of-work (PoW) networks. The best known PoW network is Bitcoin. The name “hashrate” derives from the “hashing” algorithms that are used to generate “hash” code. The Bitcoin network uses the SHA256 hashing algorithm. If you take any word and run it through SHA256 you will get a long string of numbers and letters as output. If you have that long string of numbers and letters, it is not possible to run them back through the algorithm to find out what the initial word was. The algorithm has encrypted the word.

This is related to PoW as follows.

PoW is the system whereby “miners” use costly computing power to solve a puzzle and earn the right to add the next block of transactions to the blockchain. The puzzle involves producing a hash that is equal to or less than a target hash by changing a single number (called a ‘nonce’ for “number used only once”). The odds are stacked overwhelmingly against any single random guess, so miners must run millions of trials (i.e., compute millions of hashes). The solution, once found, is broadcast to the network, and authenticated by other miners who measure if the appropriate amount of computing power (work) was used to produce the hash.

The cost of producing the hash dishonestly should outweigh the cost of doing it honestly.

This is how the Bitcoin network maintains its integrity without a third-party providing oversight (e.g., a banking regulator). Honesty is further rewarded with a distribution of new bitcoin to the successful miner. If the miner gets it wrong or tries to cheat, other network users won’t use their proposed block, and the dishonest miners have wasted their resources.

The hashrate on the Bitcoin network is the total computer power that is being used to mine and process transactions. The unit of measurement on the Bitcoin network is “exa-hashes per second” (EH/s). One exa-hash is one quintillion hashes. At the time of writing, the Bitcoin hashrate is around 268 EH/s. That means miners are computing 268 quintillion hashes per second. Note, quintillion = 1 followed by 18 zeroes. So, 268 EH/s = 268,000,000,000,000,000,000 hashes per second.

Not only is that an interesting thing to know, but it also has important implications for the security of the network.

The Bitcoin network is vulnerable to a 51% attack. This is a situation where a miner gets control of 51% of the computing power of the network. That miner would, theoretically, be able to block fake transactions or reverse payments that they might have made in the past. The higher the hashrate, the more computing power there is on the network, the less likely it is that one group can gain majority control. Bitcoin’s hashrate has gradually increased, with more computing power steadily being added to the network. The Bitcoin network is becoming more secure each year (so far).

One of the most ingenious parts of Bitcoin’s blockchain technology is its built-in difficulty adjustment mechanism.

The number of “guesses” it takes to produce the correct hash is calibrated automatically to ensure that a correct guess will be produced (and a new block added to the blockchain) every 10 minutes. If more computing power enters the network and miners are finding blocks more frequently, the difficulty level goes up. If it is taking longer than 10 minutes to produce a correct hash, the difficulty level is automatically decreased.

The hashrate is not highly correlated with bitcoin’s price. As we mentioned, the hashrate has steadily increased. All this while, bitcoin’s price has been famously volatile. It could be that miners have recognised that bitcoin is a scarce commodity (see previous post) and are trying to secure their share. This competition pushes the hashrate higher.

Another factor is that people purchase ASICs to use in cryptocurrency mining, attracted by the idea of making a nice profit. ASICs are application specific integrated circuits. That is, microchips designed solely for a particular application. In this case, bitcoin mining. They cannot be used for anything else. When their plans don’t work out, would-be miners sell their equipment to other miners who are running more successful operations. The continuous entry of new hopefuls adds computing power to the network, even though the bitcoin price has not been on a one-way journey to the moon.

Discussion Question

What are the benefits and disadvantages of Proof of Work?

How does Proof of Work compare with the alternative Proof of Stake protocol?