Let me start with a bit of introduction: As you may know, bitcoins are generated through mining, which is the process of adding new blocks to the blockchain. This in turn, consists of taking a bunch of transactions, adding salt, hashing the result, and see if the hash starts with a lot of zeros. If it does, you get some coins and the transactions are validated. (I’m simplifying a little.) Since the hash almost never starts with many zeros, you have to try with many many different amounts of salt. In the news this is often called “solving difficult mathematical problems”, which is ridiculous. In any case, people compete for finding a hash with many zeros in the beginning and the difficulty of the hashing problem is adjusted regularly so that the number of found blocks per unit of time is approximately one per 10 minutes. Bitcoins can be pretty valuable, especially when there is a bubble. So the more valuable, the more people will start generating lots of hashes. Since the total number of bitcoins generated by mining is fixed (the difficulty adjusts itself), this means that the cake is shared among all participants of the hash lottery. The number of tickets you own is your hashrate. Let me say this once more: Your revenue from mining is proportional to your share of the total hash rate of the network.
For example, let’s assume the only people hashing are you and I and we both hash with our CPUs (which is slow and energy inefficient). One day I come up with the idea to hash with my GPU bringing up my hash rate by a factor of 100 (at better energy efficiency). Now your hashing is basically pointless, you may es well stop doing it, or start hashing with your GPU as well. So after we both upgraded, we spent a lot of money, waste more energy, and the hashrate is a lot higher. Otherwise everything is the same, the higher hash rate is compensated by the adjusted difficulty. Game theoretically this is nothing but the the good old prisoners dilemma or, as the title says it, an arms race.
In the history of bitcoin mining there have been a number of disruptive technological changes to hashing (each bringing the hash rate up a factor of about 100), and very soon the majority of hashing will be done by integrated circuits (specialized hardware). If you hash with your GPU, you are not in the race anymore.
This is very undemocratic, but not the anti-social that Krugman is referring to. (He didn’t do his homework, because he thinks he can get away with repeating that bitcoin is drug money.) The original idea that everybody can mine bitcoin is not valid anymore. In fact, at this very moment, the hash rate of the bitcoin network is focussing sharply on those few that have specialized ASIC hardware. What can be done about this? Nothing probably. There is a variant of bitcoin called litecoin which uses the scrypt hash. They claim that it is more memory intensive and will therefore be mined on CPUs and GPUs only. I think this is bogus. As soon as litecoin becomes more valuable, somebody will make specialized hardware. If we can make special hardware to play chess, then we can also make special hardware for scrypt hashing. As you can imagine, the fear of not being the first brings out the best in humans. An ebay search for bitcoin mining devices is instructive. For instance here somebody is offering 4300 Euros for an early pre-order(!) of a device that has been delayed over and over again (shipping date was October last year).
In any case, all this is about the mining business being concentrated in the hands of a (comparably) few who can get to this specialized hardware. Making the money in your wallet is also in the hands of a few (whom you did not elect directly, or did you?), so this may not be a threat to using bitcoin per se. If nobody get’s close to 51% of the hash rate (which would basically allow stealing bitcoin), things should be fine. Some people will get very rich, just because they were lucky and moved quickly, but that’s the same in the real world. I’m curious about the future of bitcoin. Maybe it is possible to break the paypal/VISA syndicate using the public decentralized approach? To try it, I’ve set up a donations address for this page and removed all the Google ads. Let’s see if it ever sees a deposit.