By Noel Randewich
SUNNYVALE, California, Nov 3 (Reuters) - Tucked away in anair conditioned data center in Silicon Valley is a hodgepodge ofblack boxes, circuit boards and cooling fans owned by27-year-old Aaron Jackson-Wilde, a modern-day prospector lookingfor Bitcoins.
Since discovering the digital currency a few months ago,Jackson-Wilde has paid about $2,000 for his "rigs," which arepowered by specialized computer chips. They are designed to helpoperate and maintain the Bitcoin network - and, in return,generate a small reward in a process known as "Bitcoin mining."
A form of electronic money independent of traditionalbanking, Bitcoins started circulating in 2009 and have sincebecome the most prominent of several fledgling digitalcurrencies.
While they quickly gained a reputation for facilitating drugdeals and money laundering, Bitcoins have of late garneredattention from investors, such as venture capital firmAndreessen Horowitz. The volume of transactions using Bitcoinstoday remains miniscule, but enthusiasts believe thepeer-to-peer currency will play a major role in e-commerce andcould eventually become as ubiquitous as email.
Bitcoin mining is based on a unique feature of the digital currency. Unlike traditional currencies, where a central bankdecides how much money to print based on goals like controllinginflation, no central authority governs the supply of Bitcoins.
Instead, Bitcoin transactions are tracked by a network ofcomputers that solve complex mathematical problems to validatetransactions and prevent counterfeit. The system automaticallygenerates new Bitcoins as the math problems are solved andrewards them to the computer operators.
In a key twist that keeps inflation in check, the difficultyof the cryptographic math that leads to newly minted coins growsas more computers join the network.
That has led some technology professionals to target a newmarket in souped-up computers and specialized chips aimed at thegrowing ranks of Bitcoin "miners."
Consider Ravi Iyengar, who first heard of Bitcoins about sixmonths ago. Since then he has quit his job as a senior chiparchitect at Samsung Electronics and raised $1.5million to launch CoinTerra. He says he has already pre-soldmore than $5 million worth of the hardware he has designed forBitcoin mining.
"I've been in arms races throughout my career - AMD,ARM, Intel," said Iyengar, referring toprominent semiconductor companies, "but none of them match theintensity of Bitcoin mining. Each month in Bitcoin mining islike a year."
Little is known about exactly who started Bitcoin, but theconcept was introduced in a 2008 paper written under thepseudonym Satoshi Nakamoto. Since then, Satoshi Nakamoto hasbecome sort of a patron saint among advocates pushing forBitcoins as an alternative to national currencies.
Bitcoin is not backed by physical assets, is not run by anyperson or group, and its value depends on people's confidence inthe currency. The dollar price of Bitcoins has spiked over thepast year as more people became aware of the currency andspeculators jumped into the market, which remains highlyvolatile. Bitcoin recently broke $200, compared to $12 a yearago.
The goal of Bitcoin miners is to pull in more than what theyspend on their rigs - some cost over $20,000 - and theelectricity they need to keep the machines running 24 hours aday.
That is no easy feat. In the past three months, miners addedso much gear with drastically improved chips that processingpower on the network jumped from 289 terahashes per second tomore than 4,000 terahashes per second, according to The GenesisBlock, a blog that collects Bitcoin data.
In reaction, the network drove up the difficulty ofverifying each cryptographic block of transaction data, makingit even harder to break even on investments in costly mininggear.
"Bitcoin makes silicon perishable," said AndreasAntonopoulos, a digital currency entrepreneur in San Francisco."Your mining rig rots away in front of your eyes every day youhave it."
It has become so hard to make a profit that comparisons tothe 19th century California gold rush, when money was often madeselling shovels to naive prospectors, have become a running jokeamong Bitcoin miners.
"It's the guys who sell the equipment who are making themoney, not the Bitcoin miners," said Jackson-Wilde, a manager ata company that makes motorcycle batteries.
CoinTerra believes spending on new Bitcoin mining chipscould easily hit $100 million a year for the next three years,assuming no change in prices. While that is peanuts for largesemiconductor companies like Intel Corp and QualcommInc, it is a lucrative market for a handful of smalldevelopers.
About 11.9 million Bitcoins, worth $2.4 billion at recentprices, have been minted since the currency began circulating.Based on recent activity, the network is on track to createaround 1.4 million new Bitcoins annually over the next threeyears, the equivalent of more than $280 million a year at recentexchange rates.
Reflecting growing competition, Jackson-Wilde says his gear- which features model names like Erupter, Jalapeno and Spartan- now pulls in a tiny fraction of the Bitcoins it used to, buthe expects another $10,000 worth of next-generation equipment toput him in the black.
Despite the expenditures, he considers himself a hobbyistcommitted to supporting the Bitcoin network rather than aserious digital-currency investor.
"Buying and selling Bitcoins is enticing, but it's not asenticing as being part of it and actually having hardware," hesaid.
Mining with a simple laptop PC was easy back in 2009, whenthe fledgling Bitcoin network was a fraction of its currentsize. But within a year, hobbyists found that graphics chips,often referred to as GPUs and widely used by PC gamers, couldprovide a major boost in mining output.
Miners cobbled together dozens of graphics chips in theirgarages and basements, surrounded by fans to keep theelectronics from overheating.
Then in 2010, entrepreneurs caught wind. Jeff Ownby and ahandful of colleagues had just formed Butterfly Labs with thegoal of using off-the-shelf programmable chips, known as FPGAs,to help banks run complex financial risk simulations.
"As we were starting down the road planning this, we readabout Bitcoin and said 'Wow, this is exactly what we're tryingto do here,'" Ownby said. "It was pretty much in a hobby state,so we thought this might be something."
Butterfly Labs and other startups optimized FPGAs, which aremore typically used in factories and telecommunications gear, towork efficiently on the Bitcoin network.
In 2012, the Bitcoin arms race escalated again whenButterfly Labs and rivals, all with little or no semiconductorengineering experience, started designing chips from the groundup. Custom chips, known as application specific integratedcircuits (ASICs), are normally made by companies focused onhigh-volume products like televisions - not startups makingsmall batches of digital mining devices.
"They're the Wild West," said John Cheng, head of Californiabased-Custom Silicon Solutions, which helped Butterfly Labsdesign and manufacture its ASIC. "There's a certain rhythmyou're used to in the chip business. It's usually two or threeyears before your ramp, but these guys wanted to ramp in sixmonths."
Butterfly Labs said on Thursday it recently took adownpayment for new mining gear in Bitcoins equivalent to $1million, the largest-ever transaction in the digital currency.It identified the customer as HashTrade, a company sellingcontracts for cloud-based Bitcoin mining run in data centers.
David Johnston, executive director of BitAngels, aninvestment group, says consolidation in Bitcoin mining is wellunderway.
"Mining has been going through these different generationsand going up a learning curve, from amateurs running CPUs andGPUs to new professionally funded companies with experiencedchip designers taking it to the state of the art," Johnstonsaid.
Still, there remain plenty of oddities in the Bitcoin miningbusiness. Johnston cited ASICMiner, which both sells mining rigsand runs its own mining operations, as one of the largest andmost respected operators. The company has even sold stock toonline investors who paid in Bitcoins.
ASICMiner recently had a market value equivalent to $50million, according to data on the BitFunder online exchange.
But few know where the company is located, or even who is incharge. The chief executive communicates through web forumsunder the pseudonym "Friedcat."
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