Mining Centralization: The war on Bitcoin’s mining industry

We have all heard about the big problem of mining centralization in Bitcoin.  The deep set fears that somehow, if left unchecked, the miners will collude to defraud the network, and sabotage the whole system, all in order to satiate their own lust for profit.

This is often used as a reason to employ [central planned policy here] or to change the protocol to incentivize some other (more acceptable) form of behaviour.  Of all the ‘decentralization myths’ this one is the toughest to dispel; not because it is any more true than the other myths but because people have an inbuilt selection bias in that they often believe that a system not serving them directly must mean that system is broken, instead of realizing that they way they are interacting with the system may be at fault.  Mining has always been a very liquid market in Bitcoin, and has gone through several phases or generations, and as each new era came to an end there were very loud proponents in the industry that wailed and warned that this new change would mark the end of the network and everything would break.  Detractors said the same thing when mining moved from single CPUs to GPUs and experienced a 1000x increase in efficiency, then again when mining moved to FPGAs, and finally to custom ASICs.  The industry has seen hashrates go from MH/s, to GH/s, to TH/s.  That is a million times increase in just 7 years.  Every time, the complainers were the ones that had some entrenched interest in the current model and stood to lose money or competitiveness.  Maybe they had just bought 10 new Intel Xeon servers just to mine Bitcoins when some genius had the idea to move mining to GPUs.  Or maybe they had just bought $200,000 of GPUs when the first ASICs were released, and were caught holding the bag.  Needless to say, you can always identify the people who stand to lose something given a change by how loud they complain about it.  (Hint: take note on which miners complain about mining centralization the most)

Mining Centralization

This seems to be the latest myth propagated by those miners who cannot remain profitable given the competition in recent years that have appeared from China.  Chinese mines have some unique advantages, they have cheaper power, and labour, if they are resourceful enough to have the right connections in the country to find off-grid power, or an official who can turn a blind eye to some pesky permit violation.  China has the competitive advantage as a market due to its lack of regulations in comparison with US or EU, where regulations is a real tangible friction and cost that make it harder for a business to compete.  So the myth perpetuated goes something like this, –if you allow miners to compete fairly on profit motive alone, then surely all the mining industry will coalesce in China, where it is most efficient to do so, and then all it would take is for the untrustworthy Chinese officials to outlaw or shut down all the mining farms and then Bitcoin will be wiped out.  This story seems to be spread primarily by non-chinese miners, with a healthy dose of xenophobia.  What this amounts to is nothing more than the age old political practice of protectionism, and special interest lobbying, except in this case, there isn’t a central government to lobby, so these companies turn to lobbying the most influential central player in Bitcoin, the core developer umbrella company, Blockstream.  If you were looking for another reason to diversify the groups that operate and develop in Bitcoin, look no further.

Taking a page from history

If you look at how the mining industry has evolved, it is very similar to how companies in the DJIA have evolved over the last 100 years, albeit at a much heightened pace.  Nobody would accuse the american free market industry of being unduly centralizing or whether this is a net negative influence.  (and if you did, you probably didn’t believe in capitalism in the first place, stop reading here).  Moreover, Satoshi designed Bitcoin to work in exactly these conditions, to be resilient in the most adversarial of competitive environments, incentivizing miners to act honestly in order to protect their own profit margins in the long run.

SF Emergent Consensus slide7

chart credits to “Emergent Consensus” by Andrew Clifford 2016

SF Emergent Consensus slide6

chart credits to “Emergent Consensus” by Andrew Clifford 2016

In each column you will see the companies in their cohort coloured in the same fashion, moving from the earliest (red) to the most recent (blue).  You can see that the survival rate of companies in US industry as a whole quite closely match those in Bitcoin mining space, and the turnover is not anything extraordinary.  Newer companies are generally more efficient, as technology advances in time, and newcomers don’t usually join the market unless they think they can do so at an advantage to the incumbents.  Those that are right, tend to bump out existing companies than can no longer compete.  Old companies that manage to survive tend to be ones that can adapt to remain competitive with their newer generation coming in to replace them.  You can see that both in Bitcoin mining and DJIA, only about 40-50% of current market is controlled by established companies in each generation, and the extinction rate of companies in each new cohort is constant and a function of their age.  The only oddity in the DJIA case is that no company from the 1986 cohort survived into 2016.  I would attribute this unique statistic to the boom and bust economic volatility following the ‘Greenspan Age’ of central bank policy making (1987 to 2006), culminating in the financial crisis of 2008.

So the industry shows no signs of any undue centralization, unless you take into account that Bitcoin is an industry that competes on a global scale and honours no political borders.  If you believe that that may make a difference, then I would wonder if you also worry that most financial companies are centralized in New England east coast USA, and most technology companies are centralized in California or Texas.  Do people worry that California passing an anti-bitcoin law would cripple the network?  If no then I fail to see how the same worries about the Chinese government doing the same is warranted.  It simply is a business risk/cost that every miner operating in China needs to factor into their business model and account for, if they want to survive into the next generation and remain competitive.

I have personally talked to miners and industry experts (who are Chinese, living in China) and the consensus is that 10billion dollar market cap of Bitcoin is an insignificant drop in the bucket and not even on PBOC’s radar.  They doubt they will even take notice until Bitcoin approaches 100x that amount.  They have much bigger geopolitical issues and threats to worry about.  If and when that time comes, I believe the people who would be best positioned to adapt and adjust for it would be the businesses that would be most affected by it.  Specifically, the miners who operate in China, rather than the armchair ‘experts’ commenting through the internet on a business that they don’t truly understand anymore than a theoretical physicist would understand how to build and operate a hadron collider.

The evils of specialization

Many armchair academics will also point out how the advent of mining pools has irreparably damaged the mining ecosystem. They will argue that the miners who run the clients are no longer the ones that control the hashpower.  They will claim this breaks the incentive structure and hurts mining centralization because now one pool can speak for the many miners that they employ. This is a fallacy of course as any development that the market makes in order to further specialize only adds more efficiency in the system, and the more efficient the system the cheaper it will be to secure the network.  This argument is just as moot as arguing that mining should have remained on individual CPUs, because that would represent a more decentralized mining network.  This is a fallacy, as although technically more decentralized such a network would in no way be more secure than the current one. (Ask any bitcoiner whether ETH is more secure and you will inevitably get a resounding NO).  This continues to illustrate the point that the most decentralized network does not necessarily mean the most secure one.

Currently mining pools have specialized to become a business akin to an internet ISP. Make as many reliable connections to all your peers (and competitors) as possible. Reduce your round trip latency and orphan rate and you will be able to pay your miners more rewards. Charge a fee for this service.

Miners (aka hashers) continue to be a physical business. Sourcing cheaper power, cheaper labour and managing outages and data center maintenance issues. This is a business unto itself and it would not make sense to enforce that miners do this as well as run their own pool for the sake of “decentralization”.  It would make as much sense to enforce that every e-business run their own ISP, for the sake of internet reliability and decentralization.  If anything the creation of a new specialization in the mining economy keeps the mining pools more honest than before as they can easily lose their hash power if their service is substandard, inefficient or if they are found to be playing selfishly or censoring transactions.  The system works better than ever before in creating the most secure cryptocurrency in the world.

In general when proponents argue for regulation  to reign in the ‘uncontrolled’ market progressing and evolving by way of specialization, I implore you dear readers to put on your skeptical glasses and wield the mace of science to evaluate their claims.  I suspect more often than not you will find some actor who is about to be made obsolete, trying desperately to lobby for special protectionist policies.

4 thoughts on “Mining Centralization: The war on Bitcoin’s mining industry

  1. Don’t forget Obama’s promise that “under my plan the cost of electricity would necessarily skyrocket.” Politicians want to enact THEIR agendas on OUR backs. Imagine what some artificial price or tax on electricity would do to mining in the US of A. Expect the price of electricity to be “regulated” in years to come.

  2. I’m a fan of your blog, but this is way off the mark. There are two properties many of us desire from the miners:

    1. Good intentions: they’re not just in it for profit (or worse, short-term profit), but share some of the love of decentralization and individual freedom that originally drew people to Bitcoin.

    2. Heterogeneity: there are enough of them, widely enough spread out in every sense, that it’s impractical for them to get in a room and collude – eg, push through a hard fork that favors large miners over small. (I’m a big-blocker btw! But this is still a desirable property.)

    Bitcoin mining used to have both these properties. It no longer does; Ethereum mining arguably still does – for now. I understand why people miss both. Preserving the first was probably a pipe dream, but preserving the second really is important. There’s more to security than hash rate, and that “guys in a room” risk is real.

    The main force degrading miner heterogeneity is economies of scale. I have some hope that proof-of-stake will win out (via Ethereum or some other coin – Bitcoin miners will never accept it, decentralized or not) and, besides environmental benefits etc, will prove more resistant to economies of scale. Otherwise cryptocurrencies controlled by benign, long-term-greedy cartels may be the best we can hope for.

    • I think the precise reason that hashpower is decentralized (and will move to where ever in the world you can source power and labor efficiently (which will change as time goes on) this will keep the mining pools acting in the best interest of the network.

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