Decentralized Mining in Centralized Pools

Cong, Lin William; He, Zhiguo; Li, Jiasun

doi:10.3386/w25592

Cited by 108 publications

(76 citation statements)

References 57 publications

(24 reference statements)

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“…To capture the fact that mining tends to be competitive and open to new entrants, we assume that M → ∞ for the remainder of the paper. 12 12 In reality, mining tends to be organized around mining pools where individual miners pool their resources to compete against other miners (see Cong, He and Li (2019) for an analysis of strategic competition between a finite number of mining pools). Still, mining appears to be competitive, as currently 10 mining pools comprise about 95% of computational power (see https://www.blockchain.com/en/pools).…”

Section: Miningmentioning

confidence: 99%

The Economics of Cryptocurrencies Bitcoin and Beyond

2017

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How well can a cryptocurrency serve as a means of payment? Cryptocurrencies need to overcome double spending by using costly mining and by delaying settlement. We formalize this insight through an incentive constraint that rules out double spending and pins down the welfare costs of a cryptocurrency. We find that it is optimal to use seignorage rather than transaction fees to finance costly mining. We estimate that Bitcoin generates a large welfare loss that is about 500 times as large as a monetary economy with 2% inflation. This welfare loss can be lowered in an optimal design to the equivalent of a monetary economy with moderate inflation of about 45%. Bank topics: Digital currencies and fintech; Monetary policy; Payment clearing and settlement systems JEL codes: E4, E5, L5How well can a cryptocurrency serve as a means of payment? Since the creation of Bitcoin in 2009, many critics have denounced cryptocurrencies as fraud or outright bubbles. Others have argued that such currencies are only there to support payments for illegal activities or simply waste resources. Advocates point out, however, that -based on cryptographic principles to ensure security -these new currencies can support payments without the need to designate a third party that controls the currency or payment instrument, possibly for its own profit. 1We take up this discussion and develop a general equilibrium model of a cryptocurrency that uses a blockchain as a record-keeping device for payments. Many existing models of cryptocurrencies are built by computer scientists who focus mainly on the feasibility and security of these systems.Crucial issues, such as the incentives of participants to cheat, and the endogenous nature of some key variables, such as the real value of a cryptocurrency in exchange, have been largely ignored.Such considerations, however, are pivotal for understanding the optimal design and, hence, the economic value of cryptocurrency as a means of payment.Our focus is thus primarily on understanding how the design of a cryptocurrency influences the interactions among participants and their incentives to cheat. These incentives arise from a so-called double-spending problem. Cryptocurrencies are based on digital records that can be duplicated easily and costlessly and, thus, that can potentially be used multiple times in transactions.Our first contribution is to formalize this double-spending problem and show how it is addressed by (i) a resource-intensive competition for updating the records of transactions -a process commonly referred to as mining; and (ii) by introducing confirmation lags for settling transactions. 2 Double spending with a cryptocurrency requires one to change the record of transactions after the transactions have been recorded and confirmed in the blockchain. Since a blockchain builds records based on previous records, to revoke past transactions, one must create an alternative history of transaction records in order to double spend successfully. More intensive competition to update the chain and longer c...

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Section: Miningmentioning

confidence: 99%

The Economics of Cryptocurrencies Bitcoin and Beyond

2017

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“…Easley, O'Hara and Basu [2017] and Huberman, Leshno and Moallemi [2017] provide analyses of transaction fees, the mining game and waiting times for users in the current Bitcoin protocol. Huoy [2014] and Cong, He and Li [2018] provide analyses of the mining game. Boehm, Christin, and Moore [2015], Harvey [2016], Malinova and Park [2016], Yermack [2016, 2017], and Aune, Krellenstein, 2 Although users can observe the bids of other users and increase bids in response to their observations, we believe that analyzing the bidding game for a single block as a first-price, sealed-bid auction is appropriate for three reasons.…”

Section: Introductionmentioning

confidence: 99%

Towards a Functional Fee Market for Cryptocurrencies

et al. 2019

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Blockchain-based cryptocurrencies prioritize transactions based on their fees, creating a unique kind of fee market. Empirically, this market has failed to yield stable equilibria with predictable prices for desired levels of service. We argue that this is due to the absence of a dominant strategy equilibrium in the current fee mechanism. We propose an alternative fee setting mechanism that is inspired by generalized second price auctions. The design of such a mechanism is challenging because miners can use any criteria for including transactions and can manipulate the results of the auction after seeing the proposed fees. Nonetheless, we show that our proposed protocol is free from manipulation as the number of users increases. We further show that, for a large number of users and miners, the gain from manipulation is small for all parties. This results in users proposing fees that represent their true utility and lower variance of revenue for miners. Historical analysis shows that Bitcoin users could have saved $272,528,000 USD in transaction fees while miners could have reduced the variance of fee income by an average factor of 7.4 times.

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“…Athey et al (2016) and Pagnotta and Buraschi (2018) propose models of the valuation of digital currencies. Cong, He, and Li (2019), Easley, O'Hara, and Basu (2017), and Huberman, Leshno and Moallemi (2017) study Bitcoin mining fees and the incentives of miners in equilibrium. We view our paper as complementary to this literature.…”

Section: Introductionmentioning

confidence: 99%

Trading and Arbitrage in Cryptocurrency Markets

Makarov

Schoar

2018

SSRN Journal

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Cryptocurrency markets exhibit periods of large, recurrent arbitrage opportunities across exchanges. These price deviations are much larger across than within countries, and smaller between cryptocurrencies, highlighting the importance of capital controls for the movement of arbitrage capital. Price deviations across countries co-move and open up in times of large bitcoin appreciation. Countries with higher bitcoin premia over the US bitcoin price see widening arbitrage deviations when bitcoin appreciates. Finally, we decompose signed volume on each exchange into a common and an idiosyncratic component. The common component explains 80% of bitcoin returns. The idiosyncratic components help explain arbitrage spreads between exchanges.JEL classification: G12, G15, F38

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Decentralized Mining in Centralized Pools

Cited by 108 publications

References 57 publications

The Economics of Cryptocurrencies Bitcoin and Beyond

The Economics of Cryptocurrencies Bitcoin and Beyond

Towards a Functional Fee Market for Cryptocurrencies

Trading and Arbitrage in Cryptocurrency Markets

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