Bitcoin investment thesis - Decentralisation of nodes, hashrate and ownership

BTC mining is indeed relatively concentrated within so-called mining pools, which are groups of miners combining their computational power to realise economies of scale by increasing the probability of mining a block and receiving the block reward. The process is managed by pool operators, who are responsible for assigning mining jobs to members of the mining pool, broadcasting/propagating blocks mined, as well as distributing block rewards to pool members based on a predefined payment scheme (eg a pay-per-share (PPS) model or a pay-per-last-n-share (PPLNS) model). Importantly, under the Stratum V1 protocol (developed by SlushPool), currently used by all major mining pools to cooperate with miners, these operators are also responsible for ordering transactions to be added to new blocks mined by ‘hashers’, which technically grants them the power to censor transactions on the network. In fact, there are already some minor examples of this, such as the Blockseer Pool, which rejects transactions from blacklisted wallets, or the Marathon OFAC pool, although in the end it withdrew from mining only blocks compliant with the Office of Foreign Assets Control. An upgrade to the protocol (called Stratum V2), which is currently being introduced, would mitigate the censoring risk as it allows miners (rather than pool operators) to order transactions. However, its adoption by mining pools has been slow so far.

The top five mining pools (AntPool, Poolin, Binance Pool, ViaBTC and F2Pool based on the latest weekly data as at 30 July 2021) control c 60% of the total hashrate, while the top10 control c 90%, according to BTC.com data. Moreover, the top 1% miners in the top pools account for c 65% of its hashrate, according to the Cambridge Centre for Alternative Finance.

Theoretically, operators of some of the largest mining pools (controlling the majority of Bitcoin’s hashrate) could join forces to carry out a so-called ‘51% attack’ and reorganise the blockchain so that they can double-spend funds or systematically censor certain types of transactions (by not adding them to new blocks). However, we note that this would be contrary to the interests of BTC miners, as it would undermine Bitcoin’s credibility and almost certainly lead to a crash in BTC’s price, translating into significant losses for them given the considerable investments they made in customised application-specific integrated circuit (ASIC) mining equipment to receive BTC rewards. This represents an opportunity cost for potential attacker(s) and has been already addressed by Bitcoin’s creator(s), Satoshi Nakamoto in the white paper published in 2008, where Satoshi highlight(s) that maintaining the value of the mined coins (together with collecting transaction fees) represents a strong incentive to play by the rules.

The motivation of the respective miners to be part of a given pool is predominantly monetary and they can switch to any other pool if they conclude that the pool’s manager is not acting in their interests. Nevertheless, we do acknowledge that Stratum V1 results in a certain principal-agent problem.

Moreover, most of the top five mining pools are based in China. While the miners joining them are not necessarily located in China, China-based operations made up a significant part (most likely over 50%) of global BTC mining until recently. This was largely due to cheap electricity and good access to manufacturers of mining equipment (the key producers are in China). However, China’s recent crackdown on Bitcoin, including a ban and effective shutdown of local mining operations in recent months, is resulting in a significant shift in the geographical footprint of mining.

Here, it is worth pointing out that despite a near-50% decline in the global Bitcoin hashrate (from the peak in May 2021) as a result of the crackdown, the Bitcoin network continued to operate as usual, except for a temporary increase in the average time it took to add a new block to c 15–25 minutes (now back to the previous average of 10 minutes). This illustrates Bitcoin’s resilience as a decentralised network.