Is Miner Concentration Once Again Jeopardizing Bitcoin? Not Exactly

One of the main pillars of bitcoin’s value proposition is decentralization. Why then does the computer processing power behind the largest cryptocurrency seem to be concentrating again in one place, this time North America? The answer is multifaceted but some of the main reasons come down to where it’s the safest in this geopolitical environment and most profitable for the miners to operate.

Following China’s sweeping crackdown on the country’s crypto industry last year, miners packed up their businesses and fled to other parts of the world, where the geopolitical situation is more stable and cheap power is plentiful. They moved largely to North America, particularly to the U.S.

According to a report released by Cambridge Centre for Alternative Finance (CCAF) in October, the U.S. accounted for 35.4% of Bitcoin’s global computing power, or hashrate, at the end of August, more than doubling the 16.8% share at the end of April. Kazakhstan and Russia followed the U.S. with hashrate shares of 18.1% and 11%, respectively, at that time. Meanwhile, mining operations in mainland China had effectively dropped to zero, down from a high of 75.53% in September 2019.

Most recently, the digital-asset investment firm CoinShares, said in a research report that the largest global mining country is the U.S. with an estimated 49% of total global hashrate located in the region, as of Dec. 31, 2021.

This concentration counters bitcoin’s promise of a decentralized network, where in an ideal world hashrate would be evenly distributed globally. But the reality is far from ideal and given geopolitical instability in some key regions, the trend of miners moving to the U.S. is likely to continue.

“Ideally, miners would distribute Bitcoin’s hashrate across the globe and multiple jurisdictions, but they will migrate to the most favorable business, energy, and political climates they can find–that’s why they are coming to the United States,” said Colin Harper, head of content and research at the the crypto software and services company Luxor Technology.

It’s not hard to see why a miner would rather be in North America than anywhere else as lawmakers worldwide are starting to clamp down on crypto miners. Kazakhstan, which was a popular destination for miners leaving China, called for higher taxes, cut off power and cracked down on illegal mining operations. In February, Hong Kong-based cryptocurrency miner BIT Mining (BTCM) halted its near-$10 million mining data center construction project in Kazakhstan, citing unstable local power supply.

Having the assurance that a whole industry will not be just uprooted or disrupted overnight by the government is one of the main considerations for anyone planning to start any business, particularly in such a young sector as crypto mining.

This arguably makes the U.S., with its constitutional protections and federal system, the safest place for miners to set up. “The United States is one of the better countries to experience hashrate concentration, because the United States’ federal structure ensures strong rule of law and robust states’ rights,” Luxor’s Harper said.

Particularly after miners got burned by China’s ban, a repeat of such total disruption to business would be costly, especially given the sector has become brutally competitive, while margins sunk from their peak of 90% to between 60% and 70%.

“If it had to be that a single country hosts a large percentage of the network hashrate, then I am glad that this is in the United States, given its federated system in which individual states have large autonomy over lawmaking within their borders,” said Jurica Bulovic, head of mining at Foundry (a subsidiary of Digital Currency Group, which also owns CoinDesk).

“That diminishes the risk of an abrupt, country-wide ban on bitcoin mining, like we have seen in China,” Bulovic said.

Or, as Bryan Bullett, CEO of mining firm Bit Digital put it in October: “nobody wants to operate in a region where they face existential risks.”

Dave Perrill, CEO of data centers operator Compute North, said that the U.S. also has better access to infrastructure and a lower cost of power.

However, such a large concentration of miners relocating in the U.S. has started to draw the ire of lawmakers and regulators alike, given these firms’ massive demand for energy.

In March, the Environmental Conservation Committee of the New York State Assembly voted to move along a proposed law that would ban proof-of-work (PoW) cryptocurrency mining for two years. Meanwhile, some federal lawmakers led by Sen. Elizabeth Warren (D-Mass.), have scrutinized crypto mining companies on their climate impact.

Most recently, the U.S. Securities and Exchange Commission (SEC) proposed a new regulation that would require publicly traded companies to report information on greenhouse-gas emissions and risks related to climate change, which would affect miners due to their energy consumption. However, the mining community, for the most part, welcomed this proposed rule.

However, it’s doubtful that Washington will try to ban digital asset mining altogether as many states have already embraced the industry.

“It’s unlikely that the federal government would move to ban or disrupt mining, and if they did, the decision would have to go through federal courts, not to mention the fact that states would fight tooth-and-nail against a PoW prohibition,” Harper said.

To complicate matters for policymakers, the mining industry has already turned into a multi-billion dollar industry. In Feb. 28, research note, Wall Street bank B. Riley’s analyst Lucas Pipes wrote that the industry has already grown to almost $100 billion in gross value of bitcoin to be mined..

“Most simply, to derive total industry value, we multiply coins to be mined times current BTC price plus transaction fees. Today, this value is approximately $92B,” he said, using a bitcoin price of $38,000. As of this writing, the price of bitcoin was back up to $44,000.

Such a large industry will likely be hard to strike down completely in a short period of time.

Another threat to bitcoin’s decentralization is a handful of mining pools controlling too much hashrate.

“Mining pools are, by definition, a centralizing force in the bitcoin mining ecosystem,” Foundry’s Bulovic said. “They provide a service of aggregating hashrate from individual miners in order to minimize the inherent revenue volatility, and provide stable payouts.”

Foundry USA is the largest bitcoin pool in the world, with almost 20% of the total network’s hashrate, according to BTC.com data as of March 25.

This concentration may seem like another threat to the decentralization thesis. However, mining pools don’t control the network and don’t have a lot of clout, because any miner can quickly change pools if there is any hint of foul play, such as censoring bitcoin transactions, Bulovic said.

“Furthermore, there are developments such as Stratum V2 that would, among other things, empower individual miners to construct block templates, taking that power away from mining pools,” he added. Stratum-V2 is a new bitcoin mining protocol that is being developed, improving on many aspects of the previous version, Stratum-V1, which miners use to communicate with the mining pools. The improvements include more efficient data transfer and protections against network centralization.

“The full feature set of Stratum V2, offers the miner the choice to select their own transaction set and construct their own block templates [that determines which transactions go inside them], allowing miners to easily revolt against pools that misbehave on censorship to the detriment of the broader Bitcoin network,” according to a recent research report by Rachel Rybarczyk, a vice president at Galaxy Digital Mining. “Even if miners don’t utilize this power, the mere threat that they could, will deter pools from misbehaving.”

The numbers showing regional concentration and the mining pools’ outsized market share of the total hashrate look like a threat to decentralization. However, as long as their motivation is profit, it would be counterproductive for the miners to attack the network by banding together.

“To hit on the point about a threat to decentralization, miners ultimately act in their own interests,” Harper said, noting that they compete against each other, and wouldn’t stand to benefit by cooperating to attack the network that generates their income. And a purely malicious actor with no profit motive (say, a hostile state) would find an attack difficult and expensive to carry out, given the heft of the competition to mine blocks.

However, such concentration does increase regulatory scrutiny for the miners from the country they are setting up their business in, Harper said.

Luckily, “I think the United States’ federal structure provides unique insulation against a state-sponsored attack [against the miners],” he said.

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