Bitcoin Mining Is an Oligopoly, and Proof-of-Stake Isn't Any Better

When I first read Satoshi Nakamoto’s whitepaper, I fell in love with its idealism. A peer-to-peer electronic cash system is inclusive. It empowers people to have control over their money. Coming from Brazil, I saw hyperinflation first-hand, so I knew the value of having optionality and not relying on one single government-controlled central bank or large banking corporations.

At a glance, proof-of-work (PoW) sounds like something righteous and fair: It gives power to whoever does the work. In Bitcoin’s case, that means the miners. Unfortunately, words can be misleading. Although it seems like PoW empowers actual people to make money, today the power is really in the hands of companies that run massive node operations.

This story is part of CoinDesk's 2023 Mining Week, sponsored by Foundry. Breno Araujo is the founder and CEO of Boto.

There is a real incentive to centralize the mining operations that run and secure the Bitcoin network, due to economies of scale. The larger the miner’s operation is, the more cost-efficient it will be, maximizing its rewards. And smaller miners are pushed out. Of course, bitcoin mining's evolution from something you can do on your laptop, to the dominance of graphics processing units (GPUs) and later ASICs (or application-specific chips) is well known.

This centralization can be seen in the numbers. According to the National Bureau of Economic Research, at one point in October 2021, 10% of the miners controlled 90% of the Bitcoin network, and .01% controlled about 50% of the network. 50% is all that is needed to take control of the network. Even today, it's likely the same few dozen miners that have dominated bitcoin mining for years, even though many have been routed by the bear market.

The whole thing starts to resemble an oligarchy. Are bitcoin miners just oligarchic technocrats?

Proof-of-stake is a plutocracy?

None of this is meant to excuse proof-of-stake, the supposedly eco-friendly option when it comes to securing blockchains. When moving from PoW to PoS, the Ethereum Foundation cited the environmental benefits of the move as one of the key arguments for the change. It's hard to deny the Merge helped reduce Ethereum's carbon footprint, but it's worth noting who really benefited – after all fees barely budged, and now Ethereum's rich are only getting richer if they stake their capital.

It's no reason why so many call proof-of-stake a plutocracy. Money talks. With Coinbase holding 11.5% of all staked ether (ETH), it effectively has a 11.5% say on what happens to the network. Imagine if a single company had 11.5% of the votes on what the Federal Reserve should do (not to suggest that the Fed is democratic). You might say you trust Brian Armstrong more than Biden. And might even describe the U.S. economy as a plutocracy. But at least the U.S. rule by elites is informal, not enshrined as the official voting mechanism like Ethereum did.

Alligning incentives

Governance is about power, and power is all about incentives. I am a firm believer that if you want anyone to do anything, you need to align their incentives. And the more we can incentivize all players towards the same goal, the better. It may not always be possible to achieve equilibrium with incentives alone, but with so many things including crypto here are ways to design non-zero-sum games.

Today PoW and PoS blockchains have conflicting interests between miners/validators and network users. Users would benefit from faster and cheaper transactions, but in general, this will increase costs to miners and validators, reducing their profits. A version of this conflict came up during Bitcoin's Blocksize War, where some argued to increase the amount of data in a mined Bitcoin block, theoretically making transactions faster and cheaper. The corresponding cost for miners would be higher with bigger blocks, but fees would be lower. Who won out?

Conflict is not inherently bad, as it can lead to good outcomes. But when power is exercised unilateral, it's important to be aware of the potential conflicting interests that can lead to unfair outcomes. Of course, bitcoiners would say the small blockers were democratic, and that keeping the cost of running a node down is ultimately beneficial for Bitcoin's decentralization, as more people would be able to validate the network.

But the two sides of the debate always reminded me of the Prisoners' Dilemma though experiment in game theory, where two criminals are being questioned by authorities and each can either lie or confess. In this case both are incentivized to act selfishly and blame the other, leading to a sub-optimal outcome for both parties.

Are we doomed?

Thankfully there are more options than just PoW and PoS, and other consensus mechanisms are being explored. At a fundamental level, the most important thing blockchain developers can do is find a way to align incentivizes between miners and users.

See also: Bitcoin Mining Has a Superpower | Mining Week 2023

Going back to the Bitcoin whitepaper, Satoshi's crownng achievement may have been solving the Byzantine Generals Problem – another popular game theory experiment – for a digital cash system. In short, Satoshi discovered that a distributed pool of miners could be incentivized to agree on a single truth (in Bitcoin's case, which "block chain" is canonical) without having to trust a centralized authority, through the laws of economics.

What we've since discovered however is that those same fundamental economic laws mean that too often miners win when users lose. I don't know if there is a sustainable way to turn mining into a non-sum-game, but I imagine we might again learn something from politics. Wouldn't it be nice if we took money out of democratic systems, and wouldn't it be nice miners/validators were incentivized by something other than direct monetary rewards?