Friday, June 13, 2014

Bitcoin and 51% mining power

Meta: This doesn't cover all incentives. More a high level reminder for new folks.

Tweet: #bitcoin mining market under-studied & interesting. Where else
can 50% market leaders disappear, and market adjusts in real time?


Bitcoin mining pools are entities that serve to aggregate the security services provided by bitcoin mining hardware owned by individuals all over the world.  These mining pools execute bitcoin monetary policy -- they are the key network entities that select transactions to be included in The Official Timeline of Bitcoin Transactions (the blockchain).

The companies and individuals that own bitcoin mining hardware form a second tier in the market.  These miners choose an aggregator (mining pool) to which they provide computing services, in exchange for bitcoin payments.

The unique and interesting bit is that these second tiers miners all employ software that auto-switches between mining pools based on a variety of economic factors:  pool monetary policy choices, profitability and fee structure of the pool, technical availability of the pool, collective strength of the pool (size of the aggregation) versus other pools, etc.

Thus, a large and popular mining pool, dominating the market with >50% marketshare, may disappear in an instant.  Or another pool may be more profitable.  Second tier miners all employ software that switches between first tier aggregators in real time.  Low economic friction vis a vis market entry implies that market leadership follows three trends:
  1. Network effects generate large marketshares rapidly.
  2. Low economic friction (low cost of entry) implies market leadership changes frequently.  Every 12 months or so.
  3. The market is resilient against failure of market leaders, even those with > 50% marketshare.
It is natural and expected that miners will see a pool grow large, and switch away to other pools.  ETA:  Standard recommendation, use P2Pool.

Finally, remember that mining pools and miners are paid with tokens within the system -- bitcoins.  It is always in a miner's interest that bitcoins maintain their value.  Any behavior that harms the network as a whole will directly impact a large miner's income stream.  The larger the miner, the larger the impact.

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