Proof-of-Work Cryptocurrencies: Does Mining Technology Undermine Decentralization?

TL;DR

This paper uses a game-theoretical model to analyze how mining technology impacts decentralization in proof-of-work cryptocurrencies, revealing that hardware efficiency improvements do not necessarily lead to centralization.

Contribution

It introduces a model showing that hardware efficiency advancements enable smaller miners to grow, challenging the assumption that such tech favors larger miners and highlighting decentralization vulnerabilities.

Findings

Capacity constraints limit mining centralization.

Hardware efficiency benefits small and new miners.

Mining reward size significantly affects network security.

Abstract

Does the proof-of-work protocol serve its intended purpose of supporting decentralized cryptocurrency mining? To address this question, we develop a game-theoretical model where miners first invest in hardware to improve the efficiency of their operations, and then compete for mining rewards in a rent-seeking game. We argue that because of capacity constraints faced by miners, centralization in mining is lower than indicated by both public discourse and recent academic work. We show that advancements in hardware efficiency do not necessarily lead to larger miners increasing their advantage, but rather allow smaller miners to expand and new miners to enter the competition. Our calibrated model illustrates that hardware efficiency has a small impact on the cost of attacking a network, while the mining reward has a significant impact. This highlights the vulnerability of smaller and emerging cryptocurrencies, as well as of established cryptocurrencies transitioning to a fee-based mining reward scheme.