Decentralized Mining in Centralized Pools

51 Pages Posted: 22 Mar 2018 Last revised: 24 Oct 2018

See all articles by Lin William Cong

Lin William Cong

University of Chicago - Booth School of Business

Zhiguo He

University of Chicago - Finance

Jiasun Li

George Mason University - Department of Finance

Date Written: October 2018

Abstract

An open blockchain's well-functioning relies on adequate decentralization, yet the rise of mining pools that provide risk-sharing leads to centralization, calling into question the viability of such systems. We show that mining pools as a financial innovation significantly exacerbates the arms race and thus energy consumption for proof-of-work-based blockchains. Moreover, cross-pool diversification and endogenous pool fees generally sustain decentralization --- dominant pools better internalize the mining externality, charge higher fees, attract disproportionately less miners, and thus grows more slowly. Consequently, aggregate growth in mining pools is not accompanied by over-concentration of pools. Empirical evidence from Bitcoin mining supports our model predictions, and the economic insight applies to many other blockchain protocols.

Keywords: Arms Race, Bitcoin, Blockchain, Cryptocurrency, Financial Innovation, FinTech, Mining Pools, Risk-Sharing.

JEL Classification: D47, D82, D83, G14, G23, G28

Suggested Citation

Cong, Lin and He, Zhiguo and Li, Jiasun, Decentralized Mining in Centralized Pools (October 2018). George Mason University School of Business Research Paper No. 18-9. Available at SSRN: https://ssrn.com/abstract=3143724 or http://dx.doi.org/10.2139/ssrn.3143724

Lin Cong (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Zhiguo He

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://www.zhiguohe.com

Jiasun Li

George Mason University - Department of Finance ( email )

Fairfax, VA 22030
United States

HOME PAGE: http://https://sites.google.com/site/jiasunlihome/

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