Decentralized Mining in Centralized Pools
54 Pages Posted: 22 Mar 2018 Last revised: 10 Dec 2019
Date Written: November 1, 2019
The rise of centralized mining pools for risk sharing does not necessarily undermine the decentralization required for permissionless blockchains: Each individual miner's cross-pool diversification and endogenous fees charged by pools generally sustain decentralization, because larger pools better internalize their externality on global hash rates, charge higher fees, attract disproportionately fewer miners, and thus grow more slowly. Instead, mining pools as a financial innovation escalate the arms race among competing miners and thus significantly increase the energy consumption of proof-of-work-based consensus mechanisms. Empirical evidence from Bitcoin mining supports our model predictions. The economic insights inform many other blockchain protocols as well as the industrial organization of mainstream sectors with similar characteristics but ambiguous prior findings.
Keywords: Arms Race, Bitcoin, Blockchain, Energy Consumption, Industrial Organization, Mining Pools, PoW, Risk-Sharing
JEL Classification: D47, D82, D83, G14, G23, G28
Suggested Citation: Suggested Citation