Pitfalls of Bitcoin’s Proof-of-Work: R&D Arms Race and Mining Centralization

44 Pages Posted: 2 Nov 2018 Last revised: 17 Jun 2021

Date Written: February 4, 2020

Abstract

Does Bitcoin's proof-of-work (PoW) protocol serve its intended purpose of enabling and supporting a decentralized payment system? To address this question, we develop a game theoretical model where firms invest in research and development (R&D) before competing in a Bitcoin mining game. We show that firms fail to capture the surplus created from their research, because higher research expenditures induce a more aggressive mining game. Promoting R&D spillovers not only reduces wasteful R&D duplication and increases firms' profits, but may also raise the security of the Bitcoin system. We calibrate our model to rewards and operational costs of the Bitcoin system, and quantitatively demonstrate that the mining industry has a tendency towards centralization, against the core principles of cryptocurrencies.

Keywords: Bitcoin, proof-of-work, mining, arms race, centralization

JEL Classification: C70, G2, D43, L13

Suggested Citation

Alsabah, Humoud and Capponi, Agostino, Pitfalls of Bitcoin’s Proof-of-Work: R&D Arms Race and Mining Centralization (February 4, 2020). Available at SSRN: https://ssrn.com/abstract=3273982 or http://dx.doi.org/10.2139/ssrn.3273982

Humoud Alsabah (Contact Author)

Kuwait University ( email )

Safat, 13060
Kuwait

Agostino Capponi

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

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