Too Big to Cheat: Mining Pools' Incentives to Double Spend in Blockchain Based Cryptocurrencies

Abstract

Conventional wisdom in blockchain-based cryptocurrencies suggests that centralization of mining power undermines the credibility of cryptocurrencies because it enhances the risk of double spending attacks, where the same funds are used multiple times. However, centralization of mining power is commonly observed in cryptocurrencies. Contrary to a firmly held premise, our main findings indicate that under meager economic profits incentives to act honestly are increasing in pool size. Our results illustrate how to design dynamic incentives that generate self-enforcing mechanisms in cryptocurrencies. In this setting the prospect of losing future income provides powerful incentives for large pools (which have centralized power in mining) to voluntarily act honestly and preserve integrity of the cryptocurrency. In our model we compare the double spending costs generated by these vested interests to the cost advantage of being a large pool. Our model conclusion that centralization is harmless is consistent with practices in 13 major proof-of-work cryptocurrencies.

Keywords: Blockchain, Cryptocurrencies, Bitcoin, Double Spending Attacks

JEL Classification: D43, E42, G29