Bitcoin Blackout: Proof-of-Work and the Centralization of Mining

Abstract

Electricity constitutes one of the main input factor for miners of proof-of-work networks like Bitcoin, so they gravitate towards countries with cheap energy. We analyze risks associated with this geographical centralization by exploiting an exogenous shock to the electricity supply in a relatively small region with heavy Bitcoin mining activity. We first document a drop of about 24% in the total computing power of the Bitcoin network during a blackout that lasts several days. Compared to a control group consisting of a proof-of-stake cryptocurrency, we find evidence of blockchain congestion as fees increase substantially while the number and value of transactions decrease. The increased settlement latency on the blockchain also reduces secondary market quality as seen in higher exchange rate volatility, lower liquidity, and larger price differences between exchanges. Overall, our results suggest that geographical centralization poses system-wide risks to proof-of-work cryptocurrencies.

Keywords: Bitcoin, blockchain, proof-of-work, proof-of-stake, mining, centralization

JEL Classification: G10, G12, G14, G15, Q40