Miners' Reward Elasticity and Stability of Competing Proof-of-Work Cryptocurrencies

Abstract

The efficient processing of payments is crucial in transaction systems, particularly in those reliant on key cryptocurrencies like Bitcoin (BTC). However, the decentralized nature of these systems, coupled with the algorithmic incentives and competition among multiple cryptocurrencies for miners, poses significant challenges in analyzing transaction speed determination in Proof-of-Work (PoW) cryptocurrencies. To address these challenges, we developed a dynamic model of the multicurrency mining market where miners switch which currency to mine and identified the necessary and sufficient conditions for competing cryptocurrencies to maintain stable transaction speeds. We documented evidence of competition among cryptocurrencies for miners and estimated miners' hash supply reward elasticity using a discontinuity caused by halving. We also conducted counterfactual simulations to examine the factors contributing to stability. Our results indicate that Bitcoin's stability heavily relies on external factors such as historical low hash-supply elasticity and interactions with other cryptocurrencies. Interestingly, despite their smaller size, Bitcoin's forks and their efficient difficulty adjustments significantly contribute to Bitcoin's stability. These findings imply that an algorithm upgrade to stabilize Bitcoin is highly recommended.

Keywords: Blockchain; Cryptocurrency; Proof-of-Work; SHA-256; Bitcoin; Convergency; Efficiency; Mining Market; Algorithmic Competition; Hash Supply Elasticity

JEL Classification: G00,G20, L11, L13, L17, L86