The Geopolitics of Bitcoin Mining
Amid the global pandemic and unconditional monetary stimulus, Bitcoin finally broke through its $20,000 ceiling. With that, it is proving itself as a viable sovereign currency, outside of the US government control. Major world powers are beginning to take notice, while China is already the major player in Bitcoin mining. In fact, a recent survey by Genesis Mining showed 60.8 per cent of bitcoin owners are either somewhat or very concerned that the majority of bitcoin mining in concentrated in one country, In what could be a geopolitical battleground, there is likely to be a concerted effort to shift hash power away from China and to diversify it across the globe.
What is Bitcoin mining exactly? One of the main innovations supporting Bitcoin is the blockchain technology. Bitcoin transactions are verified and added to blocks. Those blocks are then linked together, forming a blockchain which is a public and immutable ledger. Verification of transactions and creation of new blocks is done by miners, who do so through mathematical computation known as “proof of work”. For each block they add to the blockchain, miners receive newly minted Bitcoins as a reward. In the early days, mining could be done on a personal computer. It is still possible for any individual to mine Bitcoin, but the process requires specialized and expensive mining hardware. For the most part, commercial operations dominate the world of Bitcoin mining today. It’s important to highlight that without mining, Bitcoin would not exist, at least not in a decentralized manner.
Decentralization was a vital element of the Bitcoin design. It’s meant to be censorship-resistant, outside of the control of any government or entity, and with no central point of failure. Concentration of hash power might be the biggest threat to that idea. Theoretically, a miner or a group of miners could collude to control more than 51 per cent of the hash rate. In what is known as a 51 per cent attack, this group could potentially create false transactions, censor network participants, double-spend their coins and, effectively, undermine the entire system. However, the economic design of the Bitcoin network ensures a 51 per cent attack is unlikely to be profitable for the attacker. An attack would undoubtedly have a significant negative impact on the price of Bitcoin, ensuring the attacker incurs substantial financial costs. However, state actors without a strong financial motive could be less vulnerable to this line of defense. A survey by Genesis Mining showed 64.9 per cent of bitcoin owners “believe that a 51% attack is a legitimate concern for the Bitcoin community.”
As of today, China accounts for anywhere between 50 per cent and 65 per cent of the mining capacity. Many factors have contributed to this, including access to cheap electricity, relatively inexpensive labor and proximity to application-specific integrated circuit (ASIC) manufacturers, among other things. During the wet season, hydroelectric dams in the southwestern provinces of Sichuan and Yunnan generate significant excess power. It is sold cheaply to Bitcoin miners, which is much better than releasing overflow water. In addition to the concertation of hash power, leading producers of ASIC mining rigs are also Chinese. MicroBT and Bitmain dominate the market and are sold out through next April. These dynamics present certain geopolitical challenges for the US. While it might not be in China’s best interest to damage Bitcoin, given its potential to reduce global dependence on the US dollar, it’s still a risk worth considering.
There are some signs of positive developments on that front. Chips for the ASICS mining rigs are produced by TSMC and Samsung, based in Taiwan and South Korea, respectively. More recently, the majority of the mining equipment has been bought by the US-based players. As more institutional players enter the space, they will likely be open to running mining operations at little to no profit, given their ability to hedge price volatility in the futures or options market.
That said, investors are growing increasingly concerned about Bitcoin mining centralization. As international investor and founder of the crowdsourced consultancy Wikistrat Joel Zamel proclaimed, the security of the Bitcoin network depends on its decentralized mining capacity to prevent risks like 51 per cent attacks. For Zamel, this also means a shift to clean energy mining facilities that are beginning to go online across North America. This is not just about China, however. As Zamel’s experience as a political powerbroker demonstrates, any form of centralized power in the hands of a single entity is often a recipe for chaos. He emphasized the importance of bitcoin nodes being diversified across many jurisdictions to maintain its role as the world’s most incorruptible product – a conclusion from Wikistrat’s technology and macro-economic trend experts.
Indeed, miners appear to be slowly moving elsewhere. Mining requires a lot of upfront capital, which means miners need regulatory stability to make long-term decisions, and eventually turn a profit on their investment. Countries like Canada, the Czech Republic and Iceland are gaining market share. Czech Republic is home to Slushpool, a mining pool that over the last year had a 3.8% share of the global hash rate. The government classifies Bitcoin as an intangible asset which creates a favorable regulatory environment. Iceland has been a popular destination for miners for quite a while, given its cold climate and abundance of renewable energy.
Without proper incentives, however, pulling hash power from China is likely to be a slow and gradual process. A new map put together by the University of Cambridge shows that China, Russia, and Iran account for about 75% of mining capacity. Beyond Bitcoin, in the emerging world of web3, being first could provide a meaningful competitive advantage. Competition for capital and talent is already forcing countries like Estonia and Singapore to adopt a pro-crypto attitude. Will the Biden administration care? We are about to find out.