Proof-of-Work Cryptocurrencies: Does Mining Technology Undermine Decentralization?

Agostino Capponi (), Sveinn Ólafsson () and Humoud Alsabah ()
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Agostino Capponi: Department of Industrial Engineering and Operations Research, Columbia University, New York, New York 10027
Sveinn Ólafsson: School of Business, Stevens Institute of Technology, Hoboken, New Jersey 07030
Humoud Alsabah: Department of Industrial and Management Systems Engineering, Kuwait University, Kuwait City, Kuwait

Management Science, 2023, vol. 69, issue 11, 6455-6481

Abstract: Does the proof-of-work consensus protocol serve its intended purpose of supporting decentralized cryptocurrency mining? To address this question, we develop a game-theoretical model in which miners first invest in hardware to improve the efficiency of their operations and then compete for mining rewards in a rent-seeking game. We show that centralization grows with heterogeneity in mining costs, but hardware capacity constraints prevent the most efficient miners from monopolizing the mining process. Investment leads to a more decentralized network unless larger miners have a significant comparative advantage in acquiring new hardware. Our model generates empirically supported implications: (i) mining centralization is countercyclical with respect to mining reward, and (ii) a change in mining reward leads to a less-than-proportional change in hash rates.

Keywords: finance; management; research and development; industrial organization; firm objectives; organization and behavior (search for similar items in EconPapers)
Date: 2023
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