Bitcoin Mining as a Contest

Nicola Dimitri

doi:10.5195/ledger.2017.96

Abstract

This paper presents a simple game theoretic framework, assuming complete information, to model Bitcoin mining activity. It does so by formalizing the activity as an all-pay contest: a competition where participants contend with each other to win a prize by investing in computational power, and victory is probabilistic. With at least two active miners, the unique pure strategy Nash equilibrium of the game suggests the following interesting insights on the motivation for being a miner: while the optimal amount of energy consumption depends also on the reward for solving the puzzle, as long as the reward is positive the decision to be an active miner depends only on the mining costs. Moreover, the intrinsic structure of the mining activity seems to prevent the formation of a monopoly, because in an equilibrium with two miners, both of them will have positive expected profits for any level of the opponent’s costs. A monopoly could only form if the rate of return on investment were higher outside bitcoin.

Highlights

Since its introduction in 2008,1 Bitcoin has received significant attention as a peer-to-peer cryptocurrency based on blockchain technology. 2, 3, 4 Adoption of Bitcoin may exhibit advantages as well as critical aspects.[5, 6, 7] From an economic perspective, its use may facilitate exchange and possibly save on transaction costs
In this paper we focus on the mining activity as a source of economic profitability,[3] where the main strategic decision taken by miners is how much to invest in computational power to
We proposed to model the Bitcoin mining activity as a simple static game with complete information

Summary

Introduction

Since its introduction in 2008,1 Bitcoin has received significant attention as a peer-to-peer cryptocurrency based on blockchain technology. 2 , 3 , 4 Adoption of Bitcoin may exhibit advantages as well as critical aspects.[5, 6, 7] From an economic perspective, its use may facilitate exchange and possibly save on transaction costs. At the Nash equilibrium of the mining game with perfect information, while the level of computational power chosen by an active miner depends on how many bitcoins could be obtained solving the puzzle, the decision to become an active miner depends only on his own marginal costs as compared to his opponents’ cost structure. The intrinsic structure of the game prevents the emergence of a monopoly in the mining activity, since at an equilibrium with only two miners they will always have positive expected profits for any level of their marginal costs For this reason, a monopoly could form only if return on investment outside bitcoin was higher than within bitcoin.

The Model

Findings

Conclusion