March 19, 2024

Centralization of mining and the threat of censorship of sanctioned transactions in bitcoins

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10 min.

Centralization of mining and the threat of censorship of sanctioned transactions in bitcoins

Opinion

By the beginning of 2023, the largestFoundry USA Pool, owned by Barry Silbert's DGC holding, became the mining pool on the Bitcoin network. Could this threaten to freeze transactions from sanctioned addresses?

After the mining ban in China in September 2021year most of the mining capacity of the Bitcoin network was concentrated in North America, in the United States and Canada. According to data at the beginning of 2022, more than 45% of mining equipment is located in these two countries. Now this share has become even larger, as the exodus of miners from China continues into 2022. However, there is no recent information on the geographical distribution of capacity.

Over the same period, it more than doubledshare in the Foundry USA network - the only large American pool for corporate miners. In the first week of February, it remains around a third of the total network hashrate, between 32% and 34%. On some days the pool share rose to 40%.

FTX, Genesis, DCG and what does mining have to do with it

Founded in 2019, Foundry Digital is oneone of the largest mining companies in the world. It not only engages in mining at its own facilities and maintains a mining pool. This is a wide-ranging platform that includes equipment hosting services, a marketplace for ASIC miners, a logistics unit for equipment delivery, a contractor for organizing mining data centers, a training portal and a service for staking major coins on PoS.

Foundry Digital is essentiallyanalogue of Grayscale for the mining market. The company was initially positioned as a service provider for institutional clients. There are no retail miners or their equipment in its data centers. This allows you to significantly reduce costs for technical support and marketing.

In the tumultuous 2022, Foundry not onlysuffered, but on the contrary, expanded the business. At the end of November, the company bought two mining data centers from the bankrupt Compute North for $14 million, significantly below the market price. In March 2022, Foundry joined the Blockchain Association, which lobbies the interests of cryptocurrency businesses in the US government. However, so far without much success.

Foundry became one of the largest beneficiariesmass exodus of miners from China in 2021. After the ban on mining in China, the largest mining companies at that time began to export equipment. A significant part was transported to closer Kazakhstan, Mongolia, Russia and other countries. However, China and the United States are separated only by an ocean, and sea transportation of large cargo has always been cheaper than land transportation. Therefore, many miners loaded equipment onto ships and sent it to the United States and Canada, where there are regions with cheap hydroelectricity. And also the infrastructure for the immediate launch of all transported ASICs, which the Chinese took care of in advance.

Foundry was able to accept in its data centersChinese equipment worth $300 million, and it was this that ensured the growth of the share of the company’s mining pool. After all, Chinese miners could not refuse such a small thing as switching equipment to the pool of a new hoster.

So promising and growing in a crisisa business like Foundry Digital should appear to be very resilient. But there is a nuance. Foundry was originally founded as the mining division of Barry Silbert's Digital Currency Group (DCG). And as you know, after the bankruptcy of FTX, the previously prosperous DCG discovered
serious financial problems. One of the holding companies, Genesis Global, is in bankruptcy, its debts exceed $5 billion.

To close the Genesis story and avoidcomplete ruin, Silbert will have to sacrifice some of his assets. Information has already appeared about the possible sale of Coindesk, the largest news portal about the cryptocurrency industry. But $200 million is clearly not enough, and DCG will sooner or later be forced to sell some of its profitable subsidiaries. These are the Grayscale Investments cryptocurrency trusts, the Luno exchange and the Foundry Digital mining platform.

Foundry is 100% owned by DCG, it is not listed on stock exchanges and does not have a public capitalization. The potential deal likely won't be public.

Ping matters

Why do large Chinese miners afterrelocation of equipment to the USA switched to a pool owned by an American company? One can suspect political reasons and unspoken demands of the “host” here. But, most likely, the situation is much simpler and the reasons are purely technical.

Mining is a very competitive industry.Moreover, there is constant competition for each mined block. With a constant increase in mining capacity, the profitability of a unit of equipment gradually decreases. New capacities appear on the network constantly and uncontrollably. To maintain market share, industrial miners need to constantly increase capacity by purchasing new ASIC miners. This means that the faster the existing equipment mines blocks, the higher the chances of not missing out on future income, which will have to be shared with a large number of other miners.

“Golden hash”, which allows you to form andwriting a new block to the blockchain can be found by several devices located in different parts of the world at once. The reward will be received by the miner who is the first to collect a block and send it to as many nodes of the P2P network as possible. This means that every millisecond counts. Therefore, large miners take into account everything: the speed of software and hardware of the pool servers, the speed and width of communication channels, and many other factors.

If ASICs located in the USA willsend the results of work to a pool server physically located in China - it will inevitably receive them hundredths or even tenths of a second later than a server located nearby. Don’t forget about the “Great Chinese Firewall,” which creates additional delays in data transmission both when receiving from ASICs and when distributing the block. In the lost seconds, the block may go to another cryptocurrency miner. Therefore, for large miners, ping to the pool server matters. The same as for high-frequency traders - ping to the exchange server.

Chance of a "51% attack" by Foundry USA

Foundry USA is far from the first pool to receivetheoretical possibility of influencing the operation of the Bitcoin network. Its share of the hashrate has not yet gone beyond 40%, and in the history of Bitcoin there have already been periods when one pool owned more than 50% of the network hashrate. At different times, BTC Guild, Ghash.io, F2Pool and Antpool (in conjunction with BTC.com) became “dominators”. However, none of them realized the capabilities of the so-called 51% attack.

Financial difficulties of Digital Currency Groupare also reflected in subsidiaries, including Foundry Digital. This means that the expansion of the company’s own capacities will slow down or stop altogether, since the management company will take the income. And doubts about the reliability of the pool will force potential large clients and investors to find another partner to host the equipment or use the pool. Therefore, further growth of Foundry USA’s share in the global hashrate is unlikely.

Theoretically a short term rollback attackindividual transactions (double spending or others) can be organized with a small share of the network hashrate, for example, 20-25%. The luck factor can make it possible to rewrite several blocks in a row even without dominating the hashrate. Conversely, if luck turns against a miner, even one who owns 80% of the hashrate, he can create fewer blocks than other miners within a few hours.

Ownership of more than 50% of the hashrate guaranteessuperiority only over long periods. This means that the economic motivation for carrying out a 51% attack on such a large blockchain as Bitcoin is too small. The pool that launches the attack will quickly lose the power of third-party miners, which it cannot control. Thus, you need to dominate not only the current hashrate, but also the physical power of the equipment. And in 2023 it is worth billions of dollars.

Now some users are sayingthe opinion that the motivation of the pool can be not only economic, but also political. For example, if government regulators require its operator to comply with sanctions and censor transactions from a list of prohibited addresses. But the same factors apply here: for reliable long-term control over the network, you need to own more than 50% of the hashrate and equipment all this time. However, the current geographical distribution of pools and miners still does not allow this possibility.

Pools and sanctions

A question that worries many Russianscryptocurrency users - can mining pools join Western sanctions and jeopardize the cryptocurrency payments of Russians. Many blockchain analysis services are flagging an increasing number of cryptocurrency addresses as “sanctioned.” At first these were targeted sanctions, supposedly aimed only at the assets of “Russian oligarchs” and North Korean hackers, but they are becoming more widespread and vague.

In addition, the payment technology itselfThe Bitcoin blockchain leads to constant fragmentation of transaction inputs, which means that any user who is not involved in any way with sanctioned people and organizations has a chance of receiving a “sanction mark.” It is enough to receive a transaction from an exchanger or exchange that does not use automated AML services. This is especially possible in payments between individuals and small businesses. You can receive a sanctions label completely unexpectedly, as happened with Bitzlato clients
(BTC Banker). 

In other words, the implementation of sanctions policy on the blockchain becomes an indiscriminate weapon of mass destruction.

Undoubtedly, the consequences of sanctions against countries andpeople can significantly limit the decentralization of leading cryptocurrencies, which have long been under the radar of regulators. It is very difficult to challenge the freezing of a payment with sanctioned coins; at best, it will require lengthy correspondence with the technical support of the exchange (exchanger) and the provision of all kinds of documents. Without any guarantee of getting your money back.

If Foundry is sold, it is difficult to predictwho will gain control over the largest mining pool and the company’s own capacities. Both Chinese miners and leading players in the American cryptocurrency market may be interested in this - for example, Coinbase, which does not have its own mining assets. If it is an American company, it will also be obliged to comply with the sanctions.

We should not forget that in addition to Foundry DigitalIn the USA, several other major players in the mining market are located and traded on American exchanges: Riot Blockchain, Greenidge Generation, Marathon Digital, Hut8 Mining, Bit Mining and others. Their total hashrate can reach 10% of the total hashrate of the network, but they do not have their own pools and can use, among other things, the Foundry pool.

How Miners Can Operate

If the execution of sanctions includesminers - this potentially poses a great threat to the decentralization of the first cryptocurrency, and therefore to the long-term increase in the price of Bitcoin. What is very important here is how far regulators are willing to go in their requirements and what percentage of hashrate will remain in the jurisdictions under their control.

The peculiarity of Foundry USA is that on thisThe pool is operated mainly by large miners located in the USA. They have less reason to change pools even if they violate the principles of the Bitcoin network, since the loss of profitability caused by a drop in price as a result of a successful attack on the blockchain will not depend on a specific pool.

Technically a pool, subject to protocol rulesBitcoin can only act in one way: not to include transactions from sanctioned addresses in its blocks. If even the majority of pools with an overwhelming superiority in hashrate do this, victims of sanctions will be able to find loopholes.

  • Firstly, this is an increased offerкомиссии за подтверждение транзакции. В таком случае их транзакции будут обрабатываться в приоритетном порядке пулами, не соблюдающими санкции. И проблема будет решена всего лишь небольшими дополнительными затратами.

  • Secondly, it is launching your own pools,which will focus on priority confirmation of their users' transactions. Russia, Iran, and in the future China may follow this path if they lift the ban on mining. This network split policy will result in transaction confirmation delays for many participants, but will not have a critical impact on the operation of the Bitcoin blockchain.

  • It's worse if the pools are controlled by regulatorswill work to unconditionally block transactions from prohibited addresses, even violating the rules of the protocol. This will be effective if the total hashrate share exceeds 50%. In this case, controlled pools will be able to rewrite even confirmed block chains containing “sanctioned transactions.” Along with them, transactions of bona fide users included in the blocks of the “probable enemy” will disappear from the blockchain.

    Such an apocalyptic scenario is inevitablewill lead to the complete displacement of all “wrong miners and users” from the network and potentially threatens another hard fork. The network will be finally divided into at least two separate segments. And this will cause a collapse in the Bitcoin rate, since the network, under the current rules of the protocol, will not be able to oppose anything to the dictatorship of the majority of miners.

    The good news is that so far governmentsWestern countries do not oblige miners to block sanctioned transactions and there is no information in the public space about such plans. In addition to the American Foundry with 33%, a small share - about 2% of the hashrate - has the Czech Braiins Pool (formerly Slush) and the Japanese SBI Crypto (1.5%). The share of independent miners with unknown jurisdiction does not exceed 2%. Thus, US regulators are potentially able to directly or indirectly control no more than 40% of the hashrate. All other large pools are located in Asian jurisdictions.

    Based on the above, about the “miner war”For now we can only speak in the form of forecasts and assumptions. But this issue can surface at any time as the geopolitical conflict intensifies.