The regulatory control of blockchains and cryptocurrencies is increasing. From the ban on mining cryptocurrencies in China to President Joe Biden’s Financial Markets Working Group convened by Treasury Secretary Janet Yellen, the economic activities that blockchains support and make possible have become a major concern of policymakers. Finally, a provision in the proposed Infrastructure Act 2021 changes the definition of a broker to the effect that “any person who […] is responsible for the regular provision of services that effect transfers of digital assets on behalf of another person. “
The stated goal of this miner-than-broker policy change is to improve the collection of tax revenues on cryptocurrency capital gains by improving the ability of tax collectors to monitor cryptocurrency trades. Since cryptocurrency miners regularly validate transactions that transfer digital assets such as cryptocurrencies on behalf of cryptocurrency holders, these miners appear to meet this definition of a broker. Unsurprisingly, many in the cryptocurrency industry have raised concerns.
A key feature of blockchain technology is the competitive decentralized recording of records. The advantages and disadvantages of this new form of bookkeeping compared to traditional centralized financial databases are actively discussed. But the new regulation could put an early end to this debate.
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What are the direct consequences of defining miners as brokers?
First, miners – at least those based in the United States – would be subject to significantly expanded requirements for reporting to the Internal Revenue Service. The cost to miners of complying with such requirements is likely to be high and largely fixed. Miners would have to bear these costs regardless of how much mining power they have and before they mine a single block. This will deter entry and likely lead to more centralized control or concentration of mining power.
Second, these broker-miners would be responsible for complying with Know Your Customer’s regulations. Given the pseudo-anonymous nature of most cryptocurrencies, such a policy would limit the types of transactions that broker-miners can process to non-anonymous transactions. How would that work? Presumably I would register with a miner (e.g. link my driver’s license to a Bitcoin address), and miners would only validate transactions on behalf of their registered users. But if this miner is small (has little mining power) then my transactions are less likely to be processed over the Bitcoin Network (BTC). Perhaps it would be better if I (and you) registered with a bigger miner. Or maybe we should all just use Coinbase and allow a miner to process transactions on behalf of Coinbase. Again, the effect is a greater concentration of mining force.
Taken together, these policies are likely to increase concentration in U.S. cryptocurrency mining while increasing the cost of mining and potentially reducing the overall amount of mining that takes place. that is, policies would shift mining within the US from the “shadowless faceless supercoders groups” recently described by Senator Elizabeth Warren, but potentially increase user reliance on such faceless supercoders outside the United States.
What are the global consequences of defining miners as brokers?
Part of the global impact of the proposed provisions in the Infrastructure Act depends on the relative importance of U.S. cryptocurrency mining operations in the context of global mining. Recent history offers some prospects. In June, China stepped up enforcement of its Bitcoin mining ban. The result was far fewer miners. We can see this in the decline in mining difficulties seen in early July. Mining difficulty determines the speed at which transactions are processed (around 1 block per 10 minutes for Bitcoin). With a few miners, the difficulty of keeping the transaction rate constant decreases.
The lower difficulty level of mining requires less electricity to mine a block. The block reward is constant. Bitcoin’s price did not fall with the difficulty decreased in July. There are three things to keep in mind:
- The mining profits for the remaining miners must have increased.
- New miners are not quickly replacing the now offline Chinese miners.
- The competition in mining decreased.
These features are likely to lead to a consolidation or concentration of mining power. If the new regulation – especially the brokerage designation of miners – moves forward, we can likely expect similar effects.
Related: If you have a bitcoin miner, turn it on
Is higher concentration inherently bad news?
Much of the security thesis of blockchain technology is rooted in decentralization. Nobody has incentives to exclude transactions or past bans. If a miner has significant mining power – a high chance of solving multiple blocks in a row – they can potentially change part of the blockchain’s history. This situation is known as the 51% attack and raises concerns about the immutability of the blockchain.
The proposed policy has two interrelated consequences. First, higher concentration, by definition, brings miners closer to the mark at which they can effectively change the blockchain ledger. Second, and perhaps more subtle, the profitability of an attack is higher when the cost of mining goes down – it’s just cheaper to attack.
However, as my co-authors and I argue in ongoing research, such security concerns stem entirely from Bitcoin’s mining protocol, which recommends miners add new transactions to the longest chain on the blockchain. We argue that the potential success of 51% attacks results entirely from this recommendation for coordinating miners on the longest chain. We show how alternative coordination devices can increase the security of a blockchain and limit the security consequences of increased mining concentration.
No competition, no blockchain
Regardless of whether or not the current digital asset regulations in the US Infrastructure Act 2021 are passed, policymakers seem poised to improve the regulation and reporting of cryptocurrency deals. While the debate has mainly centered on the tradeoffs of improved US government oversight of cryptocurrency trading and the potential harm to US blockchain innovations, it is critically important for both policymakers and innovators to understand the likely impact of one Policy on competition within the cryptocurrency mining should be taken into account, as this competition plays a crucial role in securing blockchains.
The views, thoughts, and opinions expressed herein are solely those of the author and do not necessarily reflect the views and opinions of Cointelegraph or Carnegie Mellon University or its affiliates.
Ariel Zetlin-Jones is Associate Professor of Economics at Carnegie Mellon University. He examines the interplay between financial intermediation and macroeconomics. Since 2016, Ariel has been exploring the economics of blockchains – how economic incentives can be used to shape the blockchain consensus and stablecoin protocols, as well as the novel and economically large centralized markets currently supporting cryptocurrency trading. His research was published in the American economic report, the Journal for Political Economy and the Magazine for money economy.