Incentives for withholding hash power
Can it make economical sense for a Bitcoin miner to strategically withdraw hash-power from the Bitcoin network? It is easy to imagine situations when a miner may choose to power down obsolete hardware that has become too inefficient, when the expected gain from operating those rigs does not justify the electricity costs. But could it make sense to power down perfectly competitive mining rigs suddenly and turn them back on at a different time in the future?
Suppose Bob has 20% of mining power and decides to completely quit mining at the end of the current adjustment period. Assuming that is the only change in the mining landscape—and this is a big leap of faith, considering that other participants may have spare capacity waiting on the sidelines— the result is that for the next adjustment period of 2016 blocks, the remaining miners will experience a slowdown. Difficulty level has not adjusted but only 80% of mining capacity remains, with the result that blocks will arrive 25% slower than average. The adjustment period will take correspondingly longer than the usual two weeks, after which point the difficulty is reduced to 80% of the original. Now if there were no other changes to overall mining capacity, the system would revert to its usual pace of producing blocks, since difficulty and hash-rate have once again achieved parity. But in comes Bob out-of-left field, powering up all of his mining rigs once again. Now difficulty parameter is too low by 20%, or equivalently the network runs a 25% surplus hash-rate over the last estimate. Blocks will arrive once every 8 minutes on average and this state of affairs will continue for a shorter-than-usual adjustment period of ~11 days. At that point difficulty could have adjusted back to observed hash-rate, except Bob is not done: once again he powers down his entire operation, leaving the network with an overestimate of difficulty. This results in a cycle of alternating periods where difficulty is overestimated and underestimated, with blocks arriving too fast or too slow. This is the scenario outlined in a SecureList/Kaspersky blog post, which goes on to argue that miners have an incentive to game the system by strategically moving hash-power in and out in this fashion.
Economics of timing the (mining) market
Putting aside the question of whether other miners waiting on the sidelines would jump in to compensate if they saw difficulty levels fluctuate, let’s analyze this situation from the economic perspective of the individual miner (more likely, mining pool) we will call Bob. During the 17.5 days when his operation goes quiet, Bob collects no mining rewards at all. This is a lost opportunity cost. Mining has both fixed costs in the specialized rigs and data-center infrastructure, as well as marginal costs in electricity powering all that energy-hungry hardware. The good news for Bob is that during the next period when he is back to business-as-usual, he still has 20% share of overall network capacity. He collects the exact same proportion of rewards as before. The only difference is that those rewards arrive faster: all of those blocks come in 11.2 days instead of 14. Accordingly his economic competitiveness measured in bitcoins earned per second has improved.
So far, so good. But how does that compare against the idle time? That turns out to be the main drawback. It may look like Bob is screwing over the competition by temporarily withdrawing: everyone else is left to mine at artificially high difficulty for longer than usual. But this is illusory: the remaining players are also collecting higher share of rewards than usual. (To take one example, if hash-rate was equally distributed between 5 mining pools, after one quits each of the remaining pools will see their share increase from 20% → 25%.) While the network is producing blocks 25% slower than usual—from the standpoint of miners, their block rewards are correspondingly arriving less frequently— all of the miners left in the game are also collecting 25% more reward when they successfully mine a block. Their economic productivity measured in bitcoins collected per second has not changed at all. That means profitability has not changed either: regardless of what they are paying for electricity, continuing to mine at the artificially higher difficulty produces the same gain/loss per unit of time as before. (Again, assuming everything else is held constant: while block rewards are fixed, mining fees are variable and could go either way. A congested blockchain with slower confirmation times could result in fewer people attempting to transact, putting downward pressure on fees. But conversely it could mean that there is ever more urgency to get mined into the next block, resulting in higher fees.)
Meanwhile Bob receives diddly-squat during the entire time his rigs sit idle. That represents a complete loss of productivity for an even longer period of time; recall that the next adjustment period of artificially high-difficulty lasts longer than 14 days as remaining miners are struggling to produce blocks. That extended stretch of 0 bitcoins per second more than counters any advantage sustained during the easy-mining period. Given only the Bitcoin blockchain, it is difficult to see how strategically timing entry and exit out of the mining operation could result in improved economics for the miner playing that game.
An alternative chain is the playground of idle miners
Unless of course, the miner can find something better to do with all of that idle hardware sitting around? Enter Bitcoin Cash. Given two blockchains with compatible proof-of-work functions (in the broadest sense, meaning that hardware designed to mine for one can be converted to mine for the other without significant loss of efficiency) a new strategy becomes available to miners: instead of idling their rigs, they can simply switch over to the other chain.
The effectiveness of that strategy depends on several variables. Perhaps the most obvious one is the relative profitability of mining the alt-coin compared to Bitcoin itself. In general there is no a priori rule that mining alt-coins must be equally profitable in terms of rewards to hash-rate invested. While cost of hash-rate is relatively predictable in hardware costs and electricity, the rewards are highly volatile given the sharp fluctuations in cryptocurrency markets. More importantly, given that other blockchains such as Ethereum employ a different proof-of-work function than Bitcoin, it is often not possible to simply redirect existing hardware to mine an entirely different blockchain.
Restricting our attention to chains with compatible proof-of-work functions, there is a market dynamic to keep their profitability at approximately the same level in steady state. If a significant disparity exists, miners can jump ship to mine on the other chain. That incentive applies even to miners ideologically committed to a particular currency. If a miner only cares about Bitcoin but sees an opportunity to earn the equivalent of 10% more USD on a different chain with sufficient liquidity. The rational choice is:
- Mine that alternative currency
- Immediately cash out to all rewards to USD or other fiat currency
- Use the proceeds to buy back bitcoin on the open market
Provided the discrepancy exceeds transaction costs of making those trades, that strategy still earns more bitcoin for the adaptable miner. In the case of Bitcoin and Bitcoin Cash, relative profitability has been fluctuating wildly, partly because BCH difficulty adjustments have been very slow to kick-in after the fork. But it is plausible that in steady state—assuming the forked chain, survives that is— profitability will remain in the same neighborhood, if not exactly equal.
The other wildcard is how difficulty adjustments work on the alternative chain. Recall that sudden introduction/departure of hash-power from the network has a transient effect on the overall profitability of that blockchain. This effect is short-lived as long as the difficulty level is adjusted to account for the total mining capacity expected. With some exceptions around edge-cases (such as the rapid, emergency adjustments to deal with the massive drop in the afterwork of the hard-fork) Bitcoin Cash has similar rules to Bitcoin around scheduling: the network aims for 10-minute intervals between blocks and adjusts difficulty after every 2016 blocks to hit that target. However these two chains will not necessarily agree on when each adjustment period starts or ends. Even in steady state, they are likely to appear as two out-of-phase waves with the same frequency rather than perfectly synchronized ones.
Luckily for hypothetical miner Bob engaged in a chain-switching attack, synchronization is not necessary. After withdrawing from mining capacity from BTC, the miner can simply switch to mining BCH starting at some arbitrary point in the middle of BCH adjustment period. (Note at the time of writing, overall BCH hash-rate is much lower compared to BTC. If we continue using the 20% figure as before, that amount of BTC capacity switching sides would completely dominate the minority chain, effectively constituting a 51% attack.) Until that period completes, the network is operating at increased pace, doling out rewards too fast because the presence of the new actor has not been factored into the difficulty calculation yet. Everyone, including Bob responsible for this temporary spike, is collecting BCH at a rate faster than what one would predict given their share of mining power. After the adjustment, target block-time is restored and expected reward per unit time also gets trimmed for everyone. But miner Bob is continuing to earn some reward, albeit in a different cryptocurrency. He can continue doing that until BTC chain readjusts its difficulty to create an environment where jumping back in is appealing again. This improves the economics of chain switching compared to simply idling all rigs for an adjustment period.
But counteracting that is another factor: the act of Bob completely withdrawing from BTC and redirecting all capacity at BCH has lowered the relative profitability of BCH. There is now more hash rate chasing the same amount of block rewards in BCH, while BTC is experiencing a competitive vacuum. (This assumes BCH and BTC prices have not magically moved in the opposite direction to correct for hash-rate. While hash-power naturally follows valuation by miners voting with their rigs, it is unclear what causal mechanism exists for market-price of a cryptocurrency traded on multiple exchanges to adjust to gain/loss of hash-power.) That may in turn create incentives for hash-power to naturally defect from BCH and switch back to BTC, compensating for the original drop.
To summarize, while it appears that each miner can cause network instability & fluctuation in block times by strategically exiting/reentering the market, that behavior is unlikely to be more profitable than the simpler strategy of always mining at the same rate 24/7. The introduction of a second compatible chain however does alter the dynamics, by compensating for lost income during the idle time. But even in that scenario, it is unclear how other actors would respond because a natural equilibrium exists for the distribution of hash power between compatible chains, given rational miners with freedom to choose based on pricing. More research is necessary to shed light on these competitive dynamics.