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Bitcoin’s Approach to Decentralization

By Connor Smith

Note: This is the second part of a multi-part series in which I will examine the approaches that different blockchain networks are taking towards decentralization. Part 1 introduced the concept of decentralization at a high level, the role it plays in crypto networks, and some of the different factors inherent to a protocol that influence how decentralization will propagate at scale and influence participation. If you missed that article or would like a refresher before we dive into decentralization of the Bitcoin Network, you can do so here

With 2019 having just come to a close along with the decade, it seems like an apt time to be reflecting on Bitcoin’s approach to decentralization and how it has played out. Having entered the decade as little more than a whitepaper and an open source protocol with a handful of users and contributors, Bitcoin enters the 2020s as the best performing asset of the 2010s. Bitcoin was the first true cryptocurrency and blockchain network, and hence the longest lived. There was no blueprint for Bitcoin to follow, or generally accepted framework for launching a blockchain protocol back in 2009. The Bitcoin network we see today is a true first stab at a decentralized network for transacting value and serves as the longest running experiment for us to learn from. All blockchain protocols that have come since have been influenced by Bitcoin, mimicking certain aspects of it and trying to improve upon others. Hence, Bitcoin serves as a great foundational network to begin our examination of decentralization, as it will help you to better understand why the other networks we will explore have made the choices they did.

An Overview of How the Bitcoin Network Works

One of the most important things to understand about Bitcoin, and most commonly overlooked, is that none of the base technologies used in the creation of Bitcoin were inherently novel.  Elliptic curve cryptography, distributed systems, and the idea of proof-of-work had been well established well before Bitcoin. Even the concept of digital cash had been tried as early as the 1990s with David Chaum’s DigiCash. What was novel about Bitcoin’s design was how it combined all of these elements to solve the Double Spend Problem and built an incentive structure around it that allowed digitally native value to be securely transacted across a peer to peer network in a way that was agreed upon through a Proof-of-Work Consensus Algorithm. For those of you who might be new to crypto, I will provide a brief overview. However, I highly recommend reading the Bitcoin Whitepaper if you want a more in-depth explanation.

In short, Bitcoin’s Proof-of-Work Mechanism works as follows. Each block created on the Bitcoin Blockchain has a cryptographic hash associated with it that is generated from its index, timestamp, the block data (Bitcoin transactions), the hash of the previous block, and what is known as a nonce. The nonce is some value that will always ensure that the leading bits of the block hash will always be zeros. There is no way for miners to know what the nonce will be a priori, so they compete to solve it and ultimately the block hash. Moreover, as the compute, or hashing, power on the network increases, so does the difficulty of guessing the correct value. The hash difficulty of the network is periodically adjusted to take 10 minutes on average and once the correct nonce is computed it is broadcast to the network, the miner who calculated it is rewarded, and consensus is reached.

Image from https://en.bitcoinwiki.org/wiki/Bitcoin_transaction

As you can see, miners play a very critical role in the Bitcoin ecosystem. They’re the ones responsible for adding blocks to the Bitcoin blockchain and are compensated for contributing their compute power and helping secure the network. Yet, miners are just one actor within the Bitcoin protocol. Network participants also have the option to run either a full node or a light node on the network. Full nodes are responsible for hosting a copy of the entire Bitcoin ledger and verifying the authenticity of its transaction history all the way back to the genesis block. They simply maintain and distribute the most trusted version of the blockchain to other nodes on the network, thus not requiring the same computational resources as miners. Light nodes play a similar role to full nodes, but instead of keeping a full version of the ledger, they download the block headers to validate the authenticity of transactions. They are often peered to full nodes to further decentralize the network or can be used to help restore a full node if it is corrupted.

Aligning Incentives: Governance and Reward Structures

Let’s examine how Bitcoin attempted to balance the economics and power of stakeholders while decentralizing the network. Using the tiered network architecture described above, Bitcoin sought to create a bifurcation between how network participants are rewarded and how governance occurs. When Bitcoin was first released and blocks were CPU minable anyone could run a miner and be rewarded for contributing their compute power to secure the network while also running a full node. Given the grassroot beginnings of Bitcoin, it made sense that the small group of early adopters should be rewarded economically and have the responsibility of participating in governance. However, as the difficulty of solving blocks increased, miners started utilizing computationally superior ASICs. This made the barrier to profitable mining much steeper as just one top of the line miner cost in excess of $1000, leaving only a small subset of network participants willing to make the necessary capital investment. This high barrier to entry looks like it will continue to manifest and reduce the number of individual and decentralized miners participating on the network.

Without all network participants being able to truly compete in the mining process, there is some inherent risk of a 51% attack. This is where an individual or group of participants are able to take control of the majority of the network hashing, or computing, power to prevent transactions and determine what blocks are added to the blockchain. While in control of the economics of network, miners do not inherently hold any special authority, nor are they required to participate in governance responsibilities. Seeing as Bitcoin is an open source project, anyone running a node on the network can theoretically propose changes to the codebase that alter how transactions are validated, arrive at consensus, etc. A more thorough examination of how Bitcoin governance works may be found here, but the process is generally as follows: A user conducts research to solve some problem with Bitcoin. Once they have a solution they notify all other protocol developers, typically via a Bitcoin Improvement Proposal (BIP). After the proposal has been made, other interested protocol developers begin implementing and testing it to give a formal peer review. If the change is well received and approved it will be implemented into the node software and then node operators, exchanges, and other community members must be convinced to update the software. As long as the majority of the community finds it reasonable the network will be updated and the new rules or functionality are put into place.

So How Has Decentralization Played Out for Bitcoin?

As of writing this article there are just shy of 9000 full nodes supporting the Bitcoin network. 25.30% of these nodes reside in the U.S, 20.76% in Germany, and the remaining 53.94% are dispersed across the rest of the world, largely in Europe and Asia as can be seen below.

Image from https://bitnodes.earn.com/

It is worth noting that some, like Bitcoin Core Developer Luke Dashjr, speculate the true number of nodes on the network to be closer to 100,000. This estimate allegedly accounts for all nodes on the network and not just nodes in “listening mode” that node monitoring services use when calculating the number of nodes on the network. Regardless, this expansive, global network of nodes is what makes Bitcoin generally regarded as the most secure distributed network. If an individual wanted to undermine the network or rewrite the transaction history, he or she would have to have enough computing power to simultaneously rewrite the ledger on a majority of the nodes, which is nearly impossible (what about quantum computing?). 

Where Bitcoin is more centralized, however, is in the concentration of the mining power on the network. As of the writing of this article, the top 4 mining pools (AntPool, BTC.com, Poolin, & F2Pool) control 59.8% of the hashing power on the network, as can be viewed below. Mining pools exist to pool hashing power into groups, increasing the likelihood of receiving a Bitcoin block reward. With the amount of hashpower on the Bitcoin network today, it is practically impossible for an individual to mine Bitcoin on their own.

Image from https://www.blockchain.com/pools

All of the aforementioned pools operate in China which means that those managing the majority of hashing power on the network are highly consolidated within one region. Some view this as problematic, believing it makes it easier for a 51% attack to occur. With so few parties managing a disproportionate amount of the hashing power in the same geographic region, it would be easier for them to collude and align interests if they decided to try such an attack. However, since individual miners are free to join whichever pools they please, so if they disagree with how the pool is operating they can join a new pool. Additionally, nodes on the network can fork the network if they disagree with how the mining pools are controlling the transaction history. In addition to the majority of hashing power passing through China, the majority of the Bitcoin mining industry is powered by hardware built by Chinese manufacturer Bitmain. Bitmain is projected to have somewhere around 65% market share of the bitcoin mining hardware industry and operates both Antpool and BTC.com. Accordingly, the majority of hash power on the network is touched by Bitmain in some way, placing a considerable amount of power in their hands.

Many are concerned about the future of Bitcoin if mining power is to remain centrally concentrated within the hands of a few mining pools. If four mining pools control most of the hashing power, don’t they essentially control the future of the network? I can’t say for certain how Bitcoin will evolve in the future, but there is evidence from Bitcoin’s past to suggest that miners will not dictate how the network changes. In November of 2017, Bitcoin was slated to undergo a massive hard fork known as SegWit2x that was designed to upgrade its block size limit from 1MB to 2MB. The true motives for the update remain a heatedly debated topic. Allegedly, the intent of the upgrade was to overcome the scalability problems associated with Bitcoin and allow faster payments. However, many believed that it was a move by miners and large Bitcoin operations to subvert the network and profit by collecting more fees and selling more expensive equipment. Prior to the fork the majority of miners signaled supported the update, but there was no support from Bitcoin Core Developers and little from the community broadly. The Bitcoin community pushed for UASF (User Activated Soft Fork) which was designed to activate SegWit (Segregated Witness) without the condition of SegWit2x that block size must increase. With such low support from the community, SegWit2x failed and UASF (or BIP-148) passed – a major victory for node operators and currency hodlers.

Only time will tell if the approach Satoshi took will prove the most optimal in the long run, but so far his assumptions have been well supported. The network has been self-regulating and the incentives have been so well aligned that it has continued to gain adoption and use for over a decade. In the next article, I will explore how another veteran protocol, Factom, has approached decentralization and draw on some of the lessons to be learned. Until then, Happy New Year!