Toward Socially Optimal Bitcoin Mining

Abstract

Bitcoin is a cryptocurrency for managing and transferring money in a distributed manner. The Bitcoin network creates a complex system of economic incentives that governs its inner working, impacting the network's security guarantees and its evolution. Recent development of Bitcoin as a speculative asset and the herein skyrocketing Bitcoin price greatly incentivize participation in the network. We posit that the expansion in Bitcoin miner population and speculative transactions may not be socially desirable. The increased competition in Bitcoin mining not only exacerbates energy consumption and environmental cost, but also makes the risky mining business much riskier. In addition to the risk of unstable reward flows, the fluctuation in Bitcoin price makes the profitability of mining more uncertain. This research studies an alternative socially optimal model for the Bitcoin market (and other cryptocurrencies in general). Through equilibrium analysis, we emphasize the need to limit speculation in Bitcoin transactions, improve efficiency, diversify currency portfolio, and minimize negative externalities of the Bitcoin mining business.