May 29, 2021

Can China Control Bitcoin?

Finding out the truth in the speculation around Bitcoin ban of China and its implications for the rest of the world.

Can China Control Bitcoin?

The story so far: In the beginning (2008) Bitcoin was created. This has made a lot of people very angry and been widely regarded as a bad move.

With due apologies to Douglas Adams for hijacking his famous quotation to explain the deep secrets of cryptocurrency (which, some might assert, is nothing short of a universe of its own), Bitcoin has always been the vortex of controversy and bad press. On some rare occasions that it does get good press, laser-eyed Bitcoiners read on dubiously, wondering what's next. For every good press article, there are 10 bad press articles: The Cryptocurrency Law of Press.

To hijack yet another famous quote from a literary figure (Leo Tolstoy): all happy Bitcoiners are alike; each unhappy critic of Bitcoin is unhappy (with it) in their own way.

One of the growing reasons for discontent with Bitcoin is that people have started to see China as a threat to the health of the economy in other countries, and Bitcoin gets dragged into this heated debate. Chinese miners were growing in numbers, and this has led people to believe that in the near future China can control Bitcoin as a global currency. At face value this may sound plausible, even logical, but a deeper look throws light on why this is a flawed argument.

Much of the Data on Geolocation of Bitcoin Miners Suffers from Bias

Most of the articles in the mainstream media that posit that anything from 35-60% of Bitcoin mining happens in China, reference back to one report by Cambridge University from April 2020. The data for this study is provided by three mining pools, which are all headquartered in China. The IP of the Bitcoin miners is used as a "proxy" for geographical location. In the "Methodology" section of the data visualization, the University has clarified the underlying assumptions, and why the data may not be representative of the whole world. But these assumptions are conveniently overlooked by media outlets when citing the data. This is a statement from the Cambridge University site:

"The Bitcoin mining map is based on an extrapolation of a sample of mining pool data. This sample may not be fully representative for the following two reasons: first, it represents only a little more than a third of the total hashrate; and second, the data is provided by three Bitcoin mining pools that are all headquartered in China."

The University justifies their assumption by asserting that these pools have miners all over the world, but mining is more popular in China due to "low fee structure". But the very fact that they are HQ'd in China and represent only 1/3rd of the hashing power, suggests a plausible enough bias in the data. The geographical distribution of miners within these pools need not be representative of the distribution of the entire Bitcoin mining network.

The other underlying condition described is that there are immense seasonal variations in mining within China, based on the availability of renewable energy sources. In simple language, it means that there are seasons when renewable energy is not available, and power supply to miners shifts to non renewable energy sources or there may be other changes to mining, based on availability of power. So, at any given time, the data available will not be representative of the entire year geographically, but it is assumed to be, in this dataset (which uses data of only 8 months).

Yet another assumption this study makes is an important one: using IPs as a proxy for geo-location. In a world of Bitcoiners who value pseudonimity as a guiding principle in all-things-digital, it is fair to say that many of these IPs may be attributed to VPNs, and hence, not at all representative of geographical distribution of miners. There is no data to suggest what percentage of the users in this mining pool are using VPNs, and hence we do not know to what extent this data would be biased because of that, either way.

This is from the website of Cambridge University:

"It is no secret in the industry that hashers in certain locations use virtual private networks (VPNs) or proxy services to hide their IP address and thus location. Such behaviour may distort the overall geographic distribution and result in an overestimation of hashrate in some provinces or countries. For one of the three pools, this effect was particularly visible in the Chinese province of Zhejiang. To mitigate this effect, we have divided the hashrate of Zhejiang province proportionally among other Chinese provinces listed in the pool’s dataset."

There is no explanation for how they observe "this effect" and why distributing the data of Zhejiang province would mitigate the effect. Unless "this effect" itself is explicitly reported, and the methodology of distribution explained, this does not sound like a fair way to "correct" the data.

If the selection of Bitcoin miners had been entirely random, we could have asserted that these variations and biases would have been eliminated, and the Law of Large Numbers and Central Limit Theorem would hold, so that the random sample could be representative of the entire population of Bitcoin miners. But this is not the case. The data is taken from three mining pools who volunteered to submit their data. It is very possible that there is selection bias in the data.

The other common mistake made in asserting percentages as high as 3/4th of the Bitcoin mining network being headquartered in China is taking the geographical location of headquarters of a mining pool as the location for 100% of the miners for that pool. As was described earlier in this article, the miners for any one mining pool can come from other countries as well, and are not all in the same country. This is a known fact. Many miners participate in multiple pools, a phenomenon called "pool hopping." So, the real percentage breakup by location cannot be determined as easily. Till date, no mining pool has declared the distribution of location of its miners publicly. This leaves a wide gap for speculation and assumptions to abound.

One of the better studies by FCAT, published in July 2020, reports thus:

"Miners are not required to register and get a license to be part of the Bitcoin network – the system is permissionless and that is what makes it robust, more decentralized, and ultimately secure. Due to its open and pseudonymous attributes, it is not possible to directly observe the actual composition of the mining network – by location, size and type of operation, equipment used, or the economics and profitability."

Based on collection of data of 153 mining sites in 20 countries, they estimate that of the total hashing power of the Bitcoin network, 50% is concentrated in China, 14% in USA, as of 2020.

Total Hash Rate in April For Bitcoin. Source: Bitcoin.com
Total Hash Rate in April For Bitcoin. Source: Blockchain.com

The flooding of coal mines in China in April 2021 recently brought up the issue of control of mining power into discussion once again. There are multiple figures given for the total hash power lost due to the accidents in Chinese coal mines.

As per CoinDesk,

"top 7 Bitcoin mining pools lost, on average, 16.5% of their hash rate as a result of the incident."

The top 7 mining pools contribute to approximately 72.7% of hash rate of the Bitcoin network. Thus, an estimated 12% of total hashing rate could be said to be lost due to the coal mine accidents in China. This is still nowhere close to the figures of 60% losses floating around on the internet. The hashing rate recovered in a week, as can be seen from the Total Hash Rate chart.

It's the Chinese People Vs the Chinese Government

There is an important aspect to Bitcoin mining in China which gets obfuscated in data visualizations and murky extrapolations: the Chinese people took up Bitcoin mining as a way to hedge the risk of collapse of the Chinese economy, and as a way to step out of the cages set by the Chinese government—they are trying to solve the precise problem everyone else is trying to solve with Bitcoin. So, the Bitcoin miners are, in principle, not mining Bitcoin for the government, but against the government. Bitcoin represents libertarian ideals expressed through technology and an alt-economy devoid of repressive regimes. This is the precise reason why Bitcoin mining is popular in China, apart from lower electricity costs which make it practically possible for even those who are not very rich. In a country where financial investments are heavily regulated, and not everyone can dip their feet in everything, Bitcoin gives people that financial freedom.

Can China Control Bitcoin
Image by RABAUZ from Pixabay

Historically, the Chinese government has tried to ban Bitcoin many times, to no avail. In 2017, the Chinese government banned ICOs and cryptocurrency exchanges. But the people started buying Bitcoin peer-to-peer and with VPNs, crossing the Great Firewall of China. The price of Bitcoin temporarily dipped, sending shivers to Bitcoiners, but Bitcoin bounced back. Bitcoin means freedom for the Chinese people—something which cannot be stopped by regulations of the Chinese government.

One man's trash is another man's treasure. With the clampdown on exchanges in China, late 2017 saw the growth of Bitcoin exchanges in Japan and South Korea. New exchanges replaced old ones, and many exchanges that were headquartered in China, moved their locations to other countries. And Bitcoin continued to grow.

In the last week, along side the chaos of Chinese government's reiteration of old laws, then an added new ban on Bitcoin mining, a lot of whirlwinds were stirred and all kinds of speculation abounds. In the last one week alone, Bitcoin mining pools that were headquartered in China—like BTC.TOP, HashCow and Huobi Mall—have shut down operations, stopped acquisition of new equipment and/or geared up to shift base to other countries.

Effectively, every time the government of a country tries to ban Bitcoin or regulate it heavily, Bitcoin as a network becomes more decentralized.

China is Not Relying on Bitcoin to Challenge the Dollar

The Chinese government has been developing the digital Yuan for a long time–since 2017, some reports say. The digital Yuan is meant to solve the challenges of fiat money, and give greater control to the Chinese government over their financial system, apart from making digital payments a cakewalk. Unlike Bitcoin, the sovereign digital yuan will be directly under the control of the People's Bank of China. Its value is backed by the state. Chinese government, in partnership with tech giants like Alibaba Group, Ant Group and Tencent, have already been rolling out trials for the digital yuan, the world's first digital sovereign currency to be rolled out–though it is still not formally launched nationally.

The digital yuan would allow other countries to carry out financial transactions without going through dollar-based financial institutions. The Chinese government, which has serious concerns about Bitcoin and cryptocurrencies because they allow transactions outside the purview of the Chinese policymakers and institutions, sees the digital yuan as a problem solver in this space. The digital yuan can be exchanged and used for transactions using digital wallets, bypassing international banks, if it is rolled out internationally. China would be able to capitalize on a first mover advantage in digital currencies (CBDCs), and hence, pose a substantial threat to the hegemony currently enjoyed by the Dollar.

Bitcoin, on the other hand, continues to face restrictions in China. Cryptocurrency trading, exchanges, ICOs and now mining remain banned in China. Financial institutions in China are banned from allowing transactions for Bitcoin. In this scenario, it is unlikely that the Chinese government aims to use Bitcoin–which is not under the control of the state–to fortify its economic position internationally.

Bitcoin Price Trend Over the Last One Week: Effects of Chinese Ban
Bitcoin Price Trend Over the Last One Week. Source: binance.com

The 51% Attack is Probabilistically Unlikely

The 51% attack, as it's popularly known, is the biggest fear of the proponents of "Bitcoin is not safe" theories. There are multiple variations of these fears, and it's worthwhile to understand the nitty gritty of exactly why the 51% attack is a probabilistically unlikely situation, what it is, and what it is not.

Transactions on the Bitcoin blockchain network are added to "blocks" which, once validated by the network, are added to the Bitcoin blockchain. Each block contains from 2000-3000 transactions, depending on size of transactions. The Proof-of-Work methodology of validation of blocks ensures that the transactions cannot be fraudulently validated. The UTXO system of expending Bitcoin ensures that there cannot be a "double spend."

The "51% attack" refers to an entity on the network obtaining the 51% consensus on mining a block with their fraudulent transaction. There is only one use case for a 51% attack: double spend of someone's own Bitcoin. It's a common misunderstanding that the 51% attack can alter the rules of the network, hijack some other transaction, or convert transactions which are already declared as invalid into valid. None of these can be achieved. As such, the payoff of this type of an attack is solely monetary profit via a double transaction on Bitcoin already owned, and not any other type of fraudulent transaction or "poisoning" of the Bitcoin network.

The down side of the attack is that it is very easily possible for someone to find out that such an attack has occurred, as word of this kind gets out fast. This type of news is "juicy" and is highly likely to drive down the price of Bitcoin in no time. So the miner will actually be shooting themselves in the foot by attempting something that could possibly lead to loss. Most likely place for executing this attack would be an exchange, which have limits on withdrawal, and require KYC for higher withdrawals. The attack will not be worth the risk if it is a small amount, and will not be possible for a large amount without exposing one's identity.

A nation state would be the least likely player to carry out such an attack for multiple reasons:

1) It is difficult to "bribe" or control a huge number of miners in a short time to achieve 51% hashing power of the entire network.

2) Such an attack would have to be on mining pools, partly because they control the most hashing power, and secondly because they are easier to identify. This could temporarily stall or halt mining of Bitcoin, leaving transaction blocks orphaned—that is the worst case scenario. It still cannot change the consensus rules, or validate invalid transactions.

3) Any attempts to control a huge number of miners is certain to create enough ruckus and brouhaha to alert other miners, who will take the first exit from the "compromised" mining pool, as soon as possible. Thus the crackdown will never reach completion. The 51% consensus is a dynamic value, and as soon as the state sponsored control of a mining pool begins, and word gets out, most miners will voluntarily exit the network to save themselves and the Bitcoin network. Thus, the state will not continue to enjoy a 51% consensus, as the rest of the world will have a greater share of the remaining hashing power within a very short time.

In short, if Chinese authorities try to seize control of mining pools, it may temporarily disrupt the network, but they still will not be able to assume control over the entire network, nor poison or destroy the network permanently. Any attempts to ban or hack Bitcoin has only led to better innovation, more stability, faster transactions, higher security and a more decentralized network. So, even though in the short term there may be a flip side to any attack, in the long term, it only makes the network better in every possible way.

It's like they say—what doesn't kill you makes you stronger. You can't kill Bitcoin. You can only make it stronger.

References:

"Bitcoin: A Peer-to-Peer Electronic Cash System," Whitepaper by Satoshi Nakamoto

Bitcoin Mining Map

How Accidents in Chinese Coal Mines Are Affecting Bitcoin Mining

Can China Contain Bitcoin?

In China’s Hinterlands, Workers Mine Bitcoin for a Digital Fortune

Bitcoin Bug Bites Japan and South Korea as China Clamps Down

Is BitCoin controlled by China?

Ant Group Has Been Working With China’s Central Bank on Its CBDC Since 2017: Report

China’s Digital Currency Could Challenge Bitcoin and Even the Dollar

Are Chinese Miners a Threat to Bitcoin?

Bitcoin Power Analysis Hashrate Implications and Miner Economics

Cover Images by Jatuphon Buraphon and Sinisa Maric from Pixabay