Who Is in Control of PoW Networks?
Last week I posted a poll asking the following question:
Miners appears to be the obvious answer because hash power is directly controlled by miners. The problem is that miners are controlled by another force: financial incentives. They don’t arbitrarily pick which chain to mine, they mine the most profitable chain because they are rational economic actors.
Chain of Command
Miners are in control of the longest chain in the same way that the wheels of a car are in control of which direction it goes. The wheels are in direct control of the direction (no pun indented), but it is the driver behind the steering wheel who determines the rotation of the wheels.
What about developers? Devs are akin to a GPS system because they help to guide the driver, but are not in control. The interaction with a navigation system starts with the driver’s input to establish the final destination. The GPS will then provide turn-by-turn directions, but the driver is not blindly following instructions. He does not have to follow the instructions if he thinks they are wrong, and he may choose to use a different GPS system altogether.
If you are a driver and your final destination is a beach, but the GPS is telling you to go inland, then you should be able to quickly figure out that the GPS is wrong and that you should diverge from where it is telling you to go. Likewise, you will stop following instructions if the GPS is telling you to drive off the road into a creek or onto a brick wall.
The driver is ultimately in control, but who is the driver?
Sources of Financial Incentives
Miners chase revenue, so where does the money come from? Miner rewards come from three places: issuance of new coins, transaction fees and MEV (miner extractable value).
The revenue from issuance is a largely dependent on the market value of the coin. BTC is currently issuing 900 coins per day. At $20,000 per BTC issuance represents a daily revenue of $18 million. At the top of the last bull run, BTC was priced at $69,000 which equates to over $62 million of miner rewards per day.
Transaction fees and MEV are both a result of user activity, but there is a big caveat about the term “user”. A user is not simply a holder of a coin who also happens to transact with it on a regular basis. If the transactions are happening off-chain, through custodial services or payment channels like the Lightning Network, then there is very little or potentially zero contribution to L1 activity which is what really generates fees and MEV opportunities. Fortunately, in the case of BTC we don’t have to dig deep into this topic because roughly 98-99% of miner’s revenue is coming from issuance.
Issuance is the main source of revenue for miners, and that means that the number of coins issued * market price is the steering wheel directing where the wheels on the ground will turn to, but who is the driver?
Issuance vs Market Price
Developers can implement a new monetary policy, but increasing issuance is against the interest of stakeholders because that would debase their investment (this would be equivalent to the GPS telling drivers to go up a mountain when they want to go to the beach). Developers can also decrease issuance, and assuming that it can be done without jeopardizing the security of the network, it would be a welcomed change by stakeholders since lower issuance results in lower sell pressure from miners.
Changes to issuance may have a sound reasoning behind them, but in the case of BTC, deviating from the current issuance schedule would be breaking the network’s social contract and it would be unlikely to get any support unless there was an imminent risk of a security compromise due to insufficient miner rewards. This is a topic for a different discussion, but suffice to say that developers cannot realistically change issuance for the time being, but even if they could, they are not in control of something else that is much more important: capital flows.
Whales and Wealthy Holders Are in Control
Capital flows will determine market price, and wealthy holders control most of it. This is the correct answer to the poll, but let’s find out exactly why.
When a chain splits, the ledger is copied and stakeholders of the original coin will now own the same amount of “new coin #1” and “new coin #2”. Assuming each holder will have a preference about which version is the most valuable and which one is a “shitcoin”, they will sell one of the coins and use the proceeds to buy the other. Money moves out from one asset and enters another; this flow of capital determines the winner.
Consider the following:
- Small and medium holders (under 10 BTC) own just ~15% of BTC’s supply.
- Wealthy holders own the vast majority of BTC supply. “Whales” (over 1k BTC) own a staggering 45.6%.
- Concentration of wealth means that capital flows are also mostly determined by wealthy holders.
- Capital flows establish which coin retains the most value.
- The most valuable coin determines which chain is most profitable to mine because issuance constitutes the vast majority of PoW miner rewards.
- Miners seek profit, and they will mine the most valuable chain, which becomes the longest chain, which reinforces it as the most valuable.
- To add salt to the wound, most influencers are wealthy holders and/or wealthy holders have access to media outlets to help to push narratives for their preferred chain.
One of the most effective ways to reduce the influence of wealthy holders is to increase the reward revenue coming from users (transactions + MEV) relative to the rewards coming from the issuance subsidy. That won’t happen unless users have compelling reasons to actually use the network., aka utility. The utility from smart contracts and things like tokenized assets, DeFi, and NFTs actually help to democratize crypto networks… too bad BTC doesn’t have any of that.
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