Understanding the Bitcoin incentive mechanism

Bitcoin is a fair and just incentive game. In a decentralized ecosystem, relatively fair benefits for participants is the key to the long-term stable operation of the network. Financial incentives are the main motivation for nodes to maintain network security - nodes will be rewarded if they act honestly, and lose rewards if they act honestly.

This situation is not uncommon in the field of cryptocurrency mining. All parties have invested a large amount of money in hardware equipment and electricity consumption, hoping to recover the funds and turn them into profits by adding new blocks to the blockchain. The easiest way for miners to maximize their profits is to play by the rules.

When a new block is added to the chain, the miner will receive all the fees for the transaction, plus some of the newly generated tokens. We call this part of the new token block reward. Every 210,000 new blocks (approximately four years), the tokens earned will be halved. At the time of writing, the reward is 12.5 BTC, which will become 6.25 BTC in a few months.

Financial incentives for mining intensify competition, ultimately improving the security and decentralization of the network. Some speculate that these incentives may be rigged. In this article, we will discuss the concept of Selfish Mining.  

For a deeper understanding of Bitcoin’s incentive mechanism, please read "Introduction to Cryptocurrency Economics".

How does selfish mining work?

As early as 2013, researchers Ittay Eyal and Emin Gun Sirer published the paper "Simple Majority Principle Seems Not Enough?" "Majority is not Enough: Bitcoin Mining is Vulnerable" (Majority is not Enough: Bitcoin Mining is Vulnerable) explains the exploration and research on selfish mining. Contrary to the general public perception, this paper believes that Bitcoin’s miner incentive mechanism is flawed, which will eventually lead to centralization of the network.

Below we explain selfish mining through specific examples. Assume that the hash rate is evenly distributed among Alice, Bob, Carol, and Dan, with each of the four accounting for 25%. Alice, Bob, and Carol play by the rules, but Dan tries to make the system work for his own benefit.

Under normal circumstances, new blocks mined by miners will be immediately added to the chain. This is also what honest participants Alice, Bob, and Carol perform. However, Dan had reservations after mining the new block (not allowing the valid block to be added to the chain). Even more fortunately, he mined two blocks in a row before anyone else.

Suppose that 100,000 blocks have been mined so far, and Alice, Bob, and Carol are trying to mine the 100,001st block. Dan found the new block, but it was not published on the network. At this time, two chains are generated, namely the public chain and Dan's private chain (the latter is longer). While others were mining block 100,001, he had already mined block 100,002.

Therefore, Dan’s private chain is two blocks ahead of other chains. If good luck continues, his private chain will always have two more blocks than other chains. When others were trying to catch up and were only 1 block behind, he announced his private chain.

Currently, Dan's public private chain is longer than the chains used by others. According to the so-called Longest Chain Rule, the correct chain we use is the one with the largest accumulation of PoW (proof of work - this metric is also called work within the chain). Therefore, if a node detects a chain that has accumulated a lot of work, it will switch to that chain and contribute computing power to it.

At this time, Alice, Bob and Carol discovered that Dan’s private chain was the target that needed to be followed. All the rewards they previously earned on other chains will no longer exist, but Dan can receive rewards for blocks mined on this chain.

Is selfish mining a threat to Bitcoin?

In this case, participants would indeed be rewarded less if they worked as expected. In addition, selfish mining is extremely wasteful of resources. Note, however, that those wishing to commit this behavior have a strategic advantage over other network actors. Therefore, there will be miners following the attackers, making the situation worse.

In their paper, Eyal and Sirer emphasized that all parties in the network will cooperate with selfish entities to maximize benefits, and selfish mining will gradually increase the hash rate of the mining pool, eventually transforming a significant risk. If a single mining pool seizes most of the computing power, a 51% attack may be launched.

However, there are also many people who believe that this behavior does not pose a threat because miners have some ideological considerations and there are reward mechanisms to keep the network running in a decentralized manner. The destruction of the ecosystem will cause miners to lose all their investment in power and equipment, and make profits even more impossible.

Summary

If the miners alliance successfully implements selfish mining, it will indeed create considerable benefits for the participants. . The worst-case scenario is that this incentive model will induce honest miners to participate in selfish mining, seriously endangering the decentralization of Bitcoin.

But from a broader perspective, it makes no sense for all parties to join forces in this way. After all, a severe breach of the network would cause Bitcoin to drop, which would directly undermine the profitability of the mining industry.