What Impact Will the US Infrastructure Bill Have on the Country’s Crypto Mining Industry?

Written by: Ariel Zetlin-Jones Source: Cointelegraph

Regulatory scrutiny of blockchain and cryptocurrencies is increasing. From China’s cryptocurrency mining ban to U.S. President Biden’s Financial Markets Working Group convened by Treasury Secretary Janet Yellen, supporting blockchain and the economic activities facilitated by blockchain has become a key focus for policymakers. Most recently, a provision in the proposed 2021 infrastructure bill amended the definition of a broker to explicitly include “any person […] who is responsible for regularly providing any service of transferring digital assets on behalf of another person.”

The stated goal of this “miner-as-broker” policy change is to improve the taxation of cryptocurrency capital gains by improving the taxman’s ability to observe cryptocurrency transactions. Since cryptocurrency miners regularly verify transactions that transfer digital assets (such as cryptocurrency) on behalf of cryptocurrency holders, these miners would appear to meet this definition of brokers. Unsurprisingly, many in the cryptocurrency industry have raised concerns.

A key feature of blockchain technology is its ability to enable decentralized record keeping. The pros and cons of this new form of record keeping relative to traditional centralized financial databases is an active debate. But the new regulations could bring that debate to a premature end.

What is the direct impact of defining miners as brokers?

First, the reporting requirements for miners—at least those located in the United States—to the IRS will be greatly increased. The costs for miners to comply with these requirements could be substantial and largely fixed. Miners will need to incur these costs regardless of how much hashrate they have before mining a block. This will discourage new miners from entering the market and could lead to more centralized control or centralization of hashrate.

Second, these broker miners would be responsible for meeting Know Your Customer (KYC) regulations. Given the pseudo-anonymous nature of most cryptocurrencies, such a policy would limit the types of transactions that broker miners can process, i.e., non-anonymous transactions. How would this work? Presumably, I would register with a miner (like associating my driver's license with a Bitcoin address), and the miner would only verify transactions on behalf of their registered users. But if that miner happened to be a small miner (with a small amount of computing power), then my transaction would be unlikely to be processed on the Bitcoin (BTC) network. Perhaps if I (and you) registered with a larger miner, things would be better. Alternatively, we should all just use Coinbase and allow miners to process transactions on Coinbase's behalf. Again, the impact here is more centralized computing power.

Taken together, this policy is likely to increase the concentration of cryptocurrency mining in the U.S., while raising the cost of mining and potentially reducing the total amount of mining. In other words, this policy will divert mining practitioners within the U.S. away from the "mysterious group of anonymous super programmers" recently described by Senator Elizabeth Warren, but may increase users' dependence on such anonymous super programmers outside the United States.

What are the global implications of defining miners as brokers?

The global impact of the proposed provisions in the infrastructure bill depends in part on the relative importance of U.S. cryptocurrency mining operations to the global mining industry. Recent history provides some perspective. In June, China stepped up enforcement of its Bitcoin mining ban, and the result was a significant drop in the number of miners. We can see this in the drop in mining difficulty observed in early July. Mining difficulty controls how quickly transactions are processed (on Bitcoin, a block is produced approximately every 10 minutes). With fewer miners, difficulty drops to keep the transaction rate constant.

The lower the mining difficulty, the less electricity is required to mine a block. The block reward is constant. The price of Bitcoin did not fall as the difficulty decreased in July. Three points to note here:

• The mining profits of the remaining miners have undoubtedly increased

• New miners are not rapidly replacing Chinese miners currently offline

• Competition in the mining industry is declining

These characteristics are likely to lead to a consolidation or concentration of mining capacity. If the new regulations – especially the broker designation for miners – go ahead, similar effects can probably be expected.

Is higher concentration inherently bad news?

Much of the security argument for blockchain technology is rooted in decentralization. No one has an incentive to exclude transactions or past blocks. When a miner has significant mining power, the chances of solving multiple blocks in a row are high, and they may be able to change parts of the blockchain's history. This scenario is known as a 51% attack and raises concerns about the immutability of blockchains.

The proposed policy has two related consequences. First, by definition, higher centralization brings miners closer to a goal where they can effectively change the blockchain ledger. Second, and perhaps more subtle, when mining costs fall, the profitability of attacks is higher because attacks are less expensive.

However, as my co-authors and I demonstrate in ongoing research, this security problem stems entirely from Bitcoin’s mining protocol, which advises miners to add new transactions to the longest chain in the blockchain. We argue that the potential success of a 51% attack stems entirely from this proposal to coordinate miners on the longest chain. We show how alternative coordination devices can enhance the security of the blockchain and limit the security consequences of increased mining centralization.

Without competition, there is no blockchain

Whether or not the current provisions regarding digital assets in the 2021 U.S. Infrastructure Act pass, policymakers appear ready to increase regulation and reporting of cryptocurrency transactions. While the debate has focused on the trade-offs between increased U.S. government monitoring of cryptocurrency transactions and potential harm to U.S. blockchain innovation, policymakers and innovators alike must consider the possible impact of such policies on competition within the cryptocurrency mining industry, which plays a key role in securing blockchains.