Author: Karim Helmy & the Coin Metric Team
Summary
- Bitcoin’s decentralization can be quantified by indicators such as supply dispersion, computing power distribution, and exchange integration.
- Key indicators such as the number of active addresses and network hash rates continue to rise.
- The supply of Bitcoin is becoming more balanced, and the mining and trading markets are still competitive.
Introduction
In the past eleven years, Bitcoin has been able to operate relatively stably in the face of a large number of threats, mainly because it lacks a single controlling entity. This feature is called decentralization, and it contains a lot of loosely coupled features. Some of these characteristics are difficult to describe and measure, but others are very suitable for direct analysis.
One feature that can be directly observed is the dispersion of funds between different addresses. The distribution of wealth is a vital factor in any economy, and it is roughly consistent with the distribution of economic influence. For crypto assets that often allocate a large number of tokens to the founding team, the degree of asset dispersion is seriously insufficient.
Another feature, the distribution of computing power, can be said to be more important. Bitcoin relies on decentralization at this level to achieve its goal of maintaining a secure, censorship-resistant payment and savings system.
Bitcoin is also highly constrained by the market share distribution of exchanges, which has greatly affected the network economy. The distribution of trading volume on spot trading pairs quoted in fiat currency is particularly important because they represent the access to the real world.
In this week’s topic, we will quantify Bitcoin’s decentralization along these three vertical areas and track its development progress over a period of time.
Degree of dispersion of addresses
The existence of giant whales (that is, users who hold large amounts of funds in their assets) is a concern of many cryptocurrency holders about their viability. Particularly unequal allocation of funds may have a significant impact on the development direction of the asset market and agreement for a small number of users, and put into question the feasibility of the asset as a store of value or a medium of exchange.
Since Bitcoin balances are easy to audit, on-chain data can be used to assess the degree of dispersion. Since the funds held by the custodian in the integrated account cannot be attributed to its owner, and the reuse of addresses is generally discouraged, these estimates are not rigorous enough. However, compared with the traditional financial system, the degree of transparency it provides is still unprecedented.
There are still giant whale users in Bitcoin, but since the establishment of the network, its supply distribution has gradually become more even, and the proportion of small accounts in the total supply has also increased.
In addition to controlling an increasing proportion of supply, addresses with smaller balances still account for the majority of accounts. Faced with price fluctuations denominated in U.S. dollars, most addresses still control Bitcoin worth less than $100.
A closely related indicator, the number of unique valid addresses, also implies the usage of more network participants. Because a user can control multiple addresses, this indicator is not a perfect representation of the number of participants, but we generally think it is relevant. Recently, the number of active addresses in Bitcoin has begun to approach historical highs.
Mining
In addition to the degree of dispersion and activity on the chain, the effective decentralization of Bitcoin also depends on the distribution of computing power among miners.
Bitcoin relies on miners to ensure the security of the network and add new blocks to the blockchain. These miners compete to find the next block by calculating a large number of hash values, and usually gather into a mining pool.
In the history of the entire network, the computing power to ensure the security of the Bitcoin network has generally doubled.
Although Bitcoin mining is distributed, through national-level coercive means and crisscross integration, Bitcoin mining still has the risk of centralization. Several exchanges including Binance, OKEx and Huobi are operating mining pools. The hardware manufacturer BitMAIN owns both BTC.com and Ant Mining Pool, and is also the only investor in ViaBTC.
Even a reasonable and well-resourced mining pool is difficult to coordinate a 51% attack, because if the operator decides to attack the network, the miner may choose to leave the mining pool. New coordination protocols like Stratum V2 may greatly increase the degree of decentralization of the network by transferring the control of the block composition from the mining pool operator to the miners.
An effective indicator to measure the decentralization of computing power is the Nakamoto Coefficient, which measures the number of mining pools that need to collude in order to attack a network by 51%. Although Bitcoin has never been successfully attacked by 51%, in 2014, the mining pool GHash.io controlled more than half of the network’s computing power for about a day. During this period of time, the median coefficient of Bitcoin was 1.
Today, Bitcoin’s Nakamoto Coefficient is 4, indicating that Bitcoin is highly decentralized.
Although Bitcoin mining is distributed, through national-level coercive means and crisscross integration, Bitcoin mining still has the risk of centralization. Several exchanges including Binance, OKEx and Huobi are operating mining pools. The hardware manufacturer BitMAIN owns both BTC.com and Ant Mining Pool, and is also the only investor in ViaBTC.
Even a reasonable and well-resourced mining pool is difficult to coordinate a 51% attack, because if the operator decides to attack the network, the miner may choose to leave the mining pool. New coordination protocols like Stratum V2 may greatly increase the decentralization of the network by transferring the control of the block composition from the mining pool operator to the miners.
An effective indicator to measure the decentralization of computing power is the Nakamoto Coefficient, which measures the number of mining pools that need to collude in order to attack a network by 51%. Although Bitcoin has never been successfully attacked by 51%, in 2014, the mining pool GHash.io controlled more than half of the network’s computing power for about a day. During this period of time, the median coefficient of Bitcoin was 1.
Today, Bitcoin’s Nakamoto Coefficient is 4, indicating that Bitcoin is highly decentralized.
Exchange
Compared with miners, exchanges have less direct impact on Bitcoin’s decentralization because the role of miners has been written into the protocol. However, as the main market for acquiring and using Bitcoin, their impact on the network is also huge.
Excessive centralization among exchanges will expose the market to systemic risks in the event of bankruptcy. The most famous example in the cryptocurrency field is the 2013 Mt.Gox crisis.
Often mergers also increase the likelihood of scrutiny, thereby negating one of the main benefits of using Bitcoin. As the main channel from currency to Bitcoin, the BTC/USD market is particularly important in this regard. Although stable currencies have recently emerged as an alternative quotation asset, the fiat currency gateway is still an important way for new capital to enter the market.
Although several exchanges offer trading in the BTC/USD market, the field is usually dominated by several large companies.
An effective indicator for analyzing market concentration is the Herfindahl-Hirschman Index (HHI), which increases as the monopoly of the market increases. Although our estimates will be affected by the survivor’s bias, the HHI of the BTC/USD spot market covered by Coin Metrics has remained stable in the past year. At present, based on this indicator, we believe that the market is moderately consolidated.
In addition to the reported transaction volume, the holdings on the chain can also provide a glimpse of the industry status from another angle. The comparative balance of spot exchanges tracked by Coin Metrics’ exchange traffic is shown below. Since Coinbase avoids the reuse of hot wallet addresses, Coinbase is obviously not included in these estimates.
Source: Coin Metrics Network Data Pro
Likewise, tracking the on-chain flow of exchanges allows us to understand the market more comprehensively and confirm reported activity. These indicators also describe a relatively competitive market. The inflow of spot exchanges tracked by Coin Metrics’ exchange traffic is shown below; the behavior of outflow of funds is very similar.
in conclusion
In terms of the concentration of miners and exchanges, Bitcoin is decentralized, and its supply is becoming more and more evenly distributed. This analysis of the degree of decentralization of Bitcoin is far from comprehensive. When assessing the health of the network, other indicators such as the number of nodes and the market share of hardware manufacturers should also be considered. However, overall, the performance of the Bitcoin network in these key verticals gives us reason to remain cautiously optimistic.
