About 90% of transaction volume on Bitcoin’s blockchain does not have much economic value and the cryptocurrency’s ownership is concentrated among relatively few investors. These are the results of a new study published by researchers from the Massachusetts Institute of Technology (MIT) and the London School of Economics (LSE).
According to the authors, 90% of transaction volume on the Bitcoin blockchain is not tied to economically meaningful activities. Instead, it is a result of the cryptocurrency’s protocol design that multiplies the number of actions required for a transaction. An ancillary effect of this design is that it can be used by participants to remain anonymous.
In terms of implementation, this means that Bitcoin addresses, which are used to identify the recipient and sender of transactions, often send the cryptocurrency back to themselves for transmission and receipt transactions. The action duplicates the transaction volume without adding economic value to the blockchain.
This attribute is primarily a function of bitcoin’s blockchain in which bitcoins are stored in multiple unspent output buckets, also known as UTXOs. For example, an address with 8 bitcoins might actually hold the cryptocurrency in two buckets of 5 bitcoin and 3 bitcoin each. A transaction involving six bitcoins could actually consist of two transactions – one in which eight bitcoin is sent to the recipient and another in which balance from the transaction – 2 bitcoin – is sent back to the original address.
Hackers use this design quirk to obfuscate the destination addresses for ransom money. For example, they might create multiple addresses to split the payment. Peeling chains, as the branching chain of transactions are called, are also used by exchanges and exchange-like entities such as online wallets, OTC desks, and large institutional traders to maintain anonymity of their transactions. According to the study, these entities together account for 75% of real bitcoin volume.
The study’s authors also write that bitcoin mining capacity is highly concentrated. The top 10% of miners control 90% of mining capacity while just 0.1% control close to 50% of mining capacity. Interestingly, the concentration in mining capacity increases with drawdowns in Bitcoin’s price and decreases with an increase in its price, thereby increasing the probability of a 51% attack, an attack in which hackers collude to target a large miner, when bitcoin’s price decreases.
A third conclusion of the study is that the distribution of bitcoin is concentrated among few investors. Specifically, 5.5 million bitcoin is stored at intermediaries, such as cryptocurrency exchanges, while 8.5 million is distributed among individual investors. About three million bitcoin is owned by 1,000 investors and five million is owned by 10,000 investors.
What Are the Study’s Implications?
Concentration of bitcoin ownership means very few people benefit from an increase in the cryptocurrency’s prices. They can also manipulate its price. A previous study by the authors suggested that a net buy order of 3,000 bitcoin led to a 1% increase in the cryptocurrency’s prices.
In another interview, Antoinette Schoar, one of the study’s authors, suggested that control by a few individual investors could have dire implications in countries that have adopted bitcoin as legal tender because it could shift the benefits of seignorage from the public to early adopters.
While it increases the chances of a 51% attack from hackers, a concentration of mining capacity also has geographical implications. According to recent reports, the United States has overtaken China in the amount of computing devoted to mining bitcoin.
But the study’s authors assert that China still dominates bitcoin mining pools. (Miners contribute to mining pools and can be located anywhere). According to them, a majority of mining capacity – between 60% to 80% – is still located in China, meaning that the country’s regulatory actions against bitcoin can still influence and control its price trajectory.
Finally, there’s the question of economic value. As recently as 2018, transaction volume was considered one of the primary movers of bitcoin price. It was suggested that an increase in bitcoin price was a direct effect of parallel surge in transaction volume on bitcoin’s blockchain. The study debunks this theory. A regulatory implication is that trading volumes at cryptocurrency exchanges could come in for a closer scrutiny.