Mining Tax: Centralization For Devs, At The Cost Of Community Splits. Will BCH/ZEC Fork?

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Avatar for mduchow
4 years ago

The newest disturbing trend in the crypto space is mining taxes, which are essentially a percentage tax levied on mining revenue in order to support a development fund. The major cryptocurrencies Bitcoin Cash (BCH) and Zcash (ZEC), which have market caps of $6.85 billion and $540 million respectively, both recently proposed mining taxes.

The basic idea behind mining taxes is that a cryptocurrency needs to constantly be developed in order to remain sophisticated and competitive, and a percentage of mining revenue is continuously collected to fund development of the cryptocurrency’s code and infrastructure.

It is actually quite common for cryptocurrency projects to allocate a certain amount of pre-mined coins in order to fund development, marketing, and infrastructure. However, a mining tax is worse than a regular premine, because a percentage of miner’s machines are effectively mining for the developers, costing miners electricity and decreasing their profit margin.

Therefore, it would be better if a cryptocurrency dev team does a premine right in the beginning, rather than forcibly commandeering some of the network’s hashrate. This is especially true because miners often work with very small profit margins, and a mining tax could be enough to turn a mining farm from profitable to unprofitable.

Since a mining tax can threaten the viability of mining operations, there is a risk that introducing a mining tax will cause a subset of miners to split off and begin mining a version of the cryptocurrency without the tax. In other words, implementation of mining taxes can lead to community splits and hard forks, which can cause dramatic losses in a cryptocurrency’s value, negatively impacting all of the people holding that cryptocurrency.

Indeed, signs of a community split are already becoming apparent in the Bitcoin Cash community. BTC.top and a group of other miners who collectively represent a majority of the BCH hash rate originally proposed the tax, and it appears this mining tax will be implemented during a protocol upgrade in May 2020. Simultaneously, Bitcoin.com has decided to withdraw its support for the mining tax, although they do not have enough hashrate to stop it. If this ideological divide continues into May, a community split and the formation of a new version of BCH is likely.

Even worse, once a mining tax is implemented, it can cause a cryptocurrency to permanently have a high degree of centralization. This is because the mining tax gives a large amount of money to a centralized organization, giving that organization the power to make all future decisions for a cryptocurrency.

For example, the proposed Bitcoin Cash mining tax would supposedly only last six months, ultimately raising $6 million for development. However, the situation with Zcash proves that once a mining tax begins, the centralized organization it funds can use its power to keep the tax going indefinitely.

Zcash actually has had a mining tax since it launched in 2016, although it is branded as the ‘Founders Reward.’ Initially, Founders and vested employees received 12.8% of all mining revenues, the Electric Coin Company received 4.2%, and the Zcash Foundation received 3%. Later on, this distribution was adjusted so that the Electric Coin Company, the corporation that developed Zcash, received 8.2% of all mining revenue, showing how once a mining tax starts it can easily be changed in a centralized way.

An even better example of how a mining tax is a slippery slope towards centralization is that Zcash was supposed to discontinue the tax at the first block halving, which occurs in October. This would have lessened the severity of the block halving on the mining community.

Instead, the centralized organizations behind Zcash have been talking about the urgency of implementing a new mining tax to supplant the old one. Otherwise, the Electric Coin Company would collapse fairly quickly. This is because the Electric Coin Company has been running increasing budget deficits even with funding from the mining tax.

The shocking thing is that the Electric Coin Company has burned through tens of millions of dollars, with the Founders and vested employees using up over $100 million. This seems like enough money to fund development for more than a lifetime. Yet the money was used up as fast as it was received, and now the Zcash developers are breaking their original promise of ending the mining tax in October just so that they can continue making more money, even though they have already made a lot.

Quite bluntly, the behavior of the Zcash developers seems to be quite greedy. They are going to take more money with a new mining tax because they can — not because it is really necessary. And that’s despite the fact that this money should have gone to the miners.

Bringing this point full circle, if Bitcoin Cash were to implement a mining tax, the story of Zcash makes it obvious that the mining tax would likely continue past the six months, since the centralized dev fund organization will probably have the power to extend and raise the tax at will.

Zooming out, once a centralized organization is funded with millions of dollars from a mining tax, it basically has the power to do whatever it wants to the cryptocurrency’s code, including mandating that they will continue to receive millions of dollars. Basically, power is taken away from miners and the community and given to a select few running the centralized organization. In-effect, the cryptocurrency loses all semblance of decentralization.

A clear example of miners having no say in changes to a cryptocurrency’s code is the vote that implemented the new mining tax for Zcash. Only 88 people were given the chance to vote, and the miners were given no say. Indeed, an article on The Block mentions how this new mining tax will be implemented only if the Zcash Foundation and the Electric Coin Company approve it while ignoring that miners theoretically would have to approve the change as well since Zcash uses a Proof of Work system.

Essentially, mining taxes defeat the decentralization of PoW mining, taking the power to make decisions away from miners and giving it to a small group of people.

What really puts salt in the wound with this whole issue is that mining taxes and the associated centralized dev funds and foundations are possibly unnecessary in the first place. For example, if Zcash were to discontinue the mining tax and the Electric Coin Company collapsed, certainly developers would offer their services for free to continue Zcash development.

Indeed, the Bitcoin developers receive zero centralized funding, yet their cryptocurrency is the strongest in the world. In light of this, it seems silly to argue that centralized funding is needed for cryptocurrency development. Also, it is perhaps better for a cryptocurrency to be maintained by developers who work out of goodwill, rather than developers who would not work unless they are paid. When money is involved in development, the developers will be biased to do things that make more money. When no money is involved, as is the case with Bitcoin, the developers have the sole mission of making Bitcoin more powerful and efficient.

The final downside of mining taxes is that it causes centralized dumping on the market, taking money out of the pockets of everyone who has invested in the coin and transferring that money to the developers. Basically, the developers have to dump the coins they received in order to get any benefit from them, constantly applying downward pressure to the market, leading to an unfair situation for anyone holding the coin. Perhaps this is why Zcash lags so far behind Monero in terms of market cap.

Mining taxes like those proposed for Zcash and Bitcoin Cash do far more harm than good, especially since Bitcoin proves that centralized funding for development is not necessarily needed. Potential downsides of mining taxes are numerous. They include making mining unprofitable, community splits/hard forks, concentration of power in the hands of a small group of devs, persistent downward pressure on the market due to centralized dumping, and the cryptocurrency ultimately losing its decentralized characteristics.

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Avatar for mduchow
4 years ago

Comments

Disclaimer, I'm not defending or necessarily pro IFP.

But I really have an issue with this part:

It is actually quite common for cryptocurrency projects to allocate a certain amount of pre-mined coins in order to fund development, marketing, and infrastructure. However, a mining tax is worse than a regular premine, because a percentage of miner’s machines are effectively mining for the developers, costing miners electricity and decreasing their profit margin.

Therefore, it would be better if a cryptocurrency dev team does a premine right in the beginning, rather than forcibly commandeering some of the network’s hashrate.

You're essentially saying pre-mine is better than a block-subsidy for the devs, because it's more common? I have an issue with this statement because a pre-mine is infinitely more centralized and dangerous than a portion of the block reward. You're essentially betting on the fact that the crypto's dictator is benevolent. It's going to work out until it doesn't.

To delve a bit deeper:

because a percentage of miner’s machines are effectively mining for the developers, costing miners electricity and decreasing their profit margin.

That's not really how it works though, if 10% (or 12.5%, or whatever arbitrary %) of the block reward gets redirected somewhere other than the miner (or pool) that found the block, you're simply gonna have x% less hashrate securing the chain. It's not changing the profit margin of miners at all (it might, for a day or so until the difficulty adjusts, but miners are automatically switching to BTC in that case).

If there were no other sha256 chain AND if developers immediately dumped the coins (which they wouldn't do, I'll elaborate on that below) you would be right. But given that BCH is ~4% of BTC, 12.5% of that isn't significantly hurting miners. It would simply force miners who abuse the dynamic difficulty adjustment algorithm in BCH to quickly mine blocks to contribute to BCH development.

Even worse, once a mining tax is implemented, it can cause a cryptocurrency to permanently have a high degree of centralization. This is because the mining tax gives a large amount of money to a centralized organization, giving that organization the power to make all future decisions for a cryptocurrency.

You're right on that end, it does increase centralization, but not in any comparable way as a pre-mine would. While it wasn't a pre-mine, the whole Charlie Lee and LTC fiasco can happen to any pre-mine coins, which is disastrous.

Indeed, the Bitcoin developers receive zero centralized funding, yet their cryptocurrency is the strongest in the world.

This is flat-out false. Bitcoin Core developers are funded by Blockstream which did many fundraisers. This is exceptionally bad because then Bitcoin Core developers are incentivized to develop for Blockstream (Liquid and Lightning Network) and intentionally blocked any on-chain scaling to force users onto their proprietary solutions. Blockstream is the reason that Bitcoin Cash needs to exist.

The final downside of mining taxes is that it causes centralized dumping on the market, taking money out of the pockets of everyone who has invested in the coin and transferring that money to the developers.

This is also inaccurate in the sense that developers are incentivized to hold the crypto (beyond what they need to maintain operations) so they burn the least amount possible for a few reasons: they're working to make the network better and are indirectly rewarded for their performance (network gets better, you're worth more money) and the fact that being able to predict that you have enough cashflow for the foreseeable future is key in attracting talent. People who don't get paid because you've run out of money are not going to stick around.

Again, I feel like I have to repeat that I'm not defending the Infrastructure Funding Plan (it is flawed), but this article borderline feels like FUD because of the inaccuracies.

$ 0.10
4 years ago

I totally respect your opinion and appreciate the feedback. You make some valid points and I should have done more research before posting this. But some of those points are taken a bit out of context.

“You're essentially saying pre-mine is better than a block-subsidy for the devs, because it's more common? I have an issue with this statement because a pre-mine is infinitely more centralized and dangerous than a portion of the block reward. You're essentially betting on the fact that the crypto's dictator is benevolent. It's going to work out until it doesn't.”

I never said premining is a good thing (you can likely derive my opinion on it from the title of the article), I said premining at the beginning is better than implementing a tax years into the market and after amassing several billions of dollars in market capitalization. This is based on what I said right after you cut it off, that this can result in splits in the network like forks when something like a tax is implemented after the network is very much established. So when taken in context, I’m not saying that premining is good, I’m saying it’s better than what they are trying to do.

“That's not really how it works though, if 10% (or 12.5%, or whatever arbitrary %) of the block reward gets redirected somewhere other than the miner (or pool) that found the block, you're simply gonna have x% less hashrate securing the chain. It's not changing the profit margin of miners at all (it might, for a day or so until the difficulty adjusts, but miners are automatically switching to BTC in that case). If there were no other sha256 chain AND if developers immediately dumped the coins (which they wouldn't do, I'll elaborate on that below) you would be right. But given that BCH is ~4% of BTC, 12.5% of that isn't significantly hurting miners. It would simply force miners who abuse the dynamic difficulty adjustment algorithm in BCH to quickly mine blocks to contribute to BCH development.”

In regards to miners becoming less profitable, as far as I can tell a portion of them definitely would be. I had based this off of the “dollar bill auction” theory. If rewards are $1, miners will spend up to $1 in hash power to earn it. If they would spend less, there would be more room for miners to come online to make profit. If they were to spend more, the least profitable miners would go out of business until the new marginal miner breaks even. The equation needs to stay in equilibrium for miners who are mining based on that equilibrium. Therefore with less rewards going around for the same hashrate, the miners who were marginally mining before the reward change fall below that margin and are forced to shut down. As far as switching to BTC, I don’t seem to follow the logic. Intuitively it would make sense sure, but in reality after switching to BTC then the marginal miners on that network would fall below the margin. Not really sure how the adjustment in difficulty makes sense either when trying to leverage it against this argument. The difficulty adjusts when miners leave the network and in this case they’d be leaving because they can no longer afford what they were originally breaking even on. After the adjustment the miners who were slightly above the margin fall to the margin. The miners who had to shut down in the first place are still screwed and now the miners who were more profitable become marginal. So people would indeed be losing profits if they do not adjust to the new equilibrium. If you’re trying to make the argument for those who can already afford to pay more for the same results or profitability, then again it becomes a contextual issue as I was talking about the less profitable miners.

“This is flat-out false. Bitcoin Core developers are funded by Blockstream which did many fundraisers. This is exceptionally bad because then Bitcoin Core developers are incentivized to develop for Blockstream (Liquid and Lightning Network) and intentionally blocked any on-chain scaling to force users onto their proprietary solutions. Blockstream is the reason that Bitcoin Cash needs to exist.”

I don’t know enough about the Bitcore controversy so on the basis of not knowing any better I’ll apologize and say I should have done more research. If that’s the case I am guilty of assumption and jumping to a conclusion without affirming that argument.

“This is also inaccurate in the sense that developers are incentivized to hold the crypto (beyond what they need to maintain operations) so they burn the least amount possible for a few reasons: they're working to make the network better and are indirectly rewarded for their performance (network gets better, you're worth more money) and the fact that being able to predict that you have enough cashflow for the foreseeable future is key in attracting talent. People who don't get paid because you've run out of money are not going to stick around.”

Look at Zcash. They sold over 1 million coins and have run dry and are looking for more. And that’s enough evidence to the contrary for me to confidently stand by with that. If BCH devs were to do the same and it’s allowed, they would do the same for one reason: Why would they save the coins if they can just demand for more later if nothing stopped them the first time?

$ 0.00
4 years ago

Thanks for the reply, and I wanna clarify that for some of your points I do share your concerns -- and I also appreciate the clarifications. I'll admit that I don't know much about Zcash, so I'll take your word for it that the developers are/seem pretty scummy.

However in Bitcoin Cash we are lucky to have devs who actually care about the wellbeing of the network and not only their personal wealth. The main argument for me saying that devs wouldn't immediately sell is the Bitcoin Unlimited Foundation. They're sitting on a pretty hefty BTC "rainy fund" that came from donations (since before the split between BTC and BCH) and haven't sold it in any significant manner. They are getting some criticism from the BCH community over not converting a significant amount of their BTC to BCH, but it remains that they have kept most of it for long-term planning.

With regards to your second point (apologies if I'm addressing your comment in an illogical order) about mining profitability, the point I was trying to make is that 12.5% of 4% is 0.5%, so if you consider both the BTC and BCH hashrate, global profitability would be down 0.5%. To me, this isn't enough to significantly affect miners or to put anyone out of business. What could be more worrisome is the fact that if the plan goes through, it will essentially tell miners "we're comfortable with cutting your profits to pay the devs" which is bad for long-term mining capital being invested in sha256.

If you're looking for more info on what happened between BTC and BCH I highly recommend these https://medium.com/@johnblocke blog posts giving some insight on the scaling debate as it was occurring and the censorship on /r/bitcoin.

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4 years ago

Friend @mduchow your article has seemed really amazing that is why we have decided to translate it to the Spanish-speaking community, your introduction about mining taxes has been great and your argument about the damage that the mining tax can cause has been truly amazing, congratulations on your great article!!

https://read.cash/@Spanish-translator-community/mineria-centralizacion-para-desarrolladores-a-costa-de-divisiones-comunitariasbch-zec-at-mduchow-11499ecd

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4 years ago

Very cool, I'm glad that you found it useful. I appreciate you sharing it!

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4 years ago

However, a mining tax is worse than a regular premine, because a percentage of miner’s machines are effectively mining for the developers, costing miners electricity

Ok, that's completely wrong. If 10% of the mining reward is moved to devs, then the electricity used to secure BCH will get 10% lower. There will be no cost to miners, as the BCH difficulty will immediately go down: they will mine BCH less and get paid less. It's an exchange - security for development.

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4 years ago

I'll have to refer you to my reply to the other comment because you're making the same point. I have to disagree this isn't an exchange, this is an authoritarian centralized power comitting theft and strong arming those who don't want to comply.

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4 years ago

That too.

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4 years ago