Proof-Of-Work Consensus under Exogenous Distress : Evidence from Mining Shocks in the Bitcoin Ecosystem

We investigate the impact of exogenous shocks on network and stability parameters in proof-of-work-based permissionless blockchains with concentrated mining ecosystems, such as the Bitcoin network. Intuitively, declining hashing power due to a shock should weaken the network by lowering the costs of an attack. We demonstrate that parallel movement of important covariates (such as the coin price) can offset this effect and keep the mining process incentive compatible. Building on a theoretical framework developed by Budish (2018) and Capponi et al. (2021) to formally describe the proof-of-work consensus design, we examine two exogenous shocks to the Chinese Bitcoin mining ecosystem to provide empirical evidence for our hypotheses. The shocks were caused by the Corona pandemic in October 2020 and grid disruptions in April 2021, respectively. Our results show i) the key structural parameters affecting the robustness of the consensus design against exogenous shocks, and ii) how market participants incorporate and value variations in the implied stability of the distributed ledger