How this ‘systemic risk’ could take down Bitcoin: experts

Blockchains are meant to be secure, but there are inherent risks in distributed digital ledger transactions

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A bitcoin trader looks afraid and holds his hands to his mouth among graphics of red arrows pointing down

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The Bitcoin (CRYPTO: BTC) price is up just over 1% over the past 24 hours, currently trading for US$62,726 (AU$83,630).

That’s down 6.3% from the token’s all-time highs of US$66,930, according to data from CoinMarketCap. Those highs were set last week, on 20 October.

Crypto investor enthusiasm at the time looked to be spurred on by the launch of the first futures-based Bitcoin exchange-traded fund (ETF) to trade on United States exchanges.

The ProShares Bitcoin Strategy ETF (NYSE: BITO) launch was highly successful. It saw a turnover of approximately US$1 billion on its first day of trading.

Yet, despite what would appear to be the growing popularity of the world’s biggest crypto, a new study by the National Bureau of Economic Research (NBER) has raised concerns. It shows a potentially alarmingly few entities hold a huge portion of all the Bitcoin mined to date.

And the concentration among the token’s miners is even more striking.

A highly concentrated crypto market

NBER’s research indicates the “top 10,000 individual investors in Bitcoin control about one-third of the cryptocurrency in circulation”, Bloomberg reported.

That’s 10,000 investors controlling a token with a current market valuation of more than US$1.18 trillion.

Determining who holds precisely how much of the token and where is no easy task. Crypto exchanges, for example, often hold onto Bitcoin for investors.

However, according to NBER, 1,000 individual investors control at least 3 million of the 18.8 million Bitcoin in circulation.

Why “at least”?

According to researchers Igor Makarov and Antoinette Schoar (quoted by Bloomberg), “This measurement of concentration most likely is an understatement since we cannot rule out that some of the largest addresses are controlled by the same entity.”

Bitcoin mining’s systemic risk

The larger concern raised by NBER centres on the concentration of miners.

The researchers found 90% of Bitcoin’s mining capacity is controlled by just 10% of the world’s miners. Moving up the ladder to the biggest players, the top 50 or so miners, representing 0.1% of the total, are believed to control 50% of mining capacity.

Why should this concern Bitcoin investors?

Because the way the blockchain works leaves it vulnerable to what’s known as a majority, or 51%, attack. That’s where the majority manages to get control of a blockchain’s hashing power.

According to the NBER report:

Our results suggest that despite the significant attention that Bitcoin has received over the last few years, the Bitcoin ecosystem is still dominated by large and concentrated players, be it large miners, Bitcoin holders or exchanges.

This inherent concentration makes Bitcoin susceptible to systemic risk and also implies that the majority of the gains from further adoption are likely to fall disproportionately to a small set of participants.

That’s one more thing to keep in mind before investing your hard-earned money.

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The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and has recommended Bitcoin. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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