New York University economics professor Nouriel Roubini testified before the US Senate Banking Committee on October 11 at a hearing entitled “Exploring the Cryptocurrency and Blockchain Ecosystem” and spoke in detail about what he called “the crypto bubble of 2017 and the crypto apocalypse and bust of 2018.”
Roubini is one of the crypto sector’s most active naysayers and his 37-page written testimony to a Senate committee constituted a very negative portrayal of both crypto-currencies and blockchain. It also highlighted the role that China plays in this sector and the crypto miners who work there.
“It is clear by now that Bitcoin and other crypto-currencies represent the mother of all bubbles, which explains why literally every human being I met between Thanksgiving and Christmas of 2017 asked me first if they should buy them. Especially folks with zero financial literacy – individuals who could not tell the difference between stocks and bonds – went into a literal manic frenzy of Bitcoin and crypto buying,” he wrote.
He asserts that “99.9% of all crypto-currencies instead have no backing whatsoever of any sort and have no intrinsic value of any sort; and even the so-called ‘stable coins’ have only partial backing at best with true US dollars reserves or, like Tether, most likely no backing at all as there has never been a proper audit of their accounts.”
He is not keen on China’s role and stated that “fundamental flaws of lack of security in crypto land go well beyond the fact that mining is highly concentrated in oligopolies in shady and non-transparent and unsecure jurisdictions – China, Russia, Belarus, Georgia, etc.”
He describes miners as “massively centralized as the top four among them control three quarters of mining and behave like any oligopolist: jacking up transaction costs to increase their fat profit margins. And when it comes to security most of these miners are in non-transparent and authoritarian countries such as Russia and China.”
Roubini’s testimony also highlighted a recent study entitled “The Looming Threat of China: An Analysis of Chinese Influence on Bitcoin” by Ben Kaiser of Princeton, Mireya Jurado of Florida International University and Alex Ledger.
Among other things, the study demonstrates “the strong influence that China has over Bitcoin, and “(systematizes) the class of attacks that China can deploy against Bitcoin to better understand the threat China poses. We conclude that China has mature capabilities and strong motives for performing a variety of attacks against Bitcoin.”
The authors state that “Bitcoin’s rise in China began in 2013. Mining pools managed by individuals in China have constituted over half of the total network hash power since 2015 and currently more hash power is located in China than in any other country.
“Through this time, China’s official position on Bitcoin remained ambiguous and regulators proved unwilling to institute tight controls despite expressing concerns over criminal activity, subversion of capital controls and speculative risk. This tenuous equilibrium between demand by Chinese users and investors and intermittent regulatory impedance shaped Bitcoin’s global trajectory until it was punctured in 2017 by firm regulations on the exchange industry,” the authors stated.
The report’s discussion of the Great Firewall that China has deployed is particularly noteworthy.
“China operates a variety of internet control measures that can affect Bitcoin traffic. The most well-understood system is the Great Firewall (GFW), which performs on-path surveillance and traffic filtering using deep packet inspection (DPI) and active probing of connection endpoints. As an on-path tool, the GFW can observe network traffic and inject new packets, but it cannot prevent packets that have already been sent from reaching their destination.
“For more active traffic tampering,” continues the report, “China operates a separate in-path tool known as the Great Cannon, which can inject malicious code into packets in transit and levy denial-of-service attacks by redirecting traffic to a target host. Both of these systems primarily operate on traffic transiting between China and the rest of the world, but central government regulators also control all Internet Service Providers.”
The authors offer further insights into the mining edge China enjoys as well as hash power and empty block flows in particular.
“At the time of writing, 74% of the hash power on the Bitcoin network is in Chinese-managed mining pools. Pool miners cannot be directly controlled by China, but the managers are located within China and as such are subject to Chinese authorities. Because managers are responsible for assigning mining jobs and propagating completed blocks, they control the inputs and outputs of their miners, allowing Chinese authorities indirect control over that hash power.
“China has more direct control over the hash power physically located in China. This is a significant share of the global hash rate – more than controlled by any other single country but the precise quantity is unknown.”
Empty blocks on the other hand are tied to block size and their impact on revenue streams associated with Bitcoin mining. Below the authors shed further light on the role of the Great Firewall here too.
“Prior to May 2015, empty blocks were produced at a consistent rate of 2% to 3%, except for a few aberrations in 2011 and 2012 before Bitcoin was widely used. Beginning in May 2015, a noticeable spike up to around 5% that lasts through June 2016 is visible. We examined the behavior of the eight largest mining pools during this period, which cumulatively found nearly 80% of all block. The four Chinese pools cumulatively account for 64% of the hash power while non-Chinese pools account for 24%.
“Looking at the combined average rates of empty blocks produced by each of these pool groups, we see that the Chinese pool group produced an unusually high rate of empty blocks, spiking up above 7%. Meanwhile, non-Chinese miners produced empty blocks at a historically consistent rate of around 2%. These observations suggest that some factor that applied to Chinese miners – but not other miners – created an incentive to mine empty blocks. We posit that this factor is the Great Firewall, and more specifically, the bandwidth bottleneck it imparts.
“The GFW is known to limit bandwidth by inducing packet loss in TCP streams. In 2017 a test showed 6.9% packet loss in connections between the US and China and only 0.2% for connections between the US and Hong Kong, which is just outside the GFW. Packet loss causes latency, as dropped packets must be re-requested and re-sent, and this was also observed in the same test (218ms latency for Chinese agents compared to 81ms for Hong Kong).
“This latency has been observed to affect Bitcoin block propagation. In 2015 it was shown that block propagation across the GFW was an order of magnitude slower than propagation between nodes on the same side of the GFW . Separate research the following year found that mean propagation times for near-full Bitcoin blocks were 3.9 seconds between nodes on the same side of the GFW and 17.4 seconds between nodes on opposite sides, representing a slowdown of nearly 450%.”
The final paragraph in this 22-page study is worth a careful examination. Yes, Bitcoin activity in China has changed dramatically in the past year given the crackdown by Beijing, but behind the scenes, there is the constant hum of servers and computers as China’s mining oversight persists unabated.
“The growth of Chinese mining was further fueled by tax incentives and energy and land discounts offered by provincial governments. However, in early 2018 local regulators were directed by the central bank to ensure that Bitcoin miners no longer received preferential treatment and shortly thereafter to scale down Bitcoin mining by regulating power usage, land use, taxes, and environmental protection.
“The stated motivation for the regulation was to make more electricity available for distribution to underserved regions, but the near-simultaneity with heavy exchange regulation suggests a focused effort to reduce Bitcoin’s overall popularity and usage in China. These efforts are ongoing, but Chinese-managed mining pools remain dominant.”
In other words, China has its hands on the Bitcoin throttle and exercises a degree of control that may be acceptable or not.
In conclusion, Roubini states that “everything that this study argues about the nefarious impact of China on Bitcoin can be said and applied to any other crypto-currency and to the role of Russia in the crypto eco-system.”