We sometimes hear that Bitcoin is indestructible and uncontrollable because of the computational power of its network, and that it would be unlikely that an attack would occur today. However, this is a caricatured view, stemming from a lack of understanding and a certain naivety, which contributes to the fragility of the system. Let’s take a look in this article at how a mining attack against Bitcoin could take place.
“Know your enemy and know yourself; if you have a hundred wars to fight, you will be victorious a hundred times over.”Sun Tzu
An increasingly restrictive regulatory environment
Bitcoin is a digital currency system that allows online payments to be “sent directly from one party to another without going through a financial institution” and is limited to a “pre-determined number of coins,” i.e., a censorship-resistant and inflation-resistant currency. In particular, the censorship-resistant aspect is crucial, as Bitcoin’s value proposition collapses immediately without it.
Nevertheless, this conception is not held by everyone, and institutional bodies all around the world have sought as early as 2013 to impose regulations for exchange platforms.
As time went on, these regulations became more precise and more restrictive, notably with the knowledge of the client (KYC) practiced on all platforms and the declaration of users’ capital gains to the tax authorities. With the demands of legislators becoming more and more urgent, it seems that we are now heading towards a full-blown regulatory war against Bitcoin with the goal of total control of Bitcoin, i.e. its final death as a concept.
This disturbing progression of regulation is unfortunately accompanied by a lack of understanding about what Bitcoin is and what it carries, so much so that some players in the ecosystem are trying to collaborate with the authorities, without success so far.
Bitcoin is a free currency system, suitable for activities in the underground economy or activities that could become illegal. This is why states, whose central principle is control, are natural enemies: they embody authority while it allows freedom, which creates a logical incompatibility. In fact, if Bitcoin were a centralized system, it would not exist for a long time, as the experiences of e-gold and Liberty Reserve show.
In this article, we will therefore try to see what states can do to take control of Bitcoin. To do so, we will imagine a fictional scenario where this regulatory war is prolonged and leads to a major mining attack.
The criminalization of Bitcoin
Let’s place ourselves in the near future, where Bitcoin continues to grow, so much so that authorities are seriously alerted to it. In this world, the use of blockchain analysis has increased and the blacklists of “dirty” Bitcoins have merged into a single list maintained by an intergovernmental organization like the FATF. This blacklist identifies all addresses containing bitcoins that have passed through illicit activities to some degree.
A group of states containing the most powerful states in the world (United States, China, European Union) then decides to make illegal all transactions moving these “dirty” bitcoins, under various pretexts such as terrorist financing.
This materializes on the one hand by criminalizing the sending and receiving of blacklisted bitcoins, acts that expose users to fines or even prison sentences. This legally obliges all merchants to impose a drastic verification on each payment, which annihilates any use in the surface economy.
On the other hand, mining these “dirty” transactions is prohibited and also exposes white market miners to fines and jail time. Since mining has a natural tendency to become centralized (for reasons such as latency in block transmission or variance in reward), it is not difficult to impose this regulation on a substantial portion of the hash power.
However, in the first preparatory stage, legal miners do not actively censor: they are simply ordered not to include blacklisted transactions in their blocks. These transactions are therefore confirmed, although their confirmation time is necessarily increased.
In this scenario, the Bitcoin economy is thus separated into two parts: the surface economy, where “dirty” Bitcoins are rejected, and the underground (free market) economy, where all Bitcoins are accepted. The size of the difference between these two markets depends on the willingness of individuals to disobey and what the state is willing to do. Transaction bans can range from transactions involving only Bitcoins directly related to the least tolerated activities (terrorism, drug trafficking) to an outright ban on Bitcoin in its entirety. A complete ban could, for example, occur because of a systematic practice of coin mixing that would “dirty” virtually all Bitcoins, and would likely be accompanied by a push for central bank digital currencies (CBDs), presented as safer and less volatile alternatives.
Also note that in this scenario, all cryptocurrencies are subject to the same regulations and attacks. The confidential use of Monero is forbidden: a transaction is only allowed if the regulator has the necessary information for identification, such as addresses, private transaction keys and private view keys. This drastic restriction allows the authorities to track the movement of funds as in Bitcoin.
The Great Attack
Despite the regulatory measures taken, people are not letting up. Some states have drifted slowly into authoritarianism, banning anonymous (non-KYC) use of Bitcoin altogether. Bitcoin is getting too big, and making its unchecked use illegal does not stop non-compliant transactions from being created (in the market) and confirmed (in mining) on the black market.
The direct consequence of this development is a drop in state revenues. This is because states are finding it increasingly difficult to collect taxes and can no longer profit from issuing their currencies, as distrust in the currency is already too high, as it is subject to high inflation.
Having failed to compel individuals by force of law, states are forced to resort to the only option that seems best to them: attacking the blockchain through mining.
They mobilize all the hash power they have. In particular, they send directives to the large groups of miners previously subject to legal authority, and requisition them if necessary. With access to the cheapest sources of power, state-approved miners have a significant advantage over competing miners, increasing their influence on the blockchain.
Once enough hash power is gathered (more than half of the network’s power), the group of states carries out its attack and orders all its miners to actively censor all “dirty” transactions by invalidating the blocks that contain them. By virtue of the essential principle of the longest chain, the chain with the most proof of work (i.e., the longest in the short term) is considered by the nodes to be the valid chain, and thus the censor chain dominates.
The attack is similar to imposing a soft fork where nodes following the old rules (in this case, no censorship) are forced to follow the new rules (in this case, censoring “dirty” transactions). All block branches containing “dirty” transactions are invalidated by the re-coordination caused by the announcement of a longer “clean” chain. After a while, the honest miners, i.e. those who build their blocks from the longer chain, notice the attack, renounce their honesty and start following the censorship themselves, in order to continue to earn an income.
This is how you end up with a censored channel. News of the censorship is likely to drive the price down, but it may also drive it up, reassuring the traditional players that Bitcoin is controllable. Either way, the states’ goal is achieved, at least temporarily.
In the long run, it is not even necessary for the state-controlled hash power to remain greater than half the power of the network. Since miners are economically rational, it is in their interest to apply censorship, as shown in an article by Juraj Bednar on the subject (describing a variant of this attack). Censorship can therefore persist for a relatively long time.
The market’s counter-attack
The attack does a lot of damage to the free economy, which can no longer function properly. Promises are exchanged in the marketplace. Channels identified as “dirty” in the Lightning network are still functioning but can no longer be settled on the channel.
In the face of active censorship, the idea of changing the proof-of-work algorithm is gaining popularity. Indeed, it is an effective short-term way to stop the attack, by making all miners’ ASICs useless. However, this change is controversial: it would drastically reduce Bitcoin’s security in the medium term by reducing the overall cost of an attack, favoring the largest (mostly legal) miners who have the capital to deploy new hash power, and increasing the insurance cost of miners. This may lead to a split between the hard fork supporters and the others, but the chain using the original proof-of-work algorithm remains in the majority.
The use of social agreement is also proposed, through a system of manual and automatic checkpoints to avoid chain re-coordinations. Nevertheless, the community judges (rightly) that this would create too much instability in the face of a hostile power that would seek to create multiple splits that could not be separated by any objective factor. No “social” measures are therefore taken on the main channel.
During the censorship period, censored transactions accumulate in the memory area of the nodes. Because their transactions are not confirmed, censored users increase their fees: some move large amounts of money and can therefore afford to pay high fees. Thus, there is a substantial increase in the level of fees paid by censored transactions.
This additional fee encourages non-cooperated miners to deploy hash power in order to confirm “dirty” transactions and collect fees. These miners operate in secrecy, but manage to communicate (privately or via flagging) in order to coordinate a “return to normal”. After a while, they manage to mobilize a majority power and then start mining “dirty” blocks: their chain is considered valid and the censorship is defeated.
However, even assuming that users are willing to pay enough fees, the victory of this first battle does not mean that censorship should cease for good: this truce simply marks the beginning of the open war between the state and Bitcoin.
The states cannot bring themselves to let Bitcoin continue and are necessarily fighting back. Since the miners under control are not getting the fees for censored transactions and are operating at a loss, the states are increasing their respective taxes and creating more money to deploy more hash power by subsidizing these miners.
This war is economically draining on both sides. On the one hand, states have to levy more and more on their citizens, in a less and less efficient way. On the other hand, Bitcoin users have to bear high levels of fees, which makes using the protocol very expensive and no longer necessarily justifies the risks taken.
After an indefinite period of time, one of the two sides gives in: the states because they can no longer extract enough wealth, or Bitcoin because the users can no longer extract a profit. In both cases, the winning side can profit from its victory: if the states win, then any attempt at digital currency will be challenged in the years to come; if Bitcoin wins, then the states will have to deal with Bitcoin for a long time, even if it means less income. Obviously, we hope that Bitcoin wins this war if it ever happens.
Thus, contrary to what some dream sellers may sometimes claim, a censorship attack could take place against Bitcoin if it managed to have sufficient influence on the income of states, especially through money creation. Nevertheless, such an attack would not mark the end of the cryptocurrency, as Bitcoin’s design allows the market to get rid of it.