Mining Taxes Can Ultimately Centralize Power Into the Hands of a Small Group of Devs, While Causing Community Splits and Price Devaluation Along the Way

February 1, 2020 / by Crypto.IQ

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 proposed mining taxes this week.

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 (BCH) community. BTC.top and a group of other miners who collectively represent a majority of the Bitcoin Cash (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 Bitcoin Cash (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 (BCH) mining tax would supposedly only last six months, ultimately raising $6 million for development. However, the situation with Zcash (ZEC) proves that once a mining tax begins, the centralized organization it funds can use its power to keep the tax going indefinitely.

Zcash (ZEC) 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 (ZEC), 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 (ZEC) 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 (ZEC) 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 (ZEC) 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 (ZEC) 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 (BCH) were to implement a mining tax, the story of Zcash (ZEC) 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 (ZEC). 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 (ZEC) uses a Proof of Work (PoW) 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 (ZEC) were to discontinue the mining tax and the Electric Coin Company collapsed, certainly developers would offer their services for free to continue Zcash (ZEC) development.

Indeed, the Bitcoin (BTC) 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 (BTC), the developers have the sole mission of making Bitcoin (BTC) 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 (ZEC) lags so far behind Monero (XMR) in terms of market cap.

Mining taxes like those proposed for Zcash (ZEC) and Bitcoin Cash (BCH) do far more harm than good, especially since Bitcoin (BTC) 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.