Hello Johannes,
Thank you for the questions. God loves thinking people. I enjoy them too.
“I'd like to understand how regulated mining pools would castrate the use of Bitcoin.”
Bitcoin will be castrated by losing its qualities of being a store of value, being permissionless and being unconfiscatable. Western governments will force all access to Bitcoin from anywhere in the world to go through regulated exchanges. The exchanges will ID each user (no longer permissionless), tax Bitcoin into parity with the government’s CBDC (limit its store of value [scarcity] with taxes), and refuse access to or confiscate any Bitcoin according to the government’s needs.
Despite the eventual nuetering of Bitcoin's unconfiscatability, a clear statement of regulatory intent from an alliance of Western governments is likely to increase Bitcoin’s public acceptability. Government approval of the regulated blockchain will enhance its trustless quality by the implicit warrantee that Bitcoin is a well-establised property right. Bitcoin will remain desireable to much of the public because it will retain the qualities of Durability, Divisibility, Portability, Fungibility, Immutability, Trust lessness, and, unlike CBDC's, Bitcoin will retain much of its Scarcity, except as modified by taxation.
Regulation of the majority of Bitcoin miners will eventually result in complete global control of all Bitcoin because regulating a majority of its miners causes several unsustainable trends for the minority of miners who chose to remain unregulated. The unsustainable trends for miners who attempt to continue confirming transactions from unregulated sources include longer and increasing confirmation times, different fees, and significant additional costs as required to avoid the seizure of their coins, their equipment and their persons by regulatory enforcers.
Regulation of the Bitcoin miners will have the same effect on the network as a soft fork (a backwards compatible change to the Bitcoin code). The effect will be to divide the Bitcoin blockchain into a majority of law-abiding and institutional users, who are willing to comply with regulation, and a minority of Bitcoiners who refuse regulation. Divide and conquer is a standard tool used by the government to dominate rivals. The regulation of Bitcoin mining by governments does not require changing the Bitcoin core code at all. It merely requires Bitcoin miners to choose their transactions differently.
If increasingly slower confirmation times and higher costs are not sufficient to cause the minority to create their own fork, the majority of miners will eventually be paid by regulators to use their greater hash power to overwrite all blocks mined by the minority. It is possible for a majority of the mining hash rate to overwrite a non-compliant block because the majority (51%) determines the longest blockchain.
The Bitcoin core code requires all nodes to follow the longest blockchain. A majority of the hash rate can overwrite any blocks produced by the minority, or the majority of the hash rate could mine only empty blocks containing no transactions at all, -so as to shut down all further transactions completely. However, such active governmental interference in mining is both unnecessary and highly unlikely.
Miners who refuse regulation will experience longer confirmation times because their hash rate determines how often they produce (win) a new block. A block of Bitcoin transactions is confirmed by the Bitcoin miners roughly every 10 minutes or 6 blocks per hour. If the majority of the mining hash rate (60%) is mining only transactions from regulated exchanges, then the minority of miners who are willing to mine transactions from unregulated sources will require an average of 25 minutes to confirm transaction in their successful blocks. (40% of the hash rate = 0.40 winning blocks x 6 blocks per hour = 2.4 confirmations per hour = an average confirmation time of every 25 minutes (60 minutes in an hour divided by 2.4 blocks won).
In addition to dramatically slowed confirmation times, those who submit transactions from unregulated sources are likely to need to pay higher transaction fees as well. Worse still, governments will declare transactions from unregulated sources to be unlawful and subject to seizure. Longer and increasing transaction confirmation times combined with higher fees, and considerable additional costs to avoid regulators are each an unsustainable trend for the minority of Bitcoin miners.
Miners from the minority will start to switch to the majority side as it becomes clear that most miners, almost every Bitcoin institution, and all lawful exchanges will only accept transactions from government regulated exchanges. Each time another minority miner switches its hash power to join the regulated majority, the time and cost to confirm an unregulated transaction will increase. The costs to avoid seizure will also increase as enforcement focuses on fewer and fewer miners willing to mine outside the law.
If the minority of miners do not fork to a new chain of their own will, the government will eventually pay a sufficient majority of the compliant miners to use their superior hash rate to overwrite any non-compliant blocks. It is the eventual overwriting of non-compliant blocks which will result in complete government control of all Bitcoin globally. The only Bitcoin that will move on the main chain will be transactions from government-controlled exchanges. Smaller forks of Bitcoin will continually spring up, but they can be attacked at any time with the far greater hash power of the main chain.
“There are too many wallets to be blacklisted. And it is easy to create new wallets.”
Regulation of Bitcoin mining means that no wallets need to be blacklisted. Instead, of blacklisting wallet addresses, exchanges will be whitelisted (approved by government). People can still hold their Bitcoin on any device. But if you want to move it, the only way to confirm your Bitcoin transaction on the blockchain will be by submitting it through a regulated exchange. Peer to peer transactions will disappear from the main chain. There will be virtually no miners to confirm them, and if a block of unregulated transactions is successfully proposed by a miner, it will be overwritten by the majority. The miner proposing the block will loose the block reward and fees.
"[I]t won’t be wallets that are blacklisted but exchanges. ... How would that work."
Government censorship of Bitcoin miners will be enforced after a transaction has been confirmed on the blockchain. The Bitcoin code allows miners to choose which transactions to include in their proposed block.
https://medium.com/the-capital/how-do-miners-pick-bitcoin-transactions-9c9eebe4d4a5
The government’s regulatory enforcement agency, or a Bitcoin Blockchain analysis company hired by the regulatory enforcement agency, will analyze the blocks mined by each Bitcoin mining pool to determine which, if any, transactions came from unregulated sources. This after the fact analysis will occur hours, days or even weeks after each block of transactions has been confirmed on the Bitcoin blockchain. Government regulators will merely issue increasingly severe fines to Bitcoin mining pools that include unregulated transactions in the blocks they have mined.
An essential understanding is that Governments will almost certainly regulate the use of Bitcoin without enforcing any change to the Bitcoin core code. Since the government is not requiring any change to the Bitcoin code, the Courts will have no problem with the government’s reasonable and ‘deminimis’ regulation of Bitcoin mining.
https://www.merriamwebster.com/dictionary/de%20minimis
Government regulation of mining is likely to be kept minimal -along these lines. "Bitcoin miners in our jurisdiction may only confirm transactions from regulated exchanges."
“How can you detect that a transaction is coming from an address associated with a particular exchange?”
Off the shelf software will make it simple to determine whether a sending address belongs to a government approved and regulated exchange.
Each cryptocurrency exchange can generate their own Bitcoin addresses.
https://medium.com/coinmonks/how-to-generate-a-bitcoin-address-step-by-step-9d7fcbf1ad0b
Exchanges will be required to reveal the blocks of Bitcoin addresses they use. A software program will simply compare the Bitcoin sender’s address of each transaction to the list of addresses known to be used by regulated exchanges.
https://bitquery.io/blog/trace-bitcoin-transaction-and-address
Since, Bitcoin miners will be barely regulated, governments are unlikely to tell exchanges how to choose their transactions.
https://medium.com/the-capital/how-do-miners-pick-bitcoin-transactions-9c9eebe4d4a5
Governments will leave it up to each Bitcoin mining pool to decide how their company will exclude transactions from unregulated sources.
The mining majority will force all Bitcoin transactions to occur through regulated exchanges The government’s detailed control over Bitcoin will occur at the exchanges themselves. Exchanges are already heavily regulated since they function both as Virtual Asset Service Providers.
https://www.fatf-gafi.org/glossary/u-z/#:~:text=Virtual%20asset%20service%20provider%20means,ii
and as money transmitters,
https://www.fincen.gov/resources/statutes-regulations/administrative-rulings/definition-money-transmitter-merchant-payment
