The second economic limitation pertains to the way the network pays miners to keep it secure. In Bitcoin, miners who add a new block to the chain …
Bitcoin has a fundamental problem that’s baked into how it keeps itself secure. A new working paper (PDF) from the Bank of International Settlements (BIS), the so-called central bank for central banks, concludes that Bitcoin is limited as a payment method because of the method, called proof of work, that it uses to secure its distributed ledger.
First, as we saw recently in an attack on Ethereum Classic, if someone is able to gain more than half the mining capacity of a proof-of-work system (many other cryptocurrencies rely on the method as well), they can use it to reverse transactions and effectively spend the same cryptocurrency twice. Called a double-spend attack, it happens when an attacker pays someone in cryptocurrency before creating an alternative version of the blockchain in which the payment never happens.
The deeper a transaction is in the blockchain, the more computing power is needed to create an alternative chain that doesn’t contain that transaction, and the lower the probability that a double-spend attack will occur. That’s why merchants who accept Bitcoin as payment can’t release the purchased goods until they wait for several additional sets of transactions, or blocks, to be added to the chain after the one containing the payment.
But a transaction isn’t truly final, argues Raphael Auer, a BIS economist, until it is so deep in the blockchain that it is in fact impossible for a double-spend attacker to profit. Achieving this, which he calls “economic payment finality,” is extremely expensive to the network.
The second economic limitation pertains to the way the network pays miners to keep it secure. In Bitcoin, miners who add a new block to the chain earn a set number of bitcoins, called the “block reward.” They can also earn transaction fees, which individual Bitcoin users propose when they submit new transactions. This income is incentive for miners to act in the interest of the whole network instead of selfishly attempting double-spend attacks. In Bitcoin, however, this will shrink over time, because the system is designed to phase out the block reward.
Transaction fees alone won’t be enough to keep the security of the system from deteriorating once this happens, says Auer, meaning that achieving true payment finality will take longer and longer. When the reward reaches zero, it might even take months for a payment to become irreversible, he writes, concluding: “The only fundamental remedy would be to depart from proof-of-work.” (See also: “Bitcoin’s inherent economics could keep it from ever being very important.”)
Auer notes that making such a substantial change to a cryptocurrency network’s software “would probably require some form of social coordination or institutionalization.”
Bitcoin has historically struggled with infighting and gridlock over technical decisions, however. Meanwhile, Ethereum is trying to switch from proof of work to an alternative method called proof of stake, and its community is realizing how difficult this is from a social perspective.
This vulnerability, if exploited, would allow malicious actors to repeatedly get ETH out of a smart contract through a bug similar to that which led to the …
Bitcoin must abandon the Proof of Work (PoW) system if the cryptocurrency is to solve current issues. It is the conclusion according to the Bank for Internation Settlement (BIS).
Why Is Proof of Work an Issue for bitcoin?
The worlds most famous cryptocurrency, Bitcoin, uses the consensus algorithm Proof of Work. It is a requirement to define an expensive computer calculation, also called mining. The computers need to solve the calculations to create a new group of trustless transactions. It is a very slow and costly process which, according to BIS is unsustainable.
The paper shows that two economic limitations affect the outlook of cryptocurrencies that use proof-of-work. The first lies in the extreme costs of ensuring payment finality in a reasonable space of time. The second is that these systems will not be able to generate transaction fees that are adequate to guarantee payment security in future.
After surveying the market for transactions and the way fees are determined, the paper finds that the liquidity of cryptocurrencies is set to shrink. When the total supply of bitcoin is out, transaction fees alone will not sustain mining expenses. It implies that the bitcoin mining could become slow and unusable.
“Simple calculations suggest that once block rewards are zero, it could take months before a Bitcoin payment is final unless new technologies are deployed to speed up payment finality.”
According to a previous article, covered by Toshi Times, around 800,000 miners had to shut down business. Because of the falling bitcoin prices, the expenses were greater than the profit which left the miners with no choice.
What can save bitcoin and must the blockchain leave proof of work?
However, updates and so-called second-layer solutions such as the Lightning Network could help. However, the only fundamental remedy would be to depart from proof-of-work. It would probably require some form of social coordination or institutionalisation.
Ethereum is the second largest cryptocurrency and does just that. They are trying to move over from Proof of Work to proof of stake (PoS). However, the upgrade Constantinople got delayed because of a vulnerability. This vulnerability, if exploited, would allow malicious actors to repeatedly get ETH out of a smart contract through a bug similar to that which led to the DAO hack.
Meanwhile, developers create new blockchain in attempts to create more scalable solutions. While Bitcoin can only perform around seven transactions per second, there are those who claim to be able to sustain millions per second. Dexon is one blockchain who stated that they would become the first to reach one million transactions per second.
It could be that Bitcoin will be the world standard, but there is a possibility that other blockchains prove to be a better version. However, the fact is that Bitcoin is the most used blockchain in the world.
Dennis Sahlström has been trading and investing since 2012 and has for the last two years been consistently profitable. He has been in the crypto- and blockchain space since the middle of 2017 and realized its potential for our world, not least how it is transforming the society we live in. He has now created an education platform, together with the wealth coach Marcus the Maria. They teach regular people how to invest and trade in the cryptocurrency market with proven strategies. If you want to learn more and feel like its time to get into this new asset class, download our free book and register to the next live training to get your future in cryptocurrencies started.
CoinDesk published an op-ed by Dowd Monday, with the title, “Bitcoin Will Still Bite The Dust,” in which the libertarian finance and economics …
Kevind Dowd. Image from Independent Institute.
By CCN.com: Kevin Dowd is a Professor of Finance and Economics in the Business School at Durham University, Northeast England, and the co-author of the 2015 paper “Bitcoin Will Bite the Dust,” along with market analyst and author, Martin Hutchinson, for the libertarian Cato Institute in Washington DC.
CoinDesk published an op-ed by Dowd Monday, with the title, “Bitcoin Will Still Bite The Dust,” in which the libertarian finance and economics professor avers that Bitcoin is doomed to failure.
Well what he says exactly is that Bitcoin will “bite the dust,” and what he means by that is:
Bitcoin can “not survive in the long run,” and “I still think that the long-run equilibrium price of bitcoin is zero. It just hasn’t bitten the dust yet.”
And technically he might be right, the same way John Maynard Keynes was right when he said:
“In the long run we are all dead.”
-John Maynard Keynes, Dead British Economist
But before we take a look at the two reasons Professor Dowd gives for why Bitcoin will “bite the dust,” here’s an excerpt about him from Wikipedia to give you an idea where he’s coming from:
“Dowd’s main subject of research is private money and free banking—monetary and financial systems that operate without any government intervention and in the absence of any central bank. A related focus of his work is on central banking and other forms of state intervention into economies, most particularly, on deposit insurance, the lender of last resort and bank capital adequacy regulation. He has repeatedly called for the abolition of central banks and an end to state intervention in the financial system.”
So here is an economist who would want Bitcoin to succeed, but doesn’t think it will. That’s interesting. It makes me think he must have a pretty good argument that Bitcoin will fail.
Again, “in the long run,” whatever that’s supposed to mean.
Does Dowd have any claim more specific than Bitcoin will bite the dust “in the long run?”
If thousands of years from now when humanity is a space-faring, interstellar civilization in the year 40,750, if they’re not still using the very blockchain which began with the first Genesis block mined by Satoshi Nakamoto in 2009, then the ghost of Kevin Dowd can gloat his prediction was true. What use is a prediction like this? If he’s so certain as to Bitcoin’s demise, will Professor Dowd be so bold as to make a forecast of roughly when Bitcoin will bite the dust?
The Two Reasons Why Prof. Kevin Dowd Says Bitcoin “Will Bite The Dust”
FIRST he claims Bitcoin is ‘a natural monopoly’:
‘To work as intended, the bitcoin system requires atomistic competition on the part of the miners who validate transactions blocks in their search for newly minted bitcoins. However, the mining industry is characterized by large economies of scale.
Indeed, these economies of scale are so large that the industry is a natural monopoly. The problem is that atomistic competition and a natural monopoly are inconsistent: the built-in centralization tendencies of the natural monopoly mean that mining firms will become bigger and bigger – and eventually produce an actual monopoly unless the system collapses before then.’
But this simply isn’t true.
There are economies of scale involved in bitcoin mining, sure, but a lot of industries that aren’t monopolies have economies of scale. Bitcoin mining happens to be one of them.
Below is a pie chart of the market share of bitcoin miners in terms of hash rate distribution.
Hash rate is how many operations a bitcoin miner’s computer is doing in a period of time. The higher the hash rate, the greater the opportunity of solving a hash function (by generating random guesses until your computer finds the correct one), which qualifies you to certify the next block of transactions in the chain and receive a reward in bitcoin.
And miners themselves are just one major stakeholder in Bitcoin.
There’s also the individuals and businesses who hold bitcoin as savings or speculative investment, and who transact business with it.
There are the exchanges.
There are the wallet companies.
And there are the developers for all of these areas.
It’s completely inaccurate to portray Bitcoin as a monopoly under someone’s central control when it is, in fact, a brilliantly envisioned, highly robust digital economic architecture with a manifold system of checks and balances built into it like the U.S. Constitution.
The Bitcoin blockchain architecture and the vast public digital ledger it has produced on its blockchain constitute the founding digital document of a new economic order based on old principles and new possibilities, and the network of people and computers that maintain it are the founding fathers of a promising establishment.
Which is part of my rebuttal to Prof. Dowd’s next contention:
SECOND he claims Bitcoin is ‘an inferior product’:
‘There is also the argument that the price of bitcoin must go to zero because an inferior product cannot survive long-term in the absence of regulatory barriers to entry.
Imagine you have a market with no entry barriers. The first firm to enter the market has 100 percent of the market share, as bitcoin once did. Competitors then come along and make inroads into the market.
Some of these offer products that are superior to the product produced by the first firm, not least because their producers have learned from some of the design flaws in the first firm’s product. And eventually superior rivals displace it completely and the market share of the first product goes to zero.’
But it’s not.
Dowd contradicts himself here. First, he says Bitcoin will bite the dust because nobody can survive in the market without getting swallowed up by a bigger beast. Then he literally says Bitcoin will bite the dust because it’s too easy for people to get into the market and compete.
And both claims are false. The first claim is false because that’s not what’s actually happening. The market for bitcoin mining is an oligopoly, not a monopoly.
The second claim is false because Bitcoin is not an inferior product. Dowd is positing that competitors will find a second mover advantage that will prove fatal to Bitcoin, but the second mover doesn’t always have the advantage.
The fact that it came first makes it a very stable boat in the waters. It has the longest, strongest blockchain, and the most battle-hardened network with the most experience weathering bugs and attacks. The fact that it came first has been a major advantage to Bitcoin.
The mere fact of its sheer size gives Bitcoin the benefits of the network effect and makes it the most difficult target for a 51% attack. The old tropes about Bitcoin being outdated because it uses a lot of energy either miss the point of Bitcoin entirely, or are deliberately misrepresenting a difference of design philosophy as Bitcoin being outdated.
This is a network that uses energy and computation on purpose to create a qualified node. That’s part of what makes Bitcoin so solid. Characterizations of Bitcoin as outdated because of transaction volume also either miss the point of Bitcoin or are deliberately misrepresenting a difference of design philosophy as Bitcoin being outdated.
Perhaps Bitcoin isn’t meant for that, but as equity for a store of value as savings, something for which fewer transactions are necessary, and which is highly valued and sought after by markets.
Bitcoin mining has faced a lot of pushback as many miners decided to quit mining due to the collapse of BTC prices below the break-even point.
Source: Volume 3 Issue 1 – Diar
The above chart shows how the Bitmain owned pools, BTC.com and Antpool’s hold on the mining power has reduced as 2018 came to an end. Relatively, it can be seen that unknown miners are stepping into the ‘Bitcoin mining game’ as Bitmain’s power over the mining wanes.
In the whole of 2018, the Bitcoin mining revenues surpassed $5.8 billion, but the surprising fact is that in January 2018, Bitcoin miners earned a whopping $12 billion, but that reward reduced by 83% as of December 2018. The miner rewards, in total reduced to $210 million.
The report stated:
“Efforts of small miners turned sour in September 2018 as record hash power made profitability near non-existent with Bitcoin’s falling price.”
It clearly mentions that the mining power has shifted from Bitmain and into the hands of unknown miners. It also recently abandoned its Amsterdam operation. Moreover, it also shut down the Texas mining farm and it is rumored that Bitmain has lost over $700 million in Q4 of 2018.
Furthermore, Jihan Wu and Micree Zhan have stepped down from their position as CEOs of Bitmain. This news has also poured cold water on their plans to go public as they’ve failed to convince the Hong Kong regulators to approve its IPO.
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Analysts determined that mining pools either owned by or heavily tied to Bitmain (Antpool, BTC.com, and ViaBTC) are now validating far less Bitcoin …
The world’s most popular cryptocurrency is a now a little bit more decentralized, thanks to the waning influence of Bitmain and the return of the anonymous Bitcoin BTC miner.
Blockchain research unit Diar has published new data revealing exactly who has been validating the Bitcoin network.
Analysts determined that mining pools either owned by or heavily tied to Bitmain (Antpool, BTC.com, and ViaBTC) are now validating far less Bitcoin blocks than this time last year.
In fact, it is “unknown” anonymous Bitcoin miners who are currently validating more blocks than any individual pool.
“[Unknown] miners closed December having solved a whopping 22 [percent] of the total blocks, up from 6 [percent] at the start of last year,” reported Diar. “The Bitcoin network is currently less likely to experience an attack given the fact the BTC.com controlled pools have lost dominance over the network.”
At pixel time, “unknown” miners accounted for more than 23 percent of the computing power driving the Bitcoin network (hash power).
Does this actually make Bitcoin ‘safer’?
Bitmain is the world’s leading manufacturer of cryptocurrency mining equipment, and has historically been a powerhouse of the Bitcoin network.
Diar reports that in early 2018, Bitmain’s mining pools accounted for 53 percent of Bitcoin’s hash power. Theoretically, this would have allowed them to collude to take control of Bitcoin with a “51-percent attack.”
This indicates a distinct correlation between Bitcoin‘s price and the number of miners who are prepared to participate in the network.
Diar did warn that January’s growth in hash rate is unlikely to be sustainable, especially if the price returns to its now-typical bearish ways. This means if Bitcoin‘s price bounces, mining pools controlled by Bitmain could come back online.
At least for now, let’s enjoy the new Bitcoin with more decentralization (and less Bitmain).