Bitcoin Calculation Problems Analysis Key Ideas
- The study of crypto-economics looks at the effect of the economic implications for decisions made in cryptographic networks (such as bitcoin).
- More attention should be paid to crypto-economics.
- A central planning protocol could be a fast way of relieving problems that bitcoin and other cryptos face, but this could make those coins less competitive.
Foreseeing The Future Of Bitcoin
Many suggestions have been put forward to address the high transaction costs for bitcoin and its weaknesses as a currency.
Bitcoin’s problems with scalability can be described as the following:
- There is no process to set and reach goals in the area of security, censorship, or decentralization.
- There no understanding of the relationship between network decisions (forks, new protocols etc.) and their economic consequences (crypto-economics).
The word “we,” in this case includes all stakeholders who are involved in the blockchain. This can include people such as developers, miners, exchange operators, writers, and advocates.
As we lack the ability to see the relationship between changes to the bitcoin network and their economic consequences, this makes us unprepared to plan for bitcoin’s future.
Hopefully, through an understanding of crypto-economics, we can better predict what the network needs from its stakeholders, as well as the changes to increase its adoption by the mainstream.
Example Of Crypto-Economics
Imagine you made a cryptocurrency that lacked a predetermined supply. Instead of using an algorithm for controlling supply and inflation, the network pre-determined how many coins were in circulation on a month to month basis, voted by a handful of human stakeholders. Would this system be better or worse than bitcoin’s supply model?
A different example: a person sending bitcoin to a transaction address needs to communicate that data to bitcoin miners to be added in a block. What is the incentive for nodes to relay this data from the person to miner, in cases when they’re uncompensated?
These and other questions are what crypto-economics attempts to answer.
The Importance Of Crypto-Economics
Satoshi Nakamoto, who is the founder of bitcoin, pioneered a new model of economics as part of bitcoin’s design. Satoshi improved the fiat model of currencies through the creation of a predictable supply of currency.
However, Nakamoto’s design bought with it numerous points of economic rigidity, also. This rigidity has revealed itself as the network has grown.
One point of rigidity is bitcoin’s calculation problem, which can be described as what happens when a small group of people attempt to allocate resources for a larger number of people against their will.
This effect was first described by Ludwig Von Mises as the Economic Calculation Problem. Mises reasoned that the value of goods and services are best left to up to the market to decide, and that bureaucratic interference cannot efficiently allocate those resources.
The Calculation Problem
In the context of bitcoin, the calculation problem means that we are left with worse transaction throughput, worse scalability, worse security, and a worse market valuation. All of these things are caused when a minority makes decisions for the majority of stakeholders. This is the effect of central planning.
In a practical sense, central planning for bitcoin occurs when developers decide the allocation of resources and services for the rest of the network.
So, the core problem of bitcoin is that a small number of developers have control of most of the resources. Developers decide the direction of the network, making it less decentralized than intended. With a small number of developers controlling bitcoin’s resources, it’s arguably the same as a centralized economy.
Example Of Bitcoin’s Centralization
In 2013, a bitcoin security researcher posted a way for an attacker to disrupt the network. An attacker could create a transaction that would take an extremely long time for nodes in the network to verify. This attack would stop other nodes from verifying transactions, or significantly slow down the network.
The security researcher’s initial suggestion was a soft fork to alter bitcoin’s consensus rules, but was rejected by the bitcoin community.
The above example illustrates that central planning is usually the easiest and fastest way to fix a problem, which is why it’s favored by banks and government institutions, and even some of the platforms that bitcoin stakeholders rely on. These are examples of centralization in the bitcoin network, which was intended to be wholly decentralized.
For instance, it’s much easier to create a centralized bitcoin bank than it is to make a truly decentralized exchange. A bank website is familiar and easy to design, and permits us to use previous ideas with little innovation. All of this is despite greater security and censorship risks, which both fly in the face of Nakamoto’s decentralized design features.
Bitcoin Calculation Problems Analysis Summary
Crypto-economics is a new field of study that has no established authorities. The security of the bitcoin network is challenging enough, even when disregarding the complexity of economics. Taking economics and security into consideration with our limited tools will be difficult, and it’s going to take a significant amount of work to bring them into reality.
The problem is that a system built on consensus with poor security has little economic value, while a consensus system with low economic efficiency is not even worth securing.
Yet, we have no other choice if we want to bring bitcoin back as a truly decentralized currency.