Bitcoin and sustainability of its security model

The security model of Bitcoin, aside from digital signatures, is primarily based on economic incentives. Miners secure the network by competing in the open market in pursuit of the block reward. Home users used to be able to “generate” coins using the Bitcoin Core client itself, with normal consumer hardware. We now have large mining farms and pools, and it is no longer feasible for the home user to mine without an expensive ASIC miner. Proof of Work, the cryptographic mechanism by which mining is performed, requires constant investment and innovation. The miner at the top must innovate to stay on top; he can not rest on his laurels, so to speak. Bitmain was seen as an unstoppable juggernaut just a year ago; there are now rumors of impending bankruptcy and selloffs. The mining market is very unforgiving, and only the most cutthroat capitalist can win at the end of the day. If he wants to continue winning, he must continue to innovate.

If you own a very significant portion of mining power you can use it in two ways. Either you realize profits by mining new bitcoins and collecting transaction fees on top, or you can attempt to cheat the network by executing or colluding to execute double spends. Empirical data shows that no significant miner has attempted this, as they would rather play the game as it’s meant to be played and protect their investment. As we see more enterprise-scale miners enter the ecosystem, they will often be initiating long-term plays that anticipate a higher Bitcoin usage in the future. These miners understand that their investment is important for the security and health of the network. Attacks would reduce the perceived security of the network and the value of their own investment. They would be shooting themselves in the foot. Constant competition and scaling is perhaps the most valuable attribute in Bitcoin’s security model. To this day it is the most secure and censorship-free public blockchain on the planet.

Many believe that these essential economic incentive systems inherent to Bitcoin’s design are overlooked in favor of a technocratic, non-economic attitude towards development and scaling. Bitcoin brilliantly encompasses and overlaps many different disciplines and ideas, however, the fate of the protocol has often found itself at the mercy of those who are only experts in certain fields, and many feel that the economic wing of Bitcoin has been ignored or misunderstood in their role in the system. Even so, there is also a wide range of economic debates within Bitcoin, showing that even the so-called economists and experts are more often than not wrong.

Bitcoin’s technological innovations are not new. Proof of work, peer to peer networking, cryptographic signatures, Merkle trees, public/distributed hashed ledgers, scripting languages, etc. have all existed in some form or another for decades. What is remarkable is that Satoshi Nakamoto was able to combine them and made an economic system, while also finding solutions to long-standing networking paradigms such as the Byzantine General’s Problem.

With all this said, the system is still (to some extent) fragile and should not be modified or upgraded without careful consideration. When a technical change is introduced with not enough foresight or due diligence, it can change the nature of the economic system itself and possibly harm the network/incentive/security model. This problem goes both ways, as they must also be mindful of scaling and when changes are not only appropriate, but necessary.

This is the problem that BTC encountered. Bitcoin (Core) altered the economic fundamentals by refusing to increase the block size, as well as introducing soft-fork “optional” upgrades such as Segwit and RBF. Many opcodes were also removed from the protocol, either out of fear of so-called spam or security concerns. Because the block size was not raised before Bitcoin’s 2017 bull run, fees got as high as $50 per transaction as blocks filled up to their capacity and many users got stuck with unconfirmed transactions for days. This stoked the flames of the long-contested scaling and fork debates and fundamentally altered the economics of the system. I will describe some of the effects we’ve seen as a result of their decision to stay at tiny blocks.

At the moment, most miner income is provided through the 12.5 bitcoin block reward (also called subsidies or inflation), but it is generally agreed that as the reward continues to halven and usage goes up, a fee market emerges and miners role in the system becomes more and more important. We can observe from several angles that:

Bitcoin becomes more sustainable as a currency, it doesn’t depend on inflation anymore.
It will be less feasible to upgrade the protocol as adoption and velocity increase.
Miner revenue becomes more predictable/stable and will eventually decouple from speculative prices. Currently, speculators trade and invest based on future predictions of price, and miners are subject to a fixed price (for example, 12.5 BTC x current market price is their expected take per block). Eventually, as fee markets emerge, the actual price of the Bitcoin will matter less as block rewards become an afterthought.
Bitcoins is right now vulnerable to an attack vector known as “mining empty blocks,” where miners can only collect the reward while not include any real-world transactions.
Miners also get incentivized to generate larger blocks and take a bigger risk to distribute them. Right now the safest option to get other miners to build on top of your block is to generate a small block, so it can be quickly distributed to other miners.
How dynamics and incentives play out in a world of fee markets vs block reward is a topic for a separate post that I may do in the future.

We currently have, in essence, four different methods by which users might want to transact or settle their bitcoin.

On-chain, generating fees for miners.
Off-chain through custodians like Coinbase, Xapo…
Off-chain through LN or sidechains
Using altcoins.
The pros and cons of these methods have been written about by others in great depth and don’t need an overview. However, because of the unwillingness of Bitcoin Core developers to increase maximum block size, competing methods and altcoins have absorbed a large portion of transactions that were once done on-chain — — custodians have more and more user funds and transact for them, sidechains and Lightning are being aggressively pushed, and there is much contention still between BTC, its forks and alts. Miners have been ignored in this debate, despite the fact that they will suffer the greatest losses and have been the most restricted while providing the most important attributes of its network security.

As Bitcoin evolves and more enterprise-level miners enter the playing field and find their place in the long-term, they will become more aware of their role as well as the unique and powerful positions of leverage they have always had. I predict that they will eventually become hostile to any competitive method which wishes to free-load on their work, which is providing a solution for censorship and double-spending through expenditure and effective management of real-world materials. I think miners will eventually do what is in their power to make the life of competition way less comfortable. The situation we are currently in is both dangerous and uncertain; it is recklessly changing Bitcoin’s incentive model and future adaptability, and it is seriously challenging Bitcoin’s robust security and sustainability model. The user experience has not made great leaps, and actual adoption has slowed to a crawl as most that were introduced to Bitcoin were investors who bought high and got burned while never really got the taste of technology itself.

Money is like a language; it has a naturally strong network effect, and the maximalist ideology that many Bitcoin users hold seems like the most probable outcome, despite the problems faced today. User experience and further adoption are a way simpler problem in that setting.