About the long-term security of the Bitcoin network
The Bank of International Settlement (BIS), sometimes dubbed the „Central Bank of the Central Bank“, released a paper about the „Doomsday Economy of Bitcoin.“ It claims that Bitcoin can‘t be secure longterm; in the future transactions will need months to reach a state of finality.
The paper has some weaknesses – it misses important details, plays up hypothesis as facts, isolates mathematics from the economic and legal context – but it states an enlightening thesis: A transaction can only be considered final, when the cost for a miner to double spend it (by mining a hidden alternative chain) is higher than the amount it sent. With this thesis the BIS reformulates Satoshi‘s security assumptions in economic terms.
You can argue about a lot of details and the mechanism of double spending. But let‘s take the number of the BIS paper, pretending it was entirely true: To be considered finalized after six blocks the mining reward for each block must be 8.3 percent of the amount sent. If you take a million dollar transaction, this would sum up to 83.000 Dollar. Let‘s take this as a mark.
Currently the BTC block reward is 12.5BTC, which are around 50.000 Dollar. It halves every four years. In 2020 it will fall to 6.25BTC, in 2024 to 3.125 and so on. In the mid 2030hties it will be less than 1BTC. As time passes by, the miners will earn almost exclusively from fees for transactions. To keep the network secure, there needs to be a lot of transactions fees.
The BTC community widely ignores or rejects this paper, mostly with the arguments that the BIS is „the arch enemy of Bitcoin“. At the same time they widely accept another theory, which is nearly identical: The fee market of Gregory Maxwell, cofounder of Blockstream and author of „a roadmap for capacity“, which has become the absolute and unquestionable roadmap for scaling BTC. As a rule of thumb you can assume that the BTC-community agrees with something, when it was said by Gregory Maxwell.
Maxwell‘s theory of the fee markets, also called „Gregonomics“, is one of the founding pillars of the roadmap of BTC. Maxwell claims that he size of the blocks must be „sharply constraint“ to create a fee market of transactions competing for „blockspace“, which – and only which – can finance the miners when the block reward will have dried out. This theory has become a common talking point when the Bitcoin community discussed increasing the blocksize limit in 2013, and due to an asymetric communication policy in most places it has become a defacto truth.
Maxwell‘s theory is that Bitcoin can‘t work as a mass market, but must be a luxury market. Sorry poor people. Bitcoin is not for you. It‘s more like Rolex than Facebook. Maxwell‘s theory reminds on the medieval model of the guilds, which regulated the production outputs of municipal craftmen with a quote to keep prices for their products high. In the 18th century this model was considered outdated for most industries. Industrialization begun, factories pushed out products in masses and sold with little individual margins.
In late 2017 however this economic model revived on Bitcoin. The high demand for Bitcoin transactions during the bubble peak and the exploited capacity of 1mb blocks made the transactions fees rise. For a short time they reached $50 and more for a single transaction. The fee market emerged and fomented chaos and confusion in the ecosystem. But Gregory Maxwell unkorked the champaign.
He was not completely wrong, though: According to the BIS, total block reward must be $83,000 to finalize a $1M payment in six blocks. With a maximum capacity of only 2,500 transaction each block in BTC, the average fee for a transactions must be $30-$40. For a short time Bitcoin was able to secure this volume without the need of a block reward. A glance into a bright future?
However, the market didn‘t accept this „fee market.“ It reacted like it always does when prices get too high: The demand broke down. Transaction number went down. Since march 2018 miner‘s income by fees goes down. Today it is as low as in late 2016. The fee market came, and the fee market failed.
An ironic turn is that this sequence of events sparked a regulation frency at formerly free-market-loving „bitcoin maximalists“ (better: „Lightning maximalists“). Pierre Rochard suggests to further decrease the blocksize limit to make fees go up. If the market doesn‘t behave like it should, when you set quotes, the answer must be more quotes. Welcome to the devil‘s circle of regulation.
Despite those shortcomings in theory and practice, no fellow Bitcoiner (BTC) will voice a doubt against Maxwell‘s theory, and it strongly influenced the evolution of Bitcoin. For example, when Gavin Andresen suggested to raise the block size limit with bip101 in early 2015, Blockstream co-founder Matt Corallo started the discussion with noting that he is „strongly against“ it, because the security of the network can‘t be secured longterm without a very strict limit.
When miners are not allowed to produce bigger blocks (for their own interest), you need an alternative method to increase capacity of the Bitcoin system. The BTC roadmap aims to do this by establishing so called „offchain“ or „second layer“ solutions, like Lightning or Sidechains. These process transactions without them going through the miner network. The fees, of course, don‘t flow to miners, but to Lightning or Sidechain nodes.
It sounds weird: Saving the income of the miners by passing their income to other parties. The common answer on this is that, firstly, Lightning is only made for small micropayments. Don‘t worry, miners will continue to earn fees from large payments. They will, secondly, even earn more, as Lightning makes Bitcoin (BTC) so super awesome, that the use of it will absolutely explode. There will be a million Lightning transactions each block, and the transactions settling the channels will make the miners earn much more money than they do now.
From a higher perspective, the model of the Lightning roadmap is similar to that of the banking system: Banks settle their balances once a day with a transaction in the ledger of the central bank, while they process bank-to-bank payments with a seperate system changing the balance of channels between banks. Like the central banks, the Bitcoin miners should be the „base layer“ or „settlement layer“. While Lightning transactions will be „unfairly cheap“, as Lightning maximalists put it, onchain transactions will become very expensive.
This model creates a lot of problems. For example, the high onchain fees make micropayments impossible even with Lightning. Who the heck pays $40 to become able to pay a few cents in the internet? Worse, the high onchain fees will make it more expensive to manage liquidity in the channels. This could make Bitcoin too expensive not just for micropayments, but also for small to medium payment, and it could significantly decrease the efficiency of routing in the mesh network, which will translate in higher fees for Lightning transactions.
But the worst effect might be that high onchain fees increase the pressure on users, to not manage their own channels, but to get an account on a central hub with deep liquidity. This will reproduce the dependencies of the fiat system. Not your keys, not your coins. Since the payment channels are completely intransparent, it will also obscure the level of fractional reserve practiced by those hubs.
But, even if … the plans of the inventor of the Bitcoin fee market, Gregory Maxwell, don‘t stop here. The company he founded, Blockstream, aims to take away even the large transactions from the miners and put them on a sidechain. There is no reason to assume that you can‘t put lightning settlement transactions on the sidechain too. With „Liquid“ Blockstream targets exchanges to transfer Bitcoins with a faster, cheaper and more private sidechain. The transaction fees go to a consortium of companies, which rule the sidechain with a new consensus protocol developed by Blockstream.
All in all, the BTC plan to secure the longterm income of miners is this: Quote and regulate the production of their product, while passing their income to Lightning and Sidechain nodes. It is rather fascinated, how this plan has become the basis of the only viable and legit roadmap for Bitcoin (BTC).
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