January 23, 2019

Bank of International Settlement:“Bitcoin fee market not working.”

Just in time for the financial dinosaurs meeting in Davos at the WEF2019, the Bank of International Settlement has dropped a paper on Bitcoin and it’s Proof-of-Work economics, going into length why the Bitcoin fee markets won’t work to incentivize miners keeping the blockchain safe:

The conclusions are, first, that Bitcoin counterfeiting via double-spending” attacks is inherently profitable, making payment finality based on proof-of-work extremely expensive. Second, the transaction market cannot generate an adequate level of mining” income via fees as users free-ride on the fees of other transactions in a block and in the subsequent blockchain.” Raphael Auer

While pretty much everything the paper states is correct at face value, the paper doesn’t uncover anything new about Bitcoin and its underlying mechanisms to solve the double-spend problem. The halving of the Bitcoin block-reward will eventually lead to a fee market financing the miners energy expenses. BIS argues that Bitcoin will suffer from the tragedy of the commons, as the demand for low transaction fees (tx fees) will decrease security and make payments unreliable, with confirmation periods of days, months and even years. Indeed, miners will have to be compensated through tx fees, but Satoshi Nakamoto himself pointed this out even before Bitcoin went live:

There will be transaction fees, so nodes will have an incentive to receive and include all the transactions they can. Nodes will eventually be compensated by transaction fees alone when the total coins created hits the pre-determined ceiling.” Satoshi Nakamoto, November 2008

Thus, we have had plenty of advance notice of the problems miners might face with making honest block creation economically feasible. We could just point out that tx fees will certainly rise along with increasing transaction volume, Bitcoin value and diminishing block rewards. tx fees & block rewards

But honestly, we only need to worry about the fee market if we falsely assumed Bitcoins value proposition was ease of use or convenience. Instead Bitcoins main value proposition is being the hardest money in the world, the perfect store-of-value for high time-frame individuals who anticipate we won’t exchange greenbacks with each other by the time we are a space faring species in 2050. The last Bitcoin will be mined sometime in the year 2140. As the network grows in size and value, a consensus on how to fund future network security will, undoubtedly, be found in time.

While looking at the some of the proposed solutions today, which include assurance contracts and dynamic block size and dynamic minimum fee, I was yet again reminded why Bitcoin is digital gold really:

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