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Monopoly Without a Monopolist: An Economic Analysis of the Bitcoin System [pdf] (columbia.edu)
118 points by Spellman on Sept 7, 2017 | hide | past | favorite | 61 comments



That is a very 2015 view - now days people don't buy bitcoin for its use in transactions, they buy bitcoin because it keeps going up. The more it goes up the less people are likely to spend it. We don't need many miners if people never spend it.

Here is one high profile example http://avc.com/2017/08/store-of-value-vs-payment-system/

(of course when it starts to go back to zero people will all try to sell and the infrastructure wont be there)

PS: The paper deals with a very interesting problem about how miners are paid. I dont want to take away from it. Just that I feel the whole BTC environment has taken a new turn that makes the problem less of an issue.


I think this is mostly correct, but I see it a bit differently. This initial wave of speculation is slowly building up network utility. Use cases like micro-transactions or Web payments become more and more viable as the network size grows. Eventually enough people own Bitcoin that it makes sense for it to be baked into a browser for micropayments, and for it to be used in lieu of Venmo/PayPal. Speculation is the boot loader for real utility


Sorry.... I had to.

"I think this is mostly correct, but I see it a bit differently. This bubble is slowly building up real housing for hard working poor and middle class people. Use cases like pay-day loans and sub-prime mortgages become more and more viable as the network size grows. Eventually enough people own mortgages that it makes sense for it to be baked into a CDO, and for it to be used in lieu of liquid assets. Bubbles are the boot loader of real utility."


I'm not saying it isn't necessarily a bubble, but the bubble analogies tend to be as lazy of thinking as speculating a never ending upward trend.

Creating utility/value from achieving network effects (something pretty common) isn't really comparable to issuing loans to people who cannot afford to pay them back, regardless if you think there's overvalued speculation or not.


I don't necessarily agree with bobbygoodlatte but it seems like you wrote a themed mad-libs rather than an analogy..

Did you mean for the terms you listed to relate to the bitcoin situation in any way?


Mainly the idea of a bubble resulting in real utility to people. If bitcoin isn't used for transactions, it's a store of value. It's gold + technology people don't understand. I don't understand how that's any different from a tulip except that you don't have to wash the dirt off of it when you uproot it.

EDIT: I was also trying to make a point that CDOs were based in a kind of network effect where the risk was submerged under an ocean of statistics. Yet in the end, the underlying assumptions were faulty and the network effects lit on fire like gasoline.



This is an interesting critique. I don't deny that other alt-coins might make use of blockchains to solve other problems that aren't currency.

The thing I'm taking away from the article is that it compares BTC to gold favorably, which is an interesting angle. I generally think that gold is an irrational investment, after all there is no intrinsic value to gold other than for jewelry electronics, and high tech science experiments but that's not what the gold bugs claim.

However, if you kind of turn the argument on its head a bit, gold is sort of like a ground up fiat currency. It has no intrinsic value and it has no army, but it forms a focal point of public consciousness that renders it deflationary fiat.

However, there are other problems with BTC even if you accept the idea of deflationary fiat. For instance, money doesn't just pool in rich people's pockets, you can literally lose a BTC wallet and the money is just gone forever. Over time, this will result in the number of BTC in circulation approaching zero. I don't know how long that will take.

The other argument against BTC is that its essentially capitalism run amok. We already destroy the environment to extract dollars, but now with cryptocurrencies, we actually have to destroy exponentially more raw energy to fuel the monetary system itself. It's a satire of capitalism in a world of environmental catastrophe.

As for the Tulips, maybe I'm interpreting the chart incorrectly, but while the options price rose to insane levels, the realized prices, for a shorter duration, still rose to 100x (options were at 200x).


> We already destroy the environment to extract dollars, but now with cryptocurrencies, we actually have to destroy exponentially more raw energy to fuel the monetary system itself.

What did you mean by "extract dollars"?

Also, the digital transfer of money throughout the globe and even just domestically requires a significant amount of processing (which requires raw energy) by many different entities. It makes me wonder if a transaction within a cryptocurrency payment system is actually more or less efficient, even with all of the miners.


I mean literally extracting resources: mining, logging, fishing, oil extraction. As resources become more scarce, the market system causes the price to shoot up, incentivizing the completion of the process to extinction. In the case of cryptocurrencies, it's abstracted somewhat since we use electricity, but those energy resources must come from somewhere, and right now it's not renewables for the most part.

I get what you're saying, but the entire idea of bitcoin is literally an exponential ramp. Each new technology that improves speed (CPU->GPU->ASIC) will be a linear step up, but mining will get exponentially harder. There are network effects from the banking world, but I don't think they should grow even as (N^2 where everyone is connected to everyone else) as they probably use something between than and a spoke and hub model.


I don't need to own bitcoin to carry out a transaction with it for longer then a few minutes. With a global cap of soon to be 28 transactions a second Bitcoin will never be competitive with Visa.


The capacity for large volume ("real life scale") of transactions with reasonable verification latency is something that I have always seen as the real blocker with Bitcoin. I continue to be slightly surprised that the issue isn't covered more actively.


«global cap of soon to be 28 transactions a second Bitcoin»

Bitcoin competes more against Western Union than against Visa. WU does only 31 transactions per second, perfectly within range of Bitcoin's capabilities (https://corporate.westernunion.com/annual-report/highlights....)


the problem currently has not been the number of TPS but the fact that different groups have incentive to "spam" the blockchain with fluff transactions 1) miners do this to set a minimum floor for transaction fees 2) subversive elements do this to make a point that Bitcoin cannot handle the use cases it was originally intended for

really thinking about this it is probably not a problem because the free market should find the true price for an on-chain immutable transaction. coffee transactions will happen off chain and be settled up on-chain (lightning network)


Micropayments are not that feasible when the fees per transaction are in the multiple dollars, surely?


Not on the blockchain. This is what Lightning Network and other Layer 2 technologies seek to enable: nearly-free micropayments.


Why not use the fabled "lightning network" layer as layer 1 if it functions as it should?

Is it not just a blockchain slapped on top of the slower blockchain?


Transactions are encoded into the blockchain to set up a "lightning channel" that incentivize the participants of off-chain transactions to correctly settle the net payments of the channel on the chain later. Only once it's set up on the blockchain can users use it for off-chain payments (which can be instantly confirmed and have much lower fees).

Once the channel is set up on the blockchain between two users and has some amount of bitcoin committed to it, the participants can securely transact between each other with only private communications between each other, without requiring transactions in the blockchain. When either user is done with the channel, either of them may broadcast the settlement transaction which withdraws the committed funds in the correct amounts to each participant. (Every time the participants make a transaction between each other, they create create a new settlement transaction, and a separate transaction which invalidates the previous settlement transaction. These are regular Bitcoin transactions, but they're held privately by the participants instead of being broadcast on the blockchain immediately. If either of the particpants tries to broadcast an earlier version of the settlement transaction, then the other participant can broadcast the invalidation transaction within a certain pre-agreed time, which rewards them the funds as punishment to the defector.)

Then the real fun comes from the "lightning network" part: if Alice wants to send funds to Charlie but has no open lightning channel to Charlie, but she knows that both her and Charlie have an open channel with Bob, then she can do an off-chain lightning transaction through Bob to Charlie, without any risk of Bob taking the funds for himself.


Importantly, the maximum net amount that can flow from A to B over the channel is capped at the amount which A contributes to the funding transaction.


The lightning network has no security (protection against double spend) on it's own. It relies on the underlying blockchain for that.


>The lightning network has no security (protection against double spend)

That's not true. By locking funds into a Lightning Network payment channel you solve the double spend problem _in the channel_ (the person receiving your payment knows that in order for you to double spend the channel, the payment recipient would need to approve the double spend). The risk of being double spent still exists on the underlying blockchain though, which is solved with a smart-contract structure that allows the counter party to the perpetrator of fraud to revoke a fraudulent double spend.


I think you misread my response, or maybe I wasn't clear, since I agree with you. I said the lightning network has no security on it's own. It requires an underlying blockchain on which to lock funds. Those underlying locked funds are what effectively secure the payments made on the lightning network channel.


What's a practical use case? It sounds like you have to deposit a balance into a lightning channel, meanwhile wait for the block to be accepted, and once the funds are in the channel any activity still needs to be verified by another block being processed and accepted into the main chain..

This process effectively doubles the required amount of transactions and time spent for the 'lightning' transaction to take place?


In Japan there are cards (and, indeed, your cell phone) that work exactly the same way. Debit cards don't really exist in Japan. Instead you buy a smart card (often the ones used for paying train or bus fares). You put some money on the card using a machine (you insert cash and it encodes the money on the card). Then you can flash the card onto a reader to pay for things (often train or bus fares, but in the past 10 years it has extended to vending machines, convenience stores, etc, etc).

Lightning is exactly the same way. You set up a contract with the payment processor. This requires the transaction to be accepted into a block. Then you make as many smaller transactions (which require no blockchain transactions) with the payment processor as you want. At any time, the payment processor can terminate the contract by cashing in the amount of money you have spent. This requires a transaction to be accepted in the block chain. After that the channel is closed and only the amount spent is transferred (the remaining amount is freed up). If it goes beyond the contract length without the payment processor cashing in, then the contract is cancelled and the total amount is freed up.

So basically it allows you to make many transactions through a payment processor, while only making 2 transactions on the block chain. Anyone can be a payment processor, but the protocol requires the payment processor to have capital equal to the transactions in process (they have to transfer funds to a third party before they get paid -- although they are guaranteed to get paid by the end of the contract).

It's actually a pretty slick protocol. Their website has a video with implementation details that explains exactly how it works: https://lightning.network/


Only two blockchain transactions, still costs multiple dollars right now.


No, once the channel is open, any number of transactions can happen within it as long as the net transfer from a party is less than the amount they committed to the channel. (I've made another post in this thread with a fuller explanation.)


The main use case is small payments. You open a channel locking X amount of funds, and then can send or receive small payments to/from other parties on the network without broadcasting those transactions to the blockchain or paying fees. The only thing that is required is a route connecting payment channels from sender to recipient. For example, if A has a channel with B, B has one with C, and C with D, then A can transact with B, C or D.


Here is some more information about what LN is doing: http://dev.lightning.community/overview/


Firstly, well the post I replied to implied that it was already there - AFAICT lightning is not in production use yet.

And secondly, frankly, I think Bitcoin dreadful for micropayments. It's really hard to get hold of for most people, requiring all sorts of setup and accounts.


«people don't buy bitcoin for its use in transactions»

Data shows otherwise. Bitcoin speculators typically leave the coins in an exchange wallet (not sufficiently technically savvy or motivated to run their own wallet). Doing so does not create a transaction on the blockchain, therefore the transaction rate (https://blockchain.info/charts/n-transactions?timespan=all&d...) reflects mostly non-investment-related transactions, and it is sharply increasing.

«The more it goes up the less people are likely to spend it.»

Historically, transaction processors like BitPay have noticed precisely the opposite. I guess people are excited to spend their newfound fortune when BTC goes up? I observe this behavior on myself: I cash out and spend more bitcoins whenever the value is going up (Jun 2011, Nov 2013, today, etc)


It's not quite like that. The number of transactions on the network has been steadily increasing because there are plenty of reasons to do your shopping in bitcoin, as 140 million Americans will find out after the Equifax hack.


> people don't buy bitcoin for its use in transactions

I'd beg to differ.. sure there is definitely a percentage of HODL'ers but to say people don't use it in transactions is straight up lunacy.

https://blockchain.info/charts/n-transactions?timespan=all https://blockchain.info/charts/trade-volume?timespan=all


The high transaction fees recently are pushing out a lot of the traditional use cases for Bitcoin. Bitcoin Cash appears to be in a position to inherit those use cases.


That's unlikely. Bitcoin cash isn't accepted anywhere yet, and unlike Bitcoin it does not have Segwit, and thus no layer2/lightning network support. It's 8MB blocks only up the on-chain scaling from like 3 tx/sec to ~20tx/sec. That's a negligible difference when compared to credit cards, paypal, etc. Bitcoin will only ever reach that kind of capacity with 2nd layer lightning network, or something like it.


When will btc adopt lightning?


Segwit was just activated on Bitcoin around two weeks ago. Among other things, segwit includes a fix for txn malleability needed to facilitate a lightning network implementation on bitcoin. The lightning network alpha release has been implemented on Litecoin, and has been on the Bitcoin testnet since the beginning of the year. My guess is it will go live before the end of the year, and adoption will ramp up next year.


Well, don't these charts only reflect new people buying Bitcoin (as an investment)?

https://blockchain.info/pt/charts/n-unique-addresses?timespa...


You could probably look at the distribution of transaction sizes to try and determine how much is investment vs commerce. A bunch of $1-10 transactions are less likely to be speculators getting into a position.


Those data don't differentiate bitcoins bought for investment and for trading.


It does, because investors typically do not transact in Bitcoin. Buying and leaving BTC in an exchange wallet does not create a transaction on the blockchain.


Speaking of economic views, I think that people tend to overlook the most fundamental part of the Blockchain based currency phenomenon today. While the technology is great, it tends to overshadow the fundamental observation that these cryptocurrencies are first and foremost currencies and then afterwards technologies. Perhaps Hacker News is not the place to have such a view, but it ought to be stated. There is a lot of misinformation out there and a lot of excitement, we ought to continually remind ourselves of this truth. These currencies and their intrinsic value are subject to the same rules of all regular currencies: supply and demand. Do people believe that these are valuable or not? The economic view trumps the technological view at the end of the day. http://benshieldsblog-blog.tumblr.com/ https://docs.google.com/document/d/18R6MTugMCZaL1A8b0gj_9F_E...


This paper is a reasonable attempt to model bitcoin by people who only see the surface of what bitcoin is.

Bitcoin is like an Onion- it has layers, and makes you cry.

As I have come to understand it there are many layers- both in technology and economics- at work here.

Most obvious is layer 2 tech like lightening network, side chains, and segwit. (which is a second layer inside the blockchain.)

But as you come to understand it better you realize, for instance, that the network has been under attack and the cost of fees is mainly due to that (when its not under attack because the attackers are moving their bitcoins) you can do micropayments-- like $1.50 sent for $0.05 transaction fee with 3 hours clearing-- which is faster and cheaper than credit cards. You get censorship resistance for free!


I can buy a coffee with a CC immediately but Bitcoin I need to wait 3 hrs?


Bitcoin clears and settles within a few blocks. Credit cards may reverse a transaction for 90 days.

The merchant could also let you leave after sending Bitcoin if the risk of double-spending was low enough (and network congestion was down).

Lightning Network will enable instant transactions without needing to wait for block confirmation, which is a true payments solution.


You don't need a globally redundant ledger to store your coffee purchases. The benefits of a blockchain over traditional financial systems is borderlessness and censorship resistance. Nobody is stopping you from buying coffee, why would you need a blockchain?


Expand from coffee to hamburgers, to gas station purchases, to groceries, etc, and soon you have ruled out a major percentage of the consumer economy. Not a deal breaker, but lots of hype for crypto is how it can replace fiat transactions wholesale or damn near it.


> The benefits of a blockchain over traditional financial systems is borderlessness and censorship resistance.

That's a subjective viewpoint. I might just want to earn my salary in Bitcoin and spend it, like a currency.


Abstract:

Many crypto-currencies, Bitcoin being the most prominent, are reliable electronic payment systems that operate without a central, trusted authority. They are enabled by blockchain technology, which deploys cryptographic tools and game theoretic incentives to create a two-sided platform. Profit maximizing computer servers called miners provide the infrastructure of the system. Its users can send payments anonymously and securely. Absent a central authority to control the system, the paper seeks to understand the operation of the system: How does the system raise revenue to pay for its infrastructure? How are usage fees determined? How much infrastructure is deployed?

A simplified economic model that captures the system’s properties answers these questions. Transaction fees and infrastructure level are determined in an equilibrium of a congestion queueing game derived from the system’s limited throughput. The system eliminates dead-weight loss from monopoly, but introduces other inefficiencies and requires congestion to raise revenue and fund infrastructure. We explore the future potential of such systems and provide design suggestions.


From the conclusion which I thought was really interesting:

> Bitcoin is not regulated. It cannot be regulated. There is no need to regulate it because as a system it is committed to the protocol as is and the transaction fees it charges the users are determined by the users independently of the miners’ efforts.

> Bitcoin’s design as an economic system is revolutionary and therefore would merit an economist’s attention and scrutiny even if it had not been functional. Its apparent functionality and usefulness should further encourage economists to study this marvelous structure.


  Bitcoin is not regulated. It cannot be regulated. There is 
  no need to regulate it because as a system it is committed 
  to the protocol as is and the transaction fees it charges 
  the users are determined by the users independently of the 
  miners’ efforts.
There's no need to regulate Bitcoin the protocol or software.

The gateways, such as the exchanges are more of an essential element in regard to regulatory and economic influence on the cryptocoin economies.


What if I were to tell you, that if bitcoin were to truly succeed, you won't NEED a gateway or exchange. You will just transact in bitcoin.


In a perfect world no true Scottsman would trade BTC directly.

Bitcoin will struggle as long as their development team struggles with fixing the 3-4 transactions per second limit. $20 fees to process a transaction in 20 minutes? Good luck.


You don’t need to touch the blockchain in order to receive a payment denominated in bitcoins. Every day millions of bitcoin-denominated transactions take place on exchanges using a centralized clearing system (you deposit BTC, transact, then withdraw BTC).

All we need is to standardize this behavior, such that each exchange doesn’t have its own closed system (essentially an SQL database with balances). Rather, we’d using an open clearing protocol, with multiple issuers in the same way we use email with multiple email providers. Each issuer/email provider is centralized, but the system as a whole is decentralized (similar to Git as well).

The simplest example of such a protocol is Stroem[1], which offers trustless micro-payments for consumers/payers, such that only merchants/payees take risks (which are proportional to how often they redeem their BTC on the blockchain). So, merchants get to choose their risk appetite: the longer they wait with redeeming, the lower the per-transaction fee, and the more often they redeem the more the security resembles on-chain transactions, with proportionally higher fees.

[1] https://www.strawpay.com/docs/stroem-payment-system.pdf


On a related note there was a paper presentation on the economics analysis of the blockchain from the Toulouse School of Economics a few months back.

[1] Presentation http://econ.sciences-po.fr/sites/default/files/file/melissa/...

[2] Presentation https://www.tse-fr.eu/sites/default/files/TSE/documents/doc/...


This paper mainly focuses on the miner-transaction fee-protocol economics, completely neglecting the real world economic interactions and history of BTC.

Satoshi's core design of bitcoin minting favored early adopters to mint coins at extremely low cost and processing power, this is why someone traded 10,000 bitcoins for two pizzas because it took no effort to generate those early on. Satoshi decided to decrease the amount of rewards as the network grew older and presumably more users would adopt it, why? This is a marketing gimmick seen with beanie babies and base ball cards where the cost of production is low yet you tell customers the supply is very limited so you must act quick while supplies last. And the supplies of this type of service are increasing with every day as alternative networks offering the same service (blockchains, trustless distributed databases) are increasingly sprouting up. The question speculators should be considering when evaluating the economic worth in trading bitcoins or any other altcoin should certainly take into consideration what value the network provides them versus alternative service networks, what the risk of volatility in each network is especially because extreme drops in value are much easier than rises in price as liquidity is severely limited and many "whale" accounts often own enough supply of coins to crash the entire market [1] [2] [3].

Exchanges like MTGox, Bitfinex, etc have been suspected of manipulating exchange rates and insider trading via maliciously scripted exchange bots within the exchange [4] [5] [6].

[1] https://bitinfocharts.com/top-100-richest-bitcoin-addresses....

[2] https://etherscan.io/tokenrichlist

[3] ETH had a presale which sold for $0.35 USD - $0.45 USD. The vast majority of cryptocoin variations premine or rapidly mint their supply, and then game speculators to pass the bag off to greater fools in what is essentialy a pyramid scheme backed by a network of databases running double-entry bookkeeping marketed as magic technology that's changing everything.

[4] https://www.theguardian.com/technology/2014/may/29/bitcoin-b...

[5] https://medium.com/@bitfinexed/are-fraudulent-tethers-being-...

[6] https://medium.com/@bitfinexed/meet-spoofy-how-a-single-enti...


>Satoshi decided to decrease the amount of rewards as the network grew older and presumably more users would adopt it, why?

Mining needed to have a way to incentivize miners before transaction fees were common, and there needed to be a system to get bitcoins out into users' hands to begin with. Once a critical mass of users have bitcoins and transaction fees support mining, there's less reason to continue minting new bitcoins.

It could be argued that continuous minting creating inflation would be desirable, but that's a big free parameter that there isn't a known best way to calculate. Bitcoin's monetary supply code was intended to function long-term, and if minting was to continue indefinitely, it's debatable what the minting rate should be, and if it was gotten wrong, it would be extremely controversial to ever change. (Some people might think 2% is a good inflation rate, but what if that's specific to now? Say economic and population growth slow down; 2% could be too much inflation.) Having the cap approach a maximum limit instead of increasing forever seems to have been a much easier decision to make and get others to trust. If there's a fixed amount of Bitcoin, then as long as Bitcoin's usage isn't decreasing, it's straightforward to imagine that the value of Bitcoin shouldn't approach zero.

>And the supplies of this type of service are increasing with every day as alternative networks offering the same service (blockchains, trustless distributed databases) are increasingly sprouting up.

A big part of Bitcoin's value is the network effects of its current user-base. The creation of an altcoin doesn't immediately fully dilute the supply of useful bitcoin-like cryptocurrency if it doesn't have the userbase.


If no Bitcoin is being minted and a certain amount is lost every year to burn addresses or mistakes, it stands to reason that at some point the amount Bitcoin in circulation would approach zero. A hacker group could grind the economy to a halt by gaining control of people's wallets and burning money, creating much larger deflation than what is caused by the economy growing.

On the other hand, as far as I understand there is a huge number of inactive coins that no-one knows whether they've been lost or not. If those coins start moving it would effectively create a large inflationary pressure.


There was no "getting bitcoins out into user's hands" other then Satoshi and the small group of minters who generated the majority of early coins. It was designed to exploit late adopters, more so when the published price is controlled by only a few unregulated black box exchange "markets".

If you look at the coin supply minted over time, in the first year ~3,000,000 coins were minted, 1/7th the total supply minted to a very very small group of humans. By 2014 half the entire supply was minted. These coins are now in in the pockets of a very very limited amount of users who spent very little resources to mint these and be granted credits in Satoshi's database. Think about this.

There's no real network effect when migration to any of the other altcoins is just as easy. It becomes incentived more so when actual usage of the BTC network is cumbersome with latency of up to several hours, and or $10-$20 transaction fees.


The early adopters also took an extraordinary RISK in buying the coins, or spending the money mining them.

Bitcoin being mainstream and safe is a very new thing. I remember just a couple years, everyone was freaking out because they were worried that China was going to ban bitcoin.

And years before that, the worry was that the US, or whoever, would try to force AML regulations onto it.

And a couple years before THAT the worry was that the US would do all of that AND arrest everyone involved in the system, and send them to jail for facilitating money laundering.

Being involved in bitcoin was a risk for early adopters, and that risk was rewarded.


Risk and reward should be in balance if you want to see Bitcoin as the type of currency people would actually use as a significant part of their economy. The first miners may have risked some (real) money, but that is nothing compared to the massive wealth¹ they would hold if Bitcoin ever did supplant local currencies — even if people used it just for coffee.

The amount of (untaxed!) wealth owned by those early miners would dwarf that of Gates and Buffet. That kind of Ayn Rand level of capitalism doesn't seem to agree with most people — although it does seem palatable amongst Bitcoin aficionados.

1: https://cointelegraph.com/news/who-owns-bitcoin-universe-fro...


Satoshi's design for the minting of supply to himself and the few individuals who scooped up the first 6-12 million coins is part of the design, for others to consider regardless.

As mainstream adoption took place, we've now seen large capital holders acquiring BTC in proportion with their current wealth.

The hodlers play a game of chicken prisoners dilemma, and it's worthwhile to consider what beanie baby they've acquired and how the sausage was made.




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