Do you remember those advertisements for Tootsie Pops… how many licks does it take to get to the center of a Tootsie Pop? Well, the Bitcoin saga is getting good because we are getting closer and closer to that chewy center.
Gavin Andresen pulled back the robe a bit today revealing the emperor’s wardrobe and it appears a bit skimpy in the size matters debate. With paragraph headings such as “Transaction Fee Death Spiral” and “Centralization Death Spiral” it would make you think that you were at the Bitcoin Fly-In at OshKosh and watching a wingwalker explain the Bitcoin safety program. The proposal is to change the blocksize in a manner that would effectively allow “anybody with a reasonably good home computer and network connection can participate as a full node on the network.”
Below is the full content of the article. Dave’s comments are in blue.
There are two sets of arguments for why we should keep the 1MB block size limit.
The first are technical; I address those in my Scalability Roadmap blog post, showing how a lot of geeky elbow grease should lead to “Bitcoin can replace every cash and credit card transaction in the world”.
The second are economic. I’ll discuss the economic arguments I’ve heard for keeping the 1MB blocksize limit, and explain why I think increasing the limit makes economic sense.
A couple of quick notes on vocabulary: when I say “miners”, I mean “solo miners and mining pool operators” — anybody selecting which transactions to include in new blocks. And when I say “people”, I mean “any entity capable of submitting transactions to the Bitcoin network.” I don’t want to insult our future Bitcoin-using Benevolent Robot Overlords.
Transaction Fee Death Spiral
The argument for not allowing arbitrarily large blocks: a maximum block size is necessary to create artificial scarcity so transaction fees do not drop to zero, leaving miners with no income, leading to no mining and the death of the network.
However, economic theory says that in a competitive market, supply, demand, and price will find an equilibrium where the price is equal to the marginal cost to suppliers plus some net income (because suppliers can always choose to do something more profitable with their time or money). In this case, price is transaction fees, supply is the willingness or ability of miners to confirm transactions, and demand is the number of transactions people want to have confirmed.
So with absolutely no artificial limits to supply (like a maximum block size), transaction fees would drop to the marginal cost miners pay for hardware, electricity and bandwidth, plus enough net income to motivate them to keep on mining rather than investing their time and money in something else. Fees would be very small, but not zero.
Fairly big assumption here that you can apply “economic theory” when Ben Lawsky has clearly stated the final solution will be reverse-engineered to optimize someone’s technology or algorithm (cough Goldman Sachs). So, right off the bat you’re building on sand rather than a free market cornerstone which is little more than a faded memory of our republic.
Centralization Death Spiral
Another argument for not allowing arbitrarily large blocks: Since there are economies of scale for buying bandwidth (or racks of servers), if there is no blocksize limit then only people able to afford servers located in big data centers will be able to run fully-validating nodes. Everybody else will have to trust them, and we’ll end up with a highly centralized system.
This is a reasonable concern, and it is why I think we should put an artificial limit on the size of blocks designed so that anybody with a reasonably good home computer and network connection can participate as a full node on the network. Limiting the supply will both increase price (fees) and decrease demand (the number of transactions people try to send) until a new equilibrium is found.
Higher transaction fees will drive some applications off the blockchain, imposing extra costs. Those costs might be financial– off-blockchain solutions will need some way to pay for themselves. And there will be time and convenience costs; it is less convenient if you must plan in advance and move coins to an off-blockchain solution that supports very low-fee transactions.
Less demand for Bitcoin transactions will lower the overall value of the Bitcoin system compared to a perfect alternative where everybody has infinite bandwidth and CPU to validate transactions. But the value of keeping Bitcoin decentralized in the real world of finite computing resources likely exceeds these costs.
Great. First you suggest a premise that applies economic theory as a form of price discovery application of supply and demand and now you want to put a governor on the go-kart of commerce so that it won’t optimize to speed. Sure, I get the tragedy of the commons that occurred through the overgrazing of high dollar ($ make note of that for future value reference) mining equipment across the democratized Bitcoin landscape, but do you think that breaking out the Mac Classic is the answer? Seriously? Is this how Elon Musk got all those government contracts and tax incentives by saying that no electric car should exceed the speed of the Energizer Bunny?
If Bitcoin in its current iteration doesn’t express a convenience yield that is sufficient to satisfy rapid and mass adoption (or at least risk managers acting as escrow agents that step forward and use Bitcoin as a wholesale platform while capturing the retail market), then let it die. More than any other organization, the Bitcoin Foundation politicized the model, so if you can’t take the K Street heat, then either kick your lobbyist out of the kitchen or get a new cryptocurrency.
Now, get back in there start paying for more congress critters to go to Ruth’s Chris because sending Jon Matonis to Budapest isn’t the answer and if Goldman Sachs is getting you down, you should cut your losses now because this is the big leagues and Savile Row custom-tailored suits are pricey and Ben Lawsky is making one for select Bitcoin enthusiasts… $400,000+ average per Goldman employee (including secretaries) and I don’t think they have a Chief Scientist. http://blogs.wsj.com/moneybeat/2014/10/16/goldman-cuts-pay-ratio-but-average-still-exceeds-400000-per-employee/
Value? Did you say value? We’ll get back to that in a second.
Block Subsidy, Fees, and Blockchain Security
All of the above gets muddled with another economic issue: will transaction fees be great enough to attract enough mining power to secure the network as the number of new bitcoins created drops to zero?
The argument is that keeping one-megabyte blocks will push up transaction fees, so as the block subsidy falls smaller blocks will make it more likely that fees will make up the difference and keep the network secure.
The counter-argument is that bigger blocks allow more transactions, so even if each transaction pays a smaller fee, the total will be greater.
I think that both of those arguments are wrong, because they are equating apples and oranges. The supply being rationed by a maximum block size is some number of bytes, which translates into a certain number of transactions. But the demand for blockchain security depends on the value and nature of the transaction; very large value transactions are typically secured by real-world contracts, long-established trust relationships, lawyers, and court systems.
So there is no guarantee that future one-megabyte blocks will be full of high-fee million-dollar transactions; it is possible we would see blocks full of tiny-fee million dollar transactions, because Gringotts Bank will take the Bank of Elbonia to court if they double-spend some large value inter-bank-settlement transaction.
There is no guarantee that future one-gigabyte blocks full of smaller transactions will generate enough fees to secure the blockchain, either. Transaction confirmation speed is important for most small-value transactions, so it is likely they will be secured using semi-trusted third parties who co-sign transactions and guarantee to never allow double-spending. And if they are secured against double-spending that way, there is little incentive for either the sender or recipient to include a transaction fee to help secure the whole network against double-spending.
It is in everybody’s best interest for the blockchain to be secure against 51% attacks, but the maximum block size will not solve that “common good” problem. Assurance contracts are a time-tested way for a community to pay for common infrastructure; see the excellent forum post from Mike Hearn for details on one way assurance contracts for blockchain security could be funded.
Value? There’s that word again? So, how exactly are you measuring value? Is it your values? Maybe you value being a chief or maybe Jon Matonis values Business Class. What’s your value metric? I thought it was Bitcoin, but it’s sounding increasingly like some more arbitrary thought of building a museum dedicated to old computers where families gather around them like they gathered around the radio listening to FDR tell them about a chicken in every pot and a Pentium in every penthouse and convenience yield is measured in BTU’s during the winter months.
You instantly put yourself into a catch-22 where your ability to be a market prognosticator with no relative measurement for value nearly guarantees that even if you succeed in maintaining your values you destroy the entire escapade. Are you talking value as measured in U.S. dollars? If so, then come out and say it? Is it network traffic and merchant adoption? Maybe it’s Budapest penetration that you’re looking for.
You see that’s the thing about genuine markets. The people that are in those markets express their values and the market functions as a feedback loop bringing those values to the forefront, literally, in the bazaar bazaar known as the free market. While I’m at it a genuine free market doesn’t have a chief scientist but rather it has a scientist in every chicken pot. If you want to take this conversation into one that focuses on the commons, then I suggest your start off with the tragedy known as communism.
If you want to delve into the depths of Garrett Hardin or Elinor Ostrom in your efforts to find the Nash Equilibrium of Bitcoin through some general populace SETI@home consensus, I would suggest you save yourself the trouble and jump straight into cybernetics and Ross Ashby’s law of requisite variety. Only variety can destroy variety and setting an arbitrary boundary based on old computers is a surefire way to relegate Bitcoin to the great moments in financial history dust bin.
One other thing. It is absolutely, positively not in everyone’s interest to secure the blockchain against 51% attacks. Where do you come up with such a belief system? That’s the equivalent of saying “It’s in everyone’s interest if Target’s credit card database doesn’t get hacked.” On the contrary, it’s in someone’s interest to hack it (cough Putin) and that’s why they hack it. Those interests may be financial or simply hacker cred, but unfortunately for you those interests do not get expressed in a blog post (ISIS withstanding), but rather usually come in the middle of the night when we are sleeping.
Leveraging Network Effects
Opinions are divided on whether Bitcoin will evolve into primarily a digital token used for storing value, a currency used as a means of exchange, or as a general global distributed ledger used to secure many different types of transactions. As Bitcoin becomes more popular for all of those uses the number of transactions will rise.
Picking one “killer app” for Bitcoin is a bad idea because Bitcoin gets its value from network effects– the more people using it, for whatever reason, the more valuable it becomes.
Here is a thought experiment: what if we decreased the block size to support just one transaction per minute (ten transactions per block)? Would more or fewer people use it? Would the Bitcoin system overall be more or less valuable? I think any reasonable person would agree that a one-transaction-per-minute Bitcoin would be less valuable than the seven-transactions-per-second system we have today.
Working toward making the Bitcoin system even more valuable over time is something I think we can all agree on.
So, is that a false trichotomy? Does success as store of value (in Tootsie Pops specifically) somehow displace Bitcoins ability to satisfy the double coincidence of wants? Who cares where it works just so long as it works. Are you setting the agenda or is the user base? I don’t get why you even wrote this section. It’s not like you’re Mark Zuckerberg and get to decide… or are you?
Are you now clarifying your “value” as being measured specifically as transaction volume, presumably measured in dollars? Well, if that’s the case Satoshi should have, could have and would have made a faster blockchain. Since when does value equate to speed? Oil tankers are valuable… or at least they were until last week? You lost me here. It’s like asking someone which car would they prefer to take on vacation; the one that drives 25 miles per hour or the one that drives 30 miles per hour? Seriously? No… SRSLY Chief? That’s your thought experiment?
Acknowledgements and Further Reading
Thanks to the following for reviewing a draft of this post: Andrea Castillo, Apostolos Chatzilakos, Carlos Guberman, Daniel Krawisz and Fernando Ulrich.
Oleg Andreev posted about block size economics earlier this year:
Assurance contracts: Mike Hearn
Technical scalability roadmap
The problem with eating out a lot is that you gain weight. The good thing about custom-tailored suits is they have plenty of extra fabric to allow your regulatory tailor, in this case the #NYDFS to let out the waistband: http://tradewithdave.com/?p=22230