Bitcoin is a live, multi-billion-dollar experiment involving tens of millions of willing participants.
It’s also a case study in game theory, the field of science that studies the interactions between decision makers whose choices affect each other.
These are the central arguments of Hasu, the pseudonymous German cryptocurrency researcher who is our guest on the latest episode of the New Money Review podcast.
Satoshi Nakamoto’s 11-year old cryptocurrency is most remarkable for its invention of a new collective incentive scheme
According to Hasu, Satoshi Nakamoto’s 11-year old cryptocurrency is most remarkable for its invention of a new collective incentive scheme, based on the translation of a real-world energy cost into a network carrying monetary value.
At the same time, says Hasu, there are still unresolved questions about the long-term viability of bitcoin and its competitors.
In bitcoin, he says, it remains to be seen whether the network will remain secure once the block subsidy—the monetary reward paid to bitcoin miners for updating and maintaining the database—is replaced entirely by transaction fees at some point during the next century.
And the ethereum network is still too centralised, argues Hasu, as a result of the relatively high cost of maintaining a fully validating ethereum node.
In the podcast, Hasu also discusses the tensions between cryptocurrencies and the legacy financial system, as well as the rapidly growing decentralised finance market.
Below are some key excerpts from the discussion between Hasu and New Money Review editor Paul Amery.
To listen to the podcast, click here.
Bitcoin’s real innovation
“None of the cryptography in bitcoin is new—it’s existed for decades. The only real invention in bitcoin was the concept of proof-of-work mining: how the database is secured, who can write to it, and associating a real-world cost to updating the database.”
“As with all systems based on incentives, you can only guess how humans in the actual world will behave. How humans react to incentives is actually pretty messy. It was far from obvious that the incentive scheme that Satoshi invented would work.”
Bitcoin’s long-term viability
“Most people think bitcoin is secured by the cryptography and don’t focus so much on the incentives involved. But there’s a growing number of people who look at how the incentives in bitcoin are changing due to the declining block subsidy, and see it as a growing concern for the future.”
“From a systems design perspective, there is a chance that things might not work out. There’s no feedback loop that could ensure transaction fees are definitely high enough. Empirically, they haven’t been enough in the past, except perhaps for one year, 2017.”
“I think bitcoin has another ten years to go before [declining block rewards] become a problem. But if the incentive for miners ever becomes insufficient, it’s not like bitcoin will just disappear from one day to the next. Instead, we’d see the settlement assurances of the blockchain degrade slowly over time. For example, there would be occasional double-spend attacks against exchanges. We’ve recently seen such attacks in smaller proof-of-work cryptocurrencies, like ethereum classic.”
“Bitcoin is not bound anywhere locally”
Bitcoin’s network security
“Hash rate is not a reliable indicator of bitcoin’s network security. For example, the amount of hash rate you can buy for $1000 goes up every year because of improvements in hardware.”
“If bitcoin gets more and more expensive and has more and more adoption, you also have this increasing risk on the other side. Where is the point at which a nation state says, ‘We have to do something about bitcoin, we’ve ignored it so far but now it’s bigger than gold’? Then the incentive to attack bitcoin via mining is much higher. You always have to look at how much bitcoin spends on its defences relative to the incentives for a possible attacker.”
“Bitcoin’s main strength is its ability to exist outside the existing financial system. The network in itself is completely independent. Bitcoin is not bound anywhere locally. Even if states went after miners, they could just relocate to any country in the world with more favourable regulations.”
“Blockchains are useful for (a) money and (b) financial services, and that’s it”
The impact of the FATF Travel Rule
“Even if the bitcoin network exists outside the current financial system, the risk is that it could still be eclipsed from the outside by very strong regulation.”
The resurgence of ethereum
“After the initial coin offering (ICO) boom and bust, many investors were disillusioned with the ethereum project, even though later on in 2018 and 2019 the fundamentals—as indicated by applications like Uniswap, Kyber or DYDX—were only getting better.”
“We’ve seen the collapse of many of the more ineffective narratives surrounding ethereum’s potential use cases into a smaller number of narratives. Blockchains are useful for (a) money and (b) financial services, and that’s it.”
Ethereum’s long-term viability
“I think the concerns about the long-term viability of ethereum are a bit overblown. In my mind the most important unresolved issue is the uncontrolled growth of the ethereum blockchain’s state. Containing state growth is so important because it’s the bottleneck for the cost of running a fully validating node. In ethereum you need around $500 of hardware to run a node, whereas in bitcoin it costs $100-200. So ethereum is more costly to run in a trustless way than bitcoin, and that’s created some bad habits among users.”
“I’m glad that we will get to see both bitcoin’s no-subsidy model and ethereum’s perpetual subsidy model play out side by side.”
Maker Dai and the decentralised finance experiment
“The Maker Dai experiment has been brilliant in teaching everyone in this space a lot about money. Especially in the bitcoin community, people tend to argue that fiat money is created out of thin air. But when you replicate the existing banking system with a project like Maker, you realise that commercial bank money is always collateralised. What banks do is merely to transform an illiquid asset into a liquid one, such as bank deposits.”
“To me, the real value of decentralised finance is that we can have many experiments play out at the same time. There’s a sandbox for people to experiment. We’ve never really had this in the traditional financial system.”
Themes for 2020
“It’s important to keep reminding people of the risks in these projects, even as we appear to be entering a new bull market.”
“I expect digital gold and decentralised finance to continue to be major trends.”
Sign up here for our monthly newsletter
Click here for a full list of episodes of the New Money Review podcast: the future of money in 30 minutes