In a new working paper from the Bank for International Settlements (BIS), principal economist Raphael Auer takes aim at bitcoin’s backbone, claiming that Proof-of-Work is a fatally flawed system.
If Auer is to be believed, then as block rewards reduce over time, the network will struggle to provide miners with an adequate level of income via fees alone, causing liquidity to dramatically fall and making it almost impossible for payments to get fully confirmed. The paper states: "Whenever block rewards decrease, the security of payments decreases and transaction fees become more important to guarantee the finality of payments. However, the economic design of the transaction market fails to generate high enough fees. A simple model suggests that ultimately, it could take nearly a year, or 50,000 blocks, before a payment could be considered ‘final’."
Without high enough fees,_ _the incentive for miners to act in the interest of the whole network is reduced, and the likelihood of "double-spend" or 51 percent attacks increases.
According to Auer, second-layer solutions like the Lightning Network could help by moving transactions off-chain, but the effectiveness would be limited by Lightning’s own scaling limitations. The only "fundamental remedy", Auer suggests, "would be to depart from Proof-of-Work" entirely.
An age-old criticism
Bitcoin’s consensus algorithm has collected a lot of critics over the years, and the paper builds on similar arguments put forward by University of Chicago economics professor Eric Budish in his 2018 report "The Economic Limits of the Blockchain".
Budish argued that unless the rewards from mining exceed a certain percentage of the value that can be stolen through a double spend attack, then the network will not be secure. This means that as the network grows, double spend attacks get more attractive, and attack prevention gets more expensive.
This doesn’t bode well for the future security of the network. But some bitcoin developers, like Jimmy Song, have argued that a healthy fee market can help keep the network secure even as block rewards reduce: "the block reward halves every 4 years and the block reward is projected to be smaller than the fees per block in about 7 years. The economic incentive structure for miners in the future depends on a fee market existing."
Given that there has never been a 51 percent attack on bitcoin, and that the last bitcoin block is not set to be mined until 2140, the economic criticism levelled by Auer might seem overly theoretical — and some suggest that the motives of the bank might be less than pure.
Sitting at the heart of global finance, the Bank for International Settlements is run by an inner elite representing the world’s major central banks. From its base in Switzerland, the group decide on the global rules that govern the financial system — co-ordinating interest rates, credit availability, and other monetary policies around the developed world.
For those that believe bitcoin to be a potential replacement for fiat currency, like Bitcoin Standard author Saifedean Ammous, the organization is bitcoin’s ultimate nemesis — and has a clear incentive to try and dismantle the crypto ecosystem.
But, despite the criticism that the paper puts forward, it’s not nearly as dismissive as previous reports, and the elite group appear to have developed a more balanced view of crypto as the ecosystem has progressed.
Just 11 months ago, Bank of International Settlements manager Agustín Carstens said cryptocurrency was a ‘Ponzi scheme‘ that "posed a threat to financial stability", and in a report issued in June of the same year, condemned cryptocurrency as "the alchemy of the age of innovation".
But, as Weiss Ratings note, the organisation has now changed tack, and has begun to engage with cryptocurrency as a potential alternative — rather than replacement — financial system:
"The overall conclusion from this paper is that, at least judging based on current technologies, in the digital age too, good money is likely to remain a social construct rather than a purely technological one: the efficiency of decentralised exchange via proof-of-work exclusively is much lower than would appear at first sight, and alternative technologies still need to demonstrate that they can function without institutional backing. But claiming that technology alone cannot do the trick is not to say that it is useless. It simply means that the focus could shift away from the issue of whether the technology can replace traditional sovereign money and financial institutions."
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