This is the final part of my trilogy of articles critiquing Bitcoin. If you haven’t already, go check out The case against Bitcoin’s security (vs POS), and The case against Bitcoin’s Energy Usage.
In this article I’ll dive into the impact of Bitcoin’s tokenomics on its long-term security, it’s governance system, and how these compare to Cardano.
First a Cardano Recap
As I will be drawing comparisons to Cardano it helps to first provide a recap on Cardano for those that are not familiar. Cardano started by taking the same design that Bitcoin is based on, and making the following changes:
- Switching the method of deciding who writes new entries into the ledger (aka block production) from the energy hungry PoW method, to the energy efficient PoS method. This has been in place since the Shelley hardfork in 2020 and been running with zero network outages ever since.
- Extending the ledger so that it can store programming logic not just monetary value. This has been in place since the Goguen hardfork in late 2021, and has given Cardano the ability to run smart contracts – which in turn open up a whole new world of usage for Cardano.
- Implementing on-chain governance so that hard decisions can be decided by Ada holders though voting. This is to come with the Voltaire hardfork, which will be developed once the current phase known as Basho is over.
We will re-visit this final point later in this article.
Hard-forks risk value dilution
Also worth a quick explainer on, is the difference between a soft-fork and a hard-fork. Hard-forks result in two competing chains as explained by Coindesk:
“A hard fork is a change to a blockchain protocol that renders older versions invalid. If older versions continue running, they will end up with a different protocol and with different data than the newer version. This can lead to significant confusion and possible errors.
…Suddenly you have two blockchains, one with both older and newer version blocks, and another with only older version blocks. Which chain grows faster will depend on which nodes get the next blocks validated, and there could end up being additional splits. It is feasible that the two (or more) chains could grow in parallel indefinitely.
This is a hard fork, and it’s potentially messy. It’s also risky, as it’s possible that bitcoins spent in a new block could then be spent again on an old block (since merchants, wallets and users running the previous code would not detect the spending on the new code, which they deem invalid).
The only solution is for one branch to be abandoned in favor of the other, which involves some miners losing out (the transactions themselves would not be lost, they’d just be re-allocated). Or, all nodes would need to switch to the newer version at the same time, which is difficult to achieve in a decentralized, widely spread system.
Or, bitcoin splits, which has happened (hello, bitcoin cash).
A soft fork is essentially the opposite of a hard fork, whereby newly implemented changes remain backward-compatible with older versions.
For example, if a protocol is changed in such a way that tightens the rules, implements a cosmetic change or adds a function that does not affect the blockchain’s structure in any way, then new version blocks will be accepted by old version nodes. Not the other way around, though: the newer, “tighter” version would reject old version blocks.
In bitcoin, old-version miners would realize their blocks were getting rejected and would be forced to upgrade.”
The key take-away here is that blockchain networks will inevitably need upgrades, and in a decentralized network different people will have diferent views over what those upgrades will be. Given that people will invariably disagree with each other, hard-forks run the risk of value being diluted from a block-chain due to chain-splits.
Bitcoin rewards are drying up
A good starting point would be to examine the Twitter thread by Reuben Yap (recommended reading):
The core tenet of Reuben’s argument is that Bitcoin’s security relies on there being miners, who are incentivized to mine through Bitcoin rewards (i.e. new Bitcoin). But the amount of rewards the Bitcoin protocol will pay out to miners is decreasing rapidly in the next few years:
Now the counter argument is that over time the price of Bitcoin is increasing so that it doesn’t matter that the Bitcoin halving cycle means the amount of Bitcoin rewarded to miners is growing smaller – that smaller amount would still be worth more in dollar terms.
However as pointed out by Reuben, this is not something that can go on indefinitely – the world hasn’t suddenly invented a way for everyone to become millionaires. Currently Bitcoin’s prices receives a boost with every 4 year halving cycle, in which the amount of new Bitcoin coming into the supply is reduced by half.
Over time however the impact of this cycle will decrease and price volatility would reduce. From the chart above we see that there’s a sharp leveling off in Bitcoin rewards as early as 2025. As a result the increase in value of Bitcoin would not be enough to compensate for the decreased rewards from mining Bitcoin – there will come a point where miners will not be earning sufficient rewards.
Assuming no other income, Bitcoin miners would find themselves competing in a smaller and smaller space and gradually drop out the race leaving a handful of mega mining companies earning all the Bitcoin. In time they too would collapse leaving just one entity. Having such a centralized set of entities acting as the worlds money printing press is not a high standard for security.
This makes the other form of miner income, transaction fees – charged whenever any transaction in Bitcoin is carried out, so vitally important. And here Reuben points out that since 2017 the number of Bitcoin transactions has not been growing:
This is because Bitcoin is inherently viewed as a store of value, something that the supporters of Bitcoin have been boldly proclaiming since Michael Saylor came on the scene. A store of value makes something a great long-term investment: Buy, hold, then eventually sell if needs must. But it dis-incentivizes the use of Bitcoin in regular transactions. This contradictory view was seen at the recent Bitcoin conference in Miami where Michael Saylor told the crowd to never sell your Bitcoin, while another Bitcoin bull, Jack Maller encouraged them to sell Bitcoin to buy groceries. A Bitcoiner’s outlook can therefore be summed up as “I don’t want to transact using Bitcoin, but I want everyone else to”. Nobody want’s to be the next Laszlo Hanyecz.
Bitcoin mining
Bitcoin has also moved on from the days of being able to mine using CPUS, then GPUs. Nowadays any serious miner would use ASICs – machines designed specifically to mine Bitcoin. As a result Bitcoin mining has become dominated by big corporations.
Bitcoin mining pools do offer a solution to this. Would recommend pausing to read this to get up to speed on them. As the article points out, one of the cons of mining pools is:
“Centralization and Control: As discussed previously, mining pools and farms bring cryptocurrency into a centralized validation and creation process. Control then becomes an issue because mining farms essentially control the rewards.”
So Bitcoin has some serious security concerns at it’s heart. Rewards are decreasing, centralization is increasing, and fees are stagnating. (Also note, everything I am saying was highlighted as far back as 2013 in this article in which stated Bitcoin woukd have to change to survive.)
Now it would be disingenuous to say Cardano won’t have it’s own day of reckoning. Rewards from staking will decrease over time and it’s effective annual inflation rate is not too dissimilar to Bitcoin’s, and so transaction fees will have to rise over time to provide pool operators with a substitute income. However fees can be increased on Cardano without risking a chain split (see governance further below) and the fact that Cardano is also a smart contract platform provides a lot more utility to Ada than simply being a store of value.
Cardano has a built in mechanism to counteract block production centralization. Bitcoin doesn’t
Just like in Bitcoin where new Bitcoin is paid as a reward, Cardano pays out rewards of new Ada. The difference is that Bitcoin gives it all to miners, where as in Cardano the rewards are shared between stake pool operators (the equivalent of a miner in a POS system), and delegators – ordinary people like you and me that select a stake pool to associate their Ada with and which in turn gives that stake pool a higher chance of earning rewards.
With Bitcoin the more electricity you can consume, the greater your the miner rewards. With Cardano the more Ada delegations you can attract the greater the stake pool rewards. What this means is that stake pools need to be popular with Ada holders in order to stay profitable. This gives Ada holders a very direct way to prevent the network from centralizing around a handful of stake pool operators.
Bitcoin’s governance model is fragile
The Bitcoin community is no stranger to having to make decisions about changes to the protocol. There are two ways in which changes can be made to the Bitcoin protocol depending on whether it’s a soft-fork or a hard-fork.
A soft-fork requires a clear miner majority expressed by blockchain voting as explained here:
Bitcoin proposals are sent out to interested parties and published publicly. The voting on whether a proposal is good for the community comes down to all involved participants, but more specifically the miners and mining pool operators as they carry the full node and are therefore capable of refusing to participate.
The method used for voting is where each miner includes a piece of code in their coinbase transaction (i.e. when they win the proof of work challenge) between a specific time set by the developers for the vote on that particular BIPS proposal.
The vote could take place over let’s say 100 blocks, in which time a mining pool will include its yes or no vote in the blockchain 30 times of it controls 30% of the hashing power, so votes are proportional to the percentage of hashing power attributed to the network.
So the process is that developers make a proposal and then miners vote on it. If there is a majority vote for yes then the code is implemented by the miners. A majority is defined as when over 55% of the miners vote for a specific change.
This method is not without controvery as it means the changes to the network are dictated by the miners. The rest of the community can weigh in with their opinions but ultimately it’s the miners vote that counts. There are no chain splits with a soft-fork so the community cannot express their disapproval short of selling their Bitcoin.
With hard-forks where you have two competing chains, the Bitcoin community can vote with their wallets and decide whether to hold the new coin or the old coin.
This however risks value dilution. It’s like a democracy in which in each election cycle the people that voted for the majority party, pack up and move to a new island to form a new government, leaving those that didn’t agree with them behind.
It’s precisely for this reason that even relatively basic decisions such as whether Bitcoin should increase it’s block-size lead to chain-splits and the creation of Bitcoin Cash, and Bitcoin SV. Not only does this result in value dilution, it also diverts a lot of the communities energy into arguing with one another in a bit to attract more converts to their side.
Cardano’s governance was designed to allow community consensus
Proof-of-stake systems tend to solve this by having community voting. See Algorand and Avalanche. I’ll however stick to Cardano as that is the one I am most familiar with.
Cardano was designed to with governance in mind and while there is some amount of community voting alread they full roadmap will be completed with Volataire:
“The Voltaire era of Cardano will provide the final pieces required for the Cardano network to become a self-sustaining system. With the introduction of a voting and treasury system, network participants will be able to use their stake and voting rights to influence the future development of the network.
“The Voltaire era of Cardano will provide the final pieces required for the Cardano network to become a self-sustaining system. With the introduction of a voting and treasury system, network participants will be able to use their stake and voting rights to influence the future development of the network.
For the Cardano network to become truly decentralized, it will require not only the distributed infrastructure introduced during the Shelley era but also the capacity to be maintained and improved over time in a decentralized way. To that end, the Voltaire era will add the ability for network participants to present Cardano improvement proposals that can be voted on by stakeholders, leveraging the already existing staking and delegation process.”
Proof-of-stake coins are therefore taclking the issue of how to deal with disagreement in a community through democractic means, You debate, you vote, you move on. Proof-of-work coins like Bitcoin, as described earlier, have you debate, you go live seperately, you continue to debate.
You do of course requires a vocal, critical, and active community for democracy to function, something which Cardano currently excels at. The community is already regularly involved in voting for how to invest an ever increasing amount of community funds, with the most recent funding round being worth $16m USD. How many communities can say they let their users decide what to do with that much money?
There is also the idea of having dReps to whom you can choose to represent your vote on your behalf. This is a way of ensuring that those that are less active still have a say, and those with small stakes can band together behind a dRep that represents their interest.
Proof-of-work allows the land-owners to consolidate power and exert control over the system. Furthermore a Bitcoin centric world would encourage an energy wastage arms race between countries as they sought to out-mine one another and be the biggest landowner.
Conclusion
This brings to an end my 3-part article examining concerns around Bitcoin. I made the argument that Bitcoin’s use case ought to be restricted to soaking up excess green energy. I then explained how Proof-of-stake coins like Cardano have the same level of security as Bitcoin. And then I discussed how Bitcoin’s lack of governance makes it very susceptible to chain splits, and is trending towards centralized control by an ever shrinking group of miners.
The purpose of these articles isn’t to necessarily bash Bitcoin (though I clearly have a strong preference for Proof-of-stake), but to encourage a skeptical mind when claims about Proof-of-work vs. Proof-of-stake are made. It’s not a simple black and white issue, and Cardano’s implementation is just one of many different types of Proof-of-stake implementations. The next 12 months will see crypto regulation being formed and it’s important for law makers to understand the nuances of the technology.
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