Bitcoin Mining is an oligopoly, and Proof-of-Stake isn’t better.

Bitcoin Mining is an oligopoly, and Proof-of-Stake isn't better.

The Evolution and Challenges of the Blockchain Industry

When Satoshi Nakamoto introduced the concept of a peer-to-peer electronic cash system in the Bitcoin whitepaper, it captivated many by its idealism and potential to empower individuals to have control over their money. The blockchain industry emerged as a decentralized alternative to traditional financial systems, offering optionality and circumventing the control of centralized entities like government-controlled central banks and large banking corporations.

At first glance, the concept of proof-of-work (PoW) seemed righteous and fair, as it rewarded those who put in the effort. In the case of Bitcoin, this meant the miners. However, the reality of PoW has evolved over time, resulting in the concentration of power in the hands of companies running large-scale node operations. This centralization is driven by economies of scale, where larger mining operations are more cost-efficient and maximize their rewards, pushing smaller miners out of the competition.

According to the National Bureau of Economic Research, a small number of miners controlled a significant percentage of the Bitcoin network, hinting at an emerging oligarchy within the industry. This concentration of power raises concerns about the democratization and decentralization that the blockchain industry aims to achieve.

Proof-of-stake (PoS), often touted as the eco-friendly alternative to PoW, also faces criticism for resembling a plutocracy. Ethereum’s transition from PoW to PoS was driven by environmental benefits, but it inadvertently resulted in wealthier participants gaining more influence over the network. For example, Coinbase holdings 11.5% of all staked ether (ETH), giving the company significant sway in decision-making processes. This concentration of power mirrors the influence of a single company over the policies of the Federal Reserve, highlighting concerns about whether the blockchain industry is becoming an exclusive domain controlled by the elites.

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In both PoW and PoS blockchains, conflicting interests between miners/validators and network users are evident. Users desire faster and cheaper transactions, while miners and validators may see reduced profits if these demands are met. This conflict of interest often resembles a zero-sum game, where one party’s gain is another party’s loss. A similar conflict arose during Bitcoin’s Blocksize War when debates centered around increasing the size of mined blocks to accommodate more transactions. The larger blocks would reduce fees but increase costs for miners. This conflict highlighted the need for alignment of incentives between different stakeholders in the blockchain industry.

Governance within the blockchain industry revolves around power, which can be effectively channeled through well-aligned incentives. In the quest for fair outcomes, designers of blockchain systems must ensure that the incentives motivate all players toward a shared goal. Achieving perfect equilibrium through incentives alone may not always be possible, but it is crucial to minimize conflicting interests that can result in unfair outcomes.

While conflicts and divergent interests can lead to productive discussions, unilateral exercise of power without considering conflicting interests may result in undesirable outcomes. A famous thought experiment in game theory, the Prisoners’ Dilemma, showcases the suboptimal outcomes that can arise when individuals prioritize personal gains without considering the bigger picture. The two sides of the Blocksize War debate bore resemblance to this scenario, where both parties acted in their own self-interest, resulting in an outcome that was not beneficial to any participant.

Fortunately, the blockchain industry is not limited to PoW and PoS, and several consensus mechanisms are being explored. The most crucial aspect for blockchain developers is to find ways to align the incentives between miners/validators and network users. Satoshi Nakamoto’s innovation in solving the Byzantine Generals Problem demonstrated that a distributed pool of miners could be incentivized to agree on a single truth without relying on a centralized authority. However, as the industry evolved, it became evident that miners often benefited at the expense of users. Finding sustainable ways to transform mining into a non-zero-sum game will be a challenge, but lessons from the field of politics could provide valuable insights. By removing direct monetary rewards as the sole incentive for miners/validators, we may discover alternative approaches that foster fair and inclusive blockchain ecosystems.

In conclusion, the blockchain industry has made significant strides since Satoshi Nakamoto’s groundbreaking whitepaper. However, challenges such as the concentration of power and conflicting interests among stakeholders pose risks to its democratic and decentralized vision. By aligning incentives and exploring alternative consensus mechanisms, the industry can navigate these challenges and forge a path towards a more equitable future.