Monday, 17 December 2012

the economics of avoiding real resource consumption in cryptocurrency mining

Readers of this blog might be interested in my proposed alternative to the "proof of work" mining system that currently underpins Bitcoin. I call it "proof of burn". Its motive is to avoid the consumption of real resources (hardware, electricity,...) which proof of work entails. It nevertheless feels, to an individual miner, just as "expensive" as real resource consumption would be.

        Bitcoin Wiki article: "Proof of burn"

The question an economist should immediately feel like asking, on hearing this, is: OK, if those real resources have not been consumed (destroyed); and yet they've disappeared from the portfolios of miners just as if they had been consumed; then... who's receiving them?! And the fascinating answer (discussed in the "Economic implications" section of the Wiki article) is: they go to all coin-holders, in proportion to holding. In other words, a proof-of-burn cryptocurrency is something like a decentralised joint-stock company! (The coins are like "shares", yielding a stream of "dividends"!)

I believe this curious fact has the potential to strengthen cryptocurrency by increasing its value to holders. They not only get the benefits of a teleportable, unseizable, undilutable asset - benefits already widely known about and discussed - but the additional, more "traditional" benefit of whatever they estimate the discounted future value to be, of [their appropriate fractional share of...] all the future fees arriving into the hands of miners! (Minus, of course, the true competitive-equilibrium costs to miners [including profit as risk-aversion "cost"] of mining's various supporting activities. Maintaining a net connection, checking blocks and transactions are valid... that sort of thing.) I call this a "traditional" sort of benefit because it's just like putting a value on a company's shares by estimating its flow of future profits. It can be enjoyed even by coin-holders who aren't particularly interested in holding cryptocurrency qua cryptocurrency. (They just follow the "spend your dividend on a treat" strategy I discuss in the article.)

This strengthening of value is not "magic" - it's not "coming from nowhere" - it's coming from precisely the fact that real resource consumption/destruction (as would have happened under proof of work) is being avoided. And the coin-holding community reaps the benefits!

A final note: the same sort of thing happens under at least the leading versions of proof of stake too. But there, coin holders have to become miners themselves to get their flow of "dividends". Now, maybe that's a good thing in some ways: many people worry that in the future, there might be too few miners. It does mean, though, that non-expert coin-holders (i.e. non-miners) can't enjoy the benefit; and in my opinion, that probably means the strengthening of value will be less. At any rate, there's lots here for economists to think about!

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