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Beyond the doomsday economics of "proof-of-work" in cryptocurrencies

Raphael Auer

No 765, BIS Working Papers from Bank for International Settlements

Abstract: This paper discusses the economics of how Bitcoin achieves data immutability, and thus payment finality, via costly computations, ie "proof-of-work". Further, it explores what the future might hold for cryptocurrencies modelled on this type of consensus algorithm. The conclusions are, first, that Bitcoin counterfeiting via "double-spending" attacks is inherently profitable, making payment finality based on proof-of-work extremely expensive. Second, the transaction market cannot generate an adequate level of "mining" income via fees as users free-ride on the fees of other transactions in a block and in the subsequent blockchain. Instead, newly minted bitcoins, known as block rewards, have made up the bulk of mining income to date. Looking ahead, these two limitations imply that liquidity is set to fall dramatically as these block rewards are phased out. Simple calculations suggest that once block rewards are zero, it could take months before a Bitcoin payment is final, unless new technologies are deployed to speed up payment finality. Second-layer solutions such as the Lightning Network might help, but the only fundamental remedy would be to depart from proof-of-work, which would probably require some form of social coordination or institutionalisation.

Keywords: cryptocurrencies; crypto-assets; digital currencies; blockchain; proof-of-work; proof-of-stake; distributed ledger technology; consensus; bitcoin; ethereum; money; digitalisation; finance; history of money (search for similar items in EconPapers)
JEL-codes: D40 D20 E42 E51 F31 G12 G28 G32 G38 L10 L50 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ict, nep-mac, nep-mon and nep-pay
Date: 2019-01
References: View references in EconPapers View complete reference list from CitEc
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Working Paper: Beyond the doomsday economics of "proof-of-work" in cryptocurrencies (2019) Downloads
Working Paper: Beyond the Doomsday Economics of “Proof-of-Work” in Cryptocurrencies (2019) Downloads
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