Bitcoin Must Centralize, But Where?

By Max Gulker

While 2017 has seen massive increases in the price of Bitcoin, it might also be remembered as a sobering year for the cryptocurrency’s early adopters and supporters. With two major forks, it has become clear that the dual dreams of Bitcoin becoming a widely used currency while remaining radically decentralized at every level are starting to come into conflict. It would be tremendously expensive and inefficient to run anything close to the number of transactions in world commerce on the Bitcoin blockchain. Much of this year’s debate has been about where that centralization should occur: among miners or in processing transactions.

If some global event left Bitcoin as the only currency in the world tomorrow, the transaction fees miners receive would skyrocket to prohibitive levels. How might the free market solve this problem? My guess is that PayPal, credit card companies, banks, or startups would quickly offer secondary levels of payment. They would keep accounts with people’s bitcoins, but people would then trade claims to those accounts on a more PayPal-like system. (This begins to look a lot like the world that economist Saifedean Ammous envisions in his upcoming book The Bitcoin Standard.) These services would charge a fee, but one far less than the going rate on the Bitcoin blockchain. Essentially, they would take advantage of economies of scale in processing transactions to offer consumers a service at much lower cost.

In the battle to scale up the Bitcoin network, the Segwit2x proposal essentially makes the scenario envisioned above easier, while the Bitcoin Cash proposal instead centralizes at the mining level, allowing for vastly increased size of the “blocks” being mined. And there’s the debate: do we trust central intermediaries to process our transactions and mine our bitcoins?

And then there are those still dreaming. Bitcoin Gold, which forked last month, basically does the opposite of Bitcoin Cash in its intended effect. Since the inception of Bitcoin mining, the market has produced expensive hardware that offers advantages, thus increasing the cost (and centralization) of mining. Bitcoin Gold offers a change that would make those new machines obsolete, bringing everyone back to the more basic equipment. Bitcoin Gold contributor Alejandro Regojo said that "with this fork, we want to show how Bitcoin can be as 'Satoshi' as possible, as social as possible, and as decentralized as possible." (As a side note, I love that “Satoshi” is now an adjective, though I’m not sure whether it means “decentralized” or just “good.”)

Ultimately, it is the miners who control the code or “rules of the game” behind Bitcoin. In my mind, that makes centralization at that level more concerning than the payment processing layer. But it’s likely that the free market would offer centralizing solutions at both levels. And there’s some irony in the fact that the evangelists of decentralization are trying to control that process from the top down. Centralized intervention to control the rules of the game? That’s so un-Satoshi, bro.

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Max Gulker

Max Gulker is an economist and writer who joined AIER in 2015. His research often focuses on free markets and technology, including blockchain and cryptocurrencies, the sharing economy, and internet commerce. He is a frequent speaker at industry conferences, especially on blockchain technology. Max’s research and writing also touch on other economic topics, including governance, competition, and small businesses.
 
Max holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Prior to AIER, Max spent time in the private sector, consulting with large technology and financial firms on antitrust and other litigation. Follow @maxgAIER.