[Question] Will the Bitcoin fee market actually work?

[TropicalFruit]

Based on other posts I’ve seen on here, many of you are Bitcoiners. While I clearly see the value proposition, I have a few questions about the protocol that haven’t been answered, and I figure the lesswrong audience is my best change.

1.) Will the fee market actually work?

Is there any evidence of a fee market working, incentive wise? Gold used inflationary proof-of-work indefinitely. Miners extract value from the monetary network by making more gold. They can increase or decrease their mining efforts due to supply and demand. This yielded a 1-2% inflation rate into perpetuity, and acted as a stable monetary system for many centuries.

Bitcoin… is trying to replace the model of inflation-paid-to-the-miners with one of voluntary fees. Has that every been tried? Are there economic reasons to strongly believe the network will remain secure as the block subsidy goes down?

2.) Will lightning ever work?

My understanding is that the current lightning network is more of a proof-of-concept, rather than an actually useful, scalable solution today. It’s almost impossible to settle on the main chain, because the TPS of the main chain is so low. Additionally, there are denial of service security issues and logistical overheads like watchtowers that make it relatively impractical in its current state.

Bitcoiners don’t seem bothered by this. Is there a good reason to believe this is just technology in its infancy, and these structural problems will slowly be solved?

3.) Can deflationary money work?

Human beings are loss averse, and most of the monetary systems throughout the world have had slight inflation to offset this. Slight loss aversion = spending too little compared to what you should be. Slight inflation is a pressure to spend more than you’d like, so it offsets the loss aversion.

I’m not sure a human biased economy can actually function on a deflationary standard, because people actually won’t spend on things that would economically benefit them, because they’re so attached to the appreciating currency.

Trying to get answers to these questions on reddit was abysmal… but we’ve got a different audience here, so hopefully someone can help me out. Thanks.

[RHollerith]

I’m not sure a human biased economy can actually function on a deflationary standard

There were long stretches of time during which the supply of gold and silver did not keep up with economic growth when gold and silver and currencies backed by gold and silver were the only currencies. Isn’t that proof that an economy can function using a deflationary currency?

[Ben]

It certainly proves something. However, one could argue that the economy didn’t function very well for much of that time. The industrial revolution happened not long after a whole load of new world gold entered Europe. That could just be because the technology and society forces that allowed the new world to be colonised where also prerequisite for industrialisation, but I think some people draw direct causality between the gold influx and industrialisation.

[TropicalFruit]

This is a super interesting take. I’ll keep it in mind if I dig into the history of monetary systems again.

[anithite]

First off, take a look at some of the numbers:
https://​​bitinfocharts.com/​​comparison/​​fee_to_reward-btc.html#alltime

Defining “work”

Will the bitcoin network shut down? No, not unless there’s some sort of global disaster. The question is what happens to the hashrate, transaction fees and general guarantees about being able to get transactions included in the blockchain, which affects the lightning network.

Current miner compensation is overwhelmingly the 6.25 BTC block reward. Fees are 2-10% of that. But consider that an average block transacts perhaps 5K BTC. Bumping current fees by 10x is plausible and there’s some past precedent. End result is 5$US fee per transaction giving miners about half the original revenue. This would be fine in a scenario where total hashpower drops by 2x or something. Current electricity use is 200M$ per day. Is that actually necessary?

Flat fees might be a problem though. Median transaction value is 300$ whereas average is much much higher. If everyone below $300 balks at a $5 fee then you lose half the fees. The obvious answer is flat+% or some other fee>F(value) requirement(IE:price discrimination). It’s a coordination problem under conditions of perfect information between a small number of pools to find a revenue maximizing price discrimination curve. A single large pool moving to flat+% tips things in that direction. Transactions that don’t comply with the % fee have their expected delay to first confirm distribution scaled by a factor of (Total_Hashpower/​Flat_fee_hashpower) So if a large pool with 1/​3rd of global hash power moves to the new fee model, large transactions with small fees see 50% higher time to first confirm. It should be pretty easy to tip the equilibrium in that direction. There will be holdouts but I expect (P=90%) that this will happen in some form.

TL:DR:expect higher fees and especially for large transactions

2.) Will lightning ever work?

To be practical, lightning has to be safe, cause people have to lock their funds into channels to use it. Fallback channel resolution requires miners to honestly prioritise transactions with higher version numbers which they might not do. A single dishonest miner can steal funds (p=fractional hashpower at critical block). Blockchains with turing complete smart contracts can do dispute resolution properly guaranteeing correct resolution even if most miners are censoring transactions.

Bitcoin can’t implement that logic (yet) but maybe some development can get something to sort of work. I don’t expect to see adoption given current tech. Other blockchains seem like a better option both for their turing complete smart contracts and lower transaction costs.

Watchtowers aren’t a problem. The economic model for those is fine. If they don’t do their job they lose their reputation and that’s easy to test.

3.) Can deflationary money work?

People sell houses right? Bitcoins can’t be eaten or lived in and so will eventually be sold. If this is a serious issue that hurts the Value Proposition --> price goes down or rises more slowly --> other assets take market share for value storage --> problem solved. There’s definitely transaction volume so it doesn’t seem like a problem.

[Dagon]

Gold used inflationary proof-of-work indefinitely.

What?! Gold used physical-world trade for a long long time, it did not (and still does not) self-host ownership transfers. The inflation/​mining of gold is absolutely disjoint from any ledger, transfer, or ownership considerations.

Bitcoin is designed to get more expensive to mine over time, and critically, to use mining as the ledger voting mechanism (that’s the proof-of-work part—it’s the blockchain contents, not the tokens). That combined use (token and blockchain) is the primary innovation which made it successful.

Whether it’s well-established enough to survive the transition to a different transaction fee/​proof system when mining is no longer feasible (or eventually, possible at all) is currently unknown. There’s no intrinsic value behind it (that is, no industrial use and no government demanding their taxes/​payments in that form), so it seems likely to me that it eventually goes to zero.

But “eventually” can be a long time. I suspect that most currencies will die as other currencies become … current. As long as they do so slowly enough that most people can trade for the more useful newer options, no worries.

I don’t think there is one human economy, and certainly not one that lasts for more than a few dozen to at most a few hundred years. The question of whether a currency is inflationary or deflationary for any given period of time is pretty small potatoes compared to all the other forces of change and competition for value measurement, trading, and storage.

[TropicalFruit]

Gold used physical-world trade for a long long time, it did not (and still does not) self-host ownership transfers.

You’re right, it’s not identical. However, monetary supply was decided via proof-of-work. Chain of ownership and custody was not. I was referring to monetary policy here, but that is an important distinction.

There’s no intrinsic value behind it (that is, no industrial use and no government demanding their taxes/​payments in that form)

The use of gold in electronics makes it a worse form of money, not better. The fact that you have to put money in your phone to make it work is very economically awkward.

As for intrinsic value—no currency has intrinsic value. It’s a network of people who agree something has value in order to animate trade.

Bitcoin’s value proposition is that it functions as a unit of account/​store of value better than any other currency right now, incentivizing people to store value and account in it. Right now, it’s store of value is there. Unit of account may be close, and medium of exchange seems a ways off, if it does, in fact, get there. That’s the value proposition—better money, thereby causing better economic coordination.

The question of whether a currency is inflationary or deflationary for any given period of time is pretty small

I hadn’t considered this. I guess we’d also expect the rate of economy fluctuation to increase, like everything else does. It’s quite possible we’ll see a technology better than Bitcoin, or even something stranger, like successful friendly AI obviating the need for money, within a century. Still, I think that if the claims of deflationary death spirals from history are accurate (which I do suspect they aren’t), then it makes sense to ask this question, even in the short-ish term.