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The Economic Limits of Bitcoin and the Blockchain

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  • Eric Budish

Abstract

The amount of computational power devoted to anonymous, decentralized blockchains such as Bitcoin's must simultaneously satisfy two conditions in equilibrium: (1) a zero-profit condition among miners, who engage in a rent-seeking competition for the prize associated with adding the next block to the chain; and (2) an incentive compatibility condition on the system's vulnerability to a “majority attack”, namely that the computational costs of such an attack must exceed the benefits. Together, these two equations imply that (3) the recurring, “flow”, payments to miners for running the blockchain must be large relative to the one-off, “stock”, benefits of attacking it. This is very expensive! The constraint is softer (i.e., stock versus stock) if both (i) the mining technology used to run the blockchain is both scarce and non-repurposable, and (ii) any majority attack is a “sabotage” in that it causes a collapse in the economic value of the blockchain; however, reliance on non-repurposable technology for security and vulnerability to sabotage each raise their own concerns, and point to specific collapse scenarios. In particular, the model suggests that Bitcoin would be majority attacked if it became sufficiently economically important — e.g., if it became a “store of value” akin to gold — which suggests that there are intrinsic economic limits to how economically important it can become in the first place.

Suggested Citation

  • Eric Budish, 2018. "The Economic Limits of Bitcoin and the Blockchain," NBER Working Papers 24717, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:24717
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    Cited by:

    1. Donato Masciandaro, 2018. "Central Bank Digital Cash and Cryptocurrencies: Insights from a New Baumol–Friedman Demand for Money," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 51(4), pages 540-550, December.
    2. Assimakis Kattis & Fabian Trottner, 2020. "Stabilizing Congestion in Decentralized Record-Keepers," Papers 2005.06093, arXiv.org.
    3. Zimmerman, Peter, 2020. "Blockchain structure and cryptocurrency prices," Bank of England working papers 855, Bank of England.
    4. Raphael Auer, 2019. "Embedded supervision: how to build regulation into blockchain finance," BIS Working Papers 811, Bank for International Settlements.
    5. Dhillon, Amrita & Kotsialou, Grammateia & McBurney, Peter & Riley, Luke, 2020. "Voting over a Distributed Ledger: An interdisciplinary perspective," SocArXiv 34df5, Center for Open Science.
    6. Lin William Cong & Zhiguo He & Jiasun Li, 2019. "Decentralized Mining in Centralized Pools," NBER Working Papers 25592, National Bureau of Economic Research, Inc.
    7. Hitoshi Matsushima, 2019. "Blockchain Disables Real-World Governance," KIER Working Papers 1017, Kyoto University, Institute of Economic Research.
    8. W. Scott Frame & Larry D. Wall & Lawrence J. White, 2018. "Technological Change and Financial Innovation in Banking: Some Implications for Fintech," FRB Atlanta Working Paper 2018-11, Federal Reserve Bank of Atlanta.
    9. He Huang, 2019. "How Does Information Transmission Influence the Value Creation Capability of a Digital Ecosystem? An Empirical Study of the Crypto-Digital Ecosystem Ethereum," Sustainability, MDPI, Open Access Journal, vol. 11(19), pages 1-16, September.
    10. Daniel Ferreira & Jin Li & Radoslawa Nikolowa, 2019. "Corporate Capture of Blockchain Governance," Working Papers 880, Queen Mary University of London, School of Economics and Finance.
    11. Raphael Auer, 2019. "Beyond the Doomsday Economics of “Proof-of-Work” in Cryptocurrencies," Globalization Institute Working Papers 355, Federal Reserve Bank of Dallas, revised 01 Feb 2019.
    12. Gandal, Neil & Gans, Joshua & Haeringer, Guillaume & Halaburda, Hanna, 2020. "The Microeconomics of Cryptocurrencies," CEPR Discussion Papers 14972, C.E.P.R. Discussion Papers.
    13. Dhillon, Amrita & Kotsialou, Grammateia & McBurney, Peter & Riley, Luke, 2019. "Introduction to Voting and the Blockchain: some open questions for economists," CAGE Online Working Paper Series 416, Competitive Advantage in the Global Economy (CAGE).
    14. Cukierman, Alex, 2019. "Welfare and Political Economy Aspects of a Central Bank Digital Currency," CEPR Discussion Papers 13728, C.E.P.R. Discussion Papers.
    15. Rod Garratt & Maarten van Oordt, 2020. "Why Fixed Costs Matter for Proof-of-Work Based Cryptocurrencies," Staff Working Papers 20-27, Bank of Canada.
    16. Carlo Gola & Andrea Caponera, 2019. "Policy issues on crypto-assets," LIUC Papers in Economics 2019-7, Cattaneo University (LIUC).
    17. Jurgen E. Schatzmann & Bernhard Haslhofer, 2020. "Bitcoin Trading is Irrational! An Analysis of the Disposition Effect in Bitcoin," Papers 2010.12415, arXiv.org.
    18. De Pace, Pierangelo & Rao, Jayant, 2020. "Comovement and Instability in Cryptocurrency Markets," Economics Department, Working Paper Series 1012, Economics Department, Pomona College, revised 14 Jan 2020.

    More about this item

    JEL classification:

    • A1 - General Economics and Teaching - - General Economics
    • D00 - Microeconomics - - General - - - General
    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G2 - Financial Economics - - Financial Institutions and Services
    • G4 - Financial Economics - - Behavioral Finance
    • L99 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Other
    • Z39 - Other Special Topics - - Tourism Economics - - - Other

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