Monday, 19 September 2011

The economics of block-chain security in bitcoin

I posted this on reddit, but copying here

Supposing miners are economically rational, they will mine if the value they get from mining (btc + tx fees) outweighs the costs (capital + electricity). Whatever the price of btcs happens to be and whatever the transaction fees happen to be, miners will enter or exit the market until rough parity is achieved. If it's a loss-making exercise then miners will leave until the difficulty reduces and it becomes neutral again. If there are large profits available then miners will enter the market until the difficulty increases and the profits disappear.

One corollary of this is that it becomes effectively free (cost of epsilon in the limit epsilon->0) to build up an arbitrarily large network of miners, as long as you do this slowly. You add an extra node, the difficulty becomes epsilon higher, some other miner decides to leave as it's no longer economically viable and then the difficulty reverts to the previous level. In summary, each additional node is self-funding so it doesn't cost anything. Rinse, repeat, until you've eventually replaced all the nodes with your own nodes.

So, it's (almost) free to build a network with >50% of the comp power, at which point you can tell your mining network to allow you to double spend. It will only allow a double spend to exist for a finite period of time before it gets reorganised, but there's no upper bound on this time. You only need to make it force enough confirmations (6?) that your counterparty accepts your double-spend as a valid transaction.
There are a lot of simplifications in the outline above - you have to account for hardware costs as well as electricity which complicates the calculations as you have to amortize, some people will have access to better technology or cheaper electricity, some people will mine for non-economic reasons and so on.

But the general argument is strong - whatever the incentives are for a normal person to mine, a crook will have the added incentive of eventual double spends. Eventually economic gravity will take hold and the crook will take over the network.

Are there any real proposals for countering this problem?

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