Why Bitcoin Will Fail to Scale?
40 Pages Posted: 4 Feb 2019
Date Written: January 26, 2019
While Bitcoin has garnered enormous attention with its promises of inexpensive, fast and trust-less payments, it falls way short of the scale provided by banks. Bitcoin throughput is limited because its ledger accepts a block of fixed maximum capacity that can accommodate approximately 2200 transactions every 10 minutes. The Bitcoin community is actively considering technology upgrades to increase the block capacity. Intuitively, one would expect that increasing the block capacity would solve this scaling problem. However, in this paper, we show that increasing the block capacity would be futile for scaling Bitcoin.
We analyze the strategic interactions of miners, who are heterogeneous in their computational power, and users, who are heterogeneous in the value of their transactions, using a game-theoretic model. We show that a relaxation of throughput congestion can facilitate large miners to tacitly collude -- artificially reducing the actualized throughput via the strategic partial filling of blocks to receive higher transaction fees. This strategic partial filling is sustained if the computing power of the smallest colluding miner is larger than a threshold. In addition, Bitcoin can only serve 50% of the demand if the colluding group power is above a threshold. We provide empirical evidence of such strategic partial filling of blocks by large miners of Bitcoin.
We show that a technological intervention, such as banning large miners, can eliminate collusion. However, this also makes the system less secure. A strategic adversary faces a trade-off between earning money as a miner and carrying out a double-spend attack to steal a large amount of money in one shot. Such an attack becomes preferable as revenues from mining decrease in the absence of collusion. Therefore, surprisingly, collusion indirectly protects the Bitcoin system by increasing miner revenue. Overall, we show that there is an economic limit to the scalability of Bitcoin. On the one hand, increasing Bitcoin's capacity invites collusion; on the other hand, if the collusion is suppressed, the system becomes insecure, which drives away the demand regardless. Our analysis raises antitrust concerns with respect to Bitcoin and suggests at least some of the anticipated competitive gains from decentralization in Bitcoin may be difficult to realize.
Keywords: Bitcoin, Blockchain, Miners, Collusion, Repeated Game, Fees, MicroPayments, Scalability, Security
JEL Classification: D43, D48, G2, G1, G00
Suggested Citation: Suggested Citation