An Economic Analysis of Difficulty Adjustment Algorithms in Proof-of-Work Blockchain Systems
49 Pages Posted: 4 Jul 2019 Last revised: 15 Mar 2022
Date Written: June 26, 2019
We develop an economic model of the Proof-of-Work blockchain system. We demonstrate that, when the hash supply is highly elastic, the Bitcoin difficulty adjustment algorithm (DAA) fails to stabilize the block arrival rate. In contrast, the DAA of another cryptocurrency, Bitcoin Cash, is stable under a weak condition. We also provide empirical evidence and simulation results supporting the model’s prediction. The current Bitcoin system might collapse once a sharp price reduction lowers the mining reward. While this crisis can be prevented through upgrading, miners may disagree because a large fraction of miners profit from the instability of DAAs.
Keywords: Blockchain, Proof-of-Work, Difficulty Adjustment, Mining, Market Design
JEL Classification: C61, D47, G20, L86
Suggested Citation: Suggested Citation