Economic Implications of Scaling Blockchains: Why the Consensus Protocol Matters

37 Pages Posted: 25 Feb 2021 Last revised: 24 May 2021

See all articles by Kose John

Kose John

New York University (NYU) - Department of Finance

Thomas J Rivera

McGill University

Fahad Saleh

Wake Forest University - Schools of Business

Date Written: December 16, 2020

Abstract

This paper examines the economic implications of scaling blockchains under two different consensus protocols: Proof-of-Work (PoW) and Proof-of-Stake (PoS). We study an economic model whereby agents can store wealth through the blockchain's cryptocurrency but may face a costly delay when liquidating due to the blockchain's finite transaction rate. Agents may expedite processing by paying fees to the blockchain's validators. Within such a model, we study the ability of a malicious agent to compromise the security of the blockchain. We show how improved scaling alleviates congestion, leading to a decrease in equilibrium fees. Under a PoW protocol, this leads validators to earn less revenue and thus spend less on computational power, lowering the cost of a successful attack and therefore the security of the PoW blockchain. Scaling has the opposite effect for the PoS protocol as alleviating congestion increases the demand and therefore the market value of the blockchain's cryptocurrency. That increased market value increases the cost of acquiring enough cryptocurrency necessary for a successful attack and thereby improves PoS blockchain security.

Keywords: Blockchain, Proof-of-Stake, Proof-of-Work, Scale, Security, Fees

JEL Classification: G0, O3

Suggested Citation

John, Kose and Rivera, Thomas and Saleh, Fahad, Economic Implications of Scaling Blockchains: Why the Consensus Protocol Matters (December 16, 2020). Available at SSRN: https://ssrn.com/abstract=3750467 or http://dx.doi.org/10.2139/ssrn.3750467

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Thomas Rivera

McGill University ( email )

1001 Sherbrooke St W
Montreal, Quebec h3A 1G5

Fahad Saleh (Contact Author)

Wake Forest University - Schools of Business

P.O. Box 7659
Winston-Salem, NC 27109-7285
United States

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