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October 5, 2022
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Bitcoin

what happened to your incentives?

Despite all the achievements of Bitcoin, it remains to be seen whether it will become a widely used currency or fulfill the decentralization potential.

In your whitepaper original, Satoshi Nakamoto introduced Bitcoin as a “Peer-to-Peer Electronic Cash System”. 13 years later Bitcoin has proven that it has clearly solved the double-spending problem by allowing transactions to take place without intermediaries and has scaled to a trillion dollar network without having had any serious security breaches.

Surprisingly, it was able to scale only based on the incentive mechanism built into that protocol. Unlike any other technology, it has never resorted to traditional equity financing or traditional governance.

reserve of value

Bitcoin may have managed to become a store of value thanks to the trust, rarity and immutability inherent in its underlying technology. These attributes, when combined with its code and money supply, have resulted in a money supply that is owned and exploited only by a few.

While we doubt that Satoshi Nakamoto had any intention of benefiting just a few or having such a negative impact on the environment, the problems could stem from the same incentive design that was at the root of his success.

Influence factors

First, built-in rarity and the fixed money supply have highly deflationary implications. Why spend now when not only is supply limited, but supply growth is also steadily decreasing.

To be a medium of exchange or unit of account, a money supply must be adjusted so that the price of goods and services is stable in the medium and long term. This is the only way the supply and demand side of an economy can make rational decisions.

Second, network security depends on an incentive mechanism that rewards those who use the most resources, in this case, the use of electricity and computer processing power.

While the number of transactions and their size do not affect the network or its speed, the accumulation of coins does affect its memory. In a network where all participants except miners are rewarded only on price appreciation, spending is not incentivized.

Third, we feel that Bitcoin’s failure to adapt is caused by the centralization of its ownership. The resource requirements to run a full voting node, let alone a mining operation, make participation very expensive. Those in control know very well that in order for it to become a widespread medium of exchange, the price appreciation will have to stop and the price of it will have to remain stable.

They may prefer the status quo or the introduction of some stablecoins on the network like Ethereum, keeping Bitcoin as the reserve currency, the ultimate guarantee.

Finally, one has to imagine what will happen when all the coins are mined. At that point, miners will only be rewarded for transaction fees, which, unless things change drastically, will be very small. What will happen to network security at this point?

Simply put, the Bitcoin blockchain is designed based on the principle of limited supply, total Bitcoin mining is slated for approximately 21 million units. Once all 21 million BTCs have been mined, the network will operate largely the same as it does now, but with one crucial difference for miners. After all Bitcoins are mined, miners will still play a key role.

In addition to block rewards, Bitcoin miners also receive all fees spent on transactions included in each block. And that will remain, after all, the network needs miners to validate transactions, this is how the Bitcoin blockchain network works, without these validators, there is no correct functioning of the network.

Perhaps the price will stabilize and miners will be rewarded for the fees generated by the large amounts of transactions while holders release their reserves, perhaps this would be one of the more certain theories to think about.

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