In the previous lecture, I discussed Proof-of-Work and how it enabled randomness in a decentralized way. But critical to Proof-of-Work is the solving of a hash puzzle. This process enables randomness only if no one node can accrue enough power to monopolize the network. And it also means that Bitcoin trading in its current implementation is potentially slow and limited. So I'm going to discuss these issues and at the end, I would discuss some broader challenges and summarize the module. So here's the first challenge to Proof-of-Work called the 51% Attack. What if a node succeeds in gaining a majority of the CPU power across all nodes? This node would then be the first to solve all the hash puzzles. And then this node could build the longest chain in the blockchain. So this system would then revert to being partially centralized. You could think about it a little bit like James coin from the few lectures ago. So let's discuss the situation. First note that if a node were to obtain a majority of CPU power it would have to act as a benevolent dictator. Now, this may not be much comfort to have a benevolent dictator, but let's foresee why it would have to act as a benevolent dictator. The only possible reward to gaining CPU power and to proposing blocks is bitcoins. Now, a malicious 51% attacker could include lots of bitcoin payments to him or herself through their address. But actually, no other nodes would let this attacker spend the coins, so it'd be a little bit pointless. So any 51% attack is limited in its profitability, and this will already reduce the incentives for such an attack. And key is the fact that any attacker is going to have a very large incentive to maintain trading in bitcoins because probably, this attacker has a lot of bitcoins through all the block rewards received over time. And that also disincentivizes this 51 is present attack in a broader sense. So we've already seen this in operation. In 2014, a mining pool came close to the 51% mark and voluntarily kept their control at 39.9% calling on others to do the same. So because the potential attackers already have a stake in the system, if they are behaving in a self interested way, they have the reasons to not only avoid the attack but avoid the circumstances that lead to the attack. Thus, this is unlikely to occur. Now, a weaker version of the 51% attack is what would happen if a small number of nodes were to control all the mining power. As bitcoin mining has become industrialized, this has been occurring. So it appears that mining power is concentrated in perhaps a small number of nodes, it's hard to say for sure. So here's a worry, these miners could form a cartel. Now I'm not saying that the credit card companies are like a cartel but if they were, maybe the same thing could happen to the small number of nodes. They could then charge high transaction fees because transaction fees are as we discussed, part of the reward for creating blocks. This is also like seigniorage, which is essentially the tax from the sovereign to inflation seigniorage, under another name. Could this occur? Yeah, it could occur. It hasn't yet occurred though, and perhaps one reason for that is that, all involved have a stake, a very large stake perhaps in the continued success of bitcoin as a currency. Okay, so, that's challenge one, the 51% attack and related oligopoly power. It hasn't proven to be a big challenge yet, we don't know for sure if it could become a big challenge but there are reasons to suspect that it won't. So Proof-of-Work Challenge 2, Resource Intensity. So bitcoin mining uses lots of electricity. Maybe uses too much electricity. Well actually, it doesn't use that much. At most at the moment, it uses only 6% of the energy used in the global banking sector. And it's way, way, way tiny compared to the energy use of total consumption. Now, why is this? Mining takes place where energy is not a scarce resource, and it can continue to do so. So, this is apparently a concern, but it turns out not really. Now perhaps, one has a philosophical concern regarding the energy use. Here's a green and environmental critique of Bitcoin. It appears that miners are using energy to basically solve a puzzle. Now that seems a little silly, right? I mean usually, if we're using energy, we are hoping to create something that people can use. But here, all of this energy is going to waste, would go this critique because it's all used for puzzle solving. So what's the point of that? It seems wasteful. Well, I think it depends how you look at it. I don't agree with this critique. In fact, Proof-of-Work does something useful. It's a technology that enables trading in Bitcoin. Now, trading in Bitcoin through Proof-of-Work is implemented as a zero-sum game. But as long as one believes Bitcoin is a net benefit to society, there is a net benefit to society in mining. It really is producing something. What is it producing? Well, it's producing the working of Bitcoin the system. So I don't think this concern is valid. Okay, so here's a third challenge. Can the network scale? So blocks are limited in size. Blocks are limited in how quickly they can be created. And this puts pretty much a hard upper limit on the number of transactions per second, and there are not very many. This is not seem sufficient to be a large scale medium of exchange and this would really cap bitcoins usefulness. This is really, I think the part of Nouriel Roubini's critique in his congressional testimony that carries the most weight. And it's safe to say that given this problem achieving scale is the most discussed issue in cryptocurrency. Blogs on cryptocurrency point out the following trilemma, that blockchain systems can have at most of the three, being decentralization, scalability, and security. But just by saying this trilemma, this trilemma doesn't mean that it's an impossibility result. So just because within bitcoin, there's no good answer to whether the network can scale, doesn't mean that there won't be an answer. Ethereum, for example, has a different version of Proof-of-Work. It uses many of the same underlying principles that I just described, but it seems perhaps to scale better. I will now summarize the module and then give some further thoughts. So Bitcoin, and perhaps other established cryptocurrencies, create a system of property rights that does not depend on enforcement by centralized authorities. These property rights can span jurisdictions, thus allowing for trades in ways that was previously expensive or difficult, or illegal. Cryptocurrencies enable this feat through technology, mathematics, and what I would call philosophical innovation. Property rights need not hold with certainty, it is sufficient that they hold probabilistically. In this module, I discussed how the digital signature, blockchain and Proof-of-Work enable these property rights and hence, Bitcoin to operate. Now, some closing thoughts. In one of the previous lectures, I pointed out that a money system is really a memory system. The Bitcoin system is a problem of collective memory. So like any society, the Bitcoin society relies on the truthfulness of this collective memory to function well. Is it possible to tamper with collective memory? Yes, it can be given enough power and a willingness of people to behave maliciously, collective memory can be tampered with. And in the 20th century, actual collective memory has been tampered with two disastrous effects. Think Stalin, or Hitler, or Mao. So Bitcoin like society relies on this not happening. Now interestingly, Bitcoin is not actually completely decentralized. It requires that nodes agree on what's called the reference software. Now, when there is agreement about what should be the reference software, something called a hard fork is created. So that's Bitcoin can flexibly accommodate descent without a solution. But there does need to be widespread agreement about what Bitcoin means. And there also must be some level of commitment to the continuation of the network. In other words, malicious behavior for its own sake could destroy Bitcoin. Thus, Bitcoin and cryptocurrency is in general a vast experiment. We don't know exactly why Bitcoin works, we only know that it does.
