Bitcoin Core developers do understand economics

By May 28, 2020Bitcoin Business
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There is a common theme in various crypto circles that Bitcoin Core developers do not understand economics, and this is therefore why they made decisions such as keeping the block size small.

This argument is often professed by people who themselves think they have a great understanding of economics because they've read Rothbard, Mises or Hazlitt. Unfortunately, they demonstrate doing so how spot on Hayek was when he wrote abut the pretense of knowledge.

In my presentation in Arnhem in 2017, I explained what are the incentives of different actors in the space and how there behavior is explained by their incentives. However, it wasn't the main point of the talk and it is definitively a point worth going over again.

In economics, a rational agent is an agent able to take into account available information, probability of various events taking place, risks and benefits, and its own self preference to make the best decisions.

Bitcoin is secured by incentives, which means it assumes a large portion of its participants are rational agents. While this is not stated in these terms in the whitepaper, Satoshi is very clear on the matter - and and study of Bitcoin's security model will confirm this from first principle to anyone willing to go through the trouble.

He ought to find it more profitable to play by the rules, such rules that favour him with more new coins than everyone else combined, than to undermine the system and the validity of his own wealth.

An agent which does not understand economics is unable to be rational and, therefore, will makes choices that are sub-optimal or even sometime detrimental according to its own preferences. Conversely, an agent which understands economics is able to make optimal choices based on available information.

In order to decide if Bitcoin Core developers understand economics or not, we need to ask ourselves if they've acted as rational agents or not.

To understand this, we first define a realistic set of preferences for Bitcoin Core developers. Let's assume that they value money and status and would rather avoid poor working conditions, such as adding upon themselves additional work and responsibilities.

Obviously, in the real world, there is not such things as a Bitcoin Core developer. Each of them are individuals with different preferences, but, fortunately, the assumptions we are making about their preference are very bland and will fit almost everyone who ever lived, and this will be sufficient for our demonstration.

An analysis of the alternatives that were available to Bitcoin Core developers when they took actions for which they are deemed to have lacked economic insight will tell us if this is effectively the case or if, they were able to understand the different incentives at play and make a rational economic choice. We will limit ourselves to the analysis of the 1MB limit and its alternatives, as it is obvious that other choices made such as RBF are simply the natural continuation of keeping that limit in place, and this is therefore the choice that matters.

Everything else being equal, every one of us would like to have more money. Bitcoin Core developers are no exception. The main sources of funding for the Bitcoin Core project, as far as I know, are Blockstream and the MIT media lab.

Blockstream is a company that makes money by selling products such as Liquid. These products are more valuable when blocks are small and therefore the incentive for Blockstream, as well as for Bitcoin Core developers funded by Blockstream, is to keep blocks small.

The MIT media lab is an academic institution. It's goal is therefore to build interesting technology and do scientific experimentation. Looking at this way, a roadmap including sidechains, lightning network and other complex technical schemes is preferable.

On the other hand, the larger block community just closed a funding round of roughly $500k that must we shared across 6 node software - and this has largely been reported from within the community as a success. My guesstimate is that it is more than an order of magnitude smaller than what is provided to the Bitcoin Core project - and for 6 projects. It is therefore not reasonable for Bitcoin Core developers to have found an alternative source of funding allowing them to make more than what they do now.

Considering the current Bitcoin Core roadmap is supported by institutions that are willing to put an order of magnitude more money into funding its infrastructure, it would be widely unrealistic from the part of these developers to expect making more money by making an alternative choice. We can therefore conclude that they made the rational choice by keeping block small when it comes to money.

The Bitcoin Core community often states that it has the best developer int he world. We can debate if this is true or not, but in our case it doesn't matter. First because economics tells us that value is subjective, and therefore it is possible that the Bitcoin Core community effectively consider these people as the best in the world, but more importantly because it doesn't mater if this is true or not, what matter is that they are conferred the status.

On the other hand, has they made an alternative choice, they'd have to deal with community leaders such as Roger Ver who consider they have to be held in tight leash and collar.

It is therefore evident that Core developers made the rational choice when they kept blocks small in term of status.

Increasing the size of the blocks require a lot of work from developers. As block gets bigger, every inefficiencies in block processing gets bigger in the same proportions - sometime worse. What can be a problem small enough to be ignored at one scale can become exceedingly important to fix once the block size is increased.

In addition to regular development work, larger block also means that various attacks on the network can be executed much faster or with much greater impact. A concrete example of such an attack is the now fixed out of memory problem revealed by Christopher Jeffrey at Breaking Bitcoin in 2017.

This in turn increase the pressure due to developer being effectively always oncall, even though nobody is paying for it.

Once again, what is the rational choice for Bitcoin Core developers is self evident.

The Bitcoin Core developers have demonstrated via their behavior that they understand their economic incentives and are able to act as rational economic agents by making choices aligned with these incentives.

On the other hand, people accusing them of being economic ignoramus have demonstrated an inability to understand the plurality of economic incentives that exist in the ecosystem, which is the base of every economic thought.

While it is undeniable that users and businesses benefit tremendously more from a Bitcoin network that is uncongested and over which transaction are cheap fast and reliable, it is also undeniable that these same users and businesses failed to provide the proper incentives for Bitcoin Core developers to make it happen. In doing so, they also demonstrated a very poor understanding of economics.

When people quoting Mises and Rothbard, bragging about their economic knowledge, fail to apply economic principle so fundamentals that they'd have Keynes and Hayek in agreement, we are reminded that markets are about human action, and that these self aggrandizing words mean very little.

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