Blocksize Economics
Hong Kong - December 2015

Part 1
The marginal cost of adding atransaction to a blockPriceBlockspace Supply & Demand Curve

DemandSupplyTransaction Volume

What is the marginal cost?
●●●The marginal cost to the miner of including an
extra transaction in a block, is small relative toother costs
The marginal costs are propagation risk and asmall amount of data processing costs
Fundamental economic problem:– Mining is necessary for security reasons, thecost of hashing is almost totally unrelated tomarginal cost of adding a transaction.Artificial cap to inflate fees●●

Since around early 2011, there has been
widespread debate about the potential
requirement for an economically relevant
blocksize limit, in order to artificially inflate
fees, to sustain mining revenue
A more recent response to this above
argument is that “orphan risk” is a marginal
cost, which can ensure high enough fees

Orphan risks●●●

Orphan risk could be the marginal cost which
drives the fee market
The larger the block the larger the orphan risk
It is argued that propagation risks ensures areasonable supply curve exists and a fee
market worksIssues with “using” orphan risk●●Propagation costs could fall exponentially over time as
technology improves. These technological improvements
are not linked to a falling requirement for network security,
therefore equilibrium difficulty could be too low
It would require orphan risk to be a significant mining cost:– Orphan risk is what the entire system is designed toprevent. Miners will push orphan risk up to the limit toincrease margins and security may fall
– Miners do not need to propagate to themselves, it
therefore helps larger miners at the expense of smaller
miners. This incentivises mining centralisation

Defence of orphan risk idea●●

Orphans are not bad and if the orphan rateincreases that is not a concern
Orphan risk is just another cost for miners.
Costs already include rent, electricity, salaries,maintenance and hardware. The “Chinese”
already have economise of scale in theseareas, therefore adding another cost makes
mining more competitive and decentralised.

Orphan risk costs are unique●●●

Orphan risk costs are the only marginal cost ofadding a transaction and therefore drive fees
With respect to other costs, we can at least
hope economise of scale run out
Orphan risk is lower for larger miners and thisis an inherent property of the system as
miners do not need to propagate tothemselves

Marginal orphan risk●

How does the marginal orphan risk changewith respect to blocksize?
– Exponential relationship?
– Linear relationship?
– Sublinear/Other?

●

Total orphan risk cost is likely to be large
relative to transaction fee revenue. The
absolute orphan rate makes no difference.

Best case: Exponential relationshipPart 2Why don't miners voluntarily
produce smaller blocks on theirown?

Will miners produce smaller blocks
on there own?
It benefits each individual miner to generate asmuch cash as possible and produce larger blocks,
the classic “tragedy of the commons” situation● Responses to the “tragedy of the commons”
argument:– This is too theoretical and unproven– This argument focuses too much on “next block
game theory”, one should focus more on thelong term “game of life”– It ignores the desire for faster confirmations●

This is happening now in commodity
markets
Iron ore– Each individual iron ore miner is increasing production, driving
prices down at the expense of the industry, to benefit themselves.
● Oil– Oil majors are producing more oil at a loss, as oil prices fall
● Gold– Gold miners are producing more gold at a loss, as gold prices fall
● Miners keep producing more until they fail, they never reduce
production voluntarily● Unlike resources industries, Bitcoin always needs a healthy mining
industry, for security purposes●Nobody is right
There are two competing visions of game theory here:– Miners care about the long term interests of thesystem - “Game of life”– Miners maximise profit in the next block - “NashEquilibrium”● In reality there are a range of miners with different
priorities● These priorities could vary throughout time, in cycles
and therefore we need to ensure the system is robust
in a variety of different scenarios●

Part 3
BIP100

BIP100 Economics
●●

●

●

Rational miners vote to maximise revenue, similar
to existing security assumptions
Mining revenue = Block reward * Exchange rate +Transaction volume * Average Fee * Exchange rate
Miners therefore vote to maximise the product of
the exchange rate, transaction volume and theaverage fee
BIP100 dynamically adjusts the limit, balancing out
competing priorities within the community, in amarket driven way, to reflect expected demandPriceVoting for larger blocks, based on
expected elasticity of demand

DemandSupply 1
Supply 2

Transaction Volume

Is BIP100 like a cartel?
●●

BIP100 enables cartel like pricing, whilst
avoiding the difficulties of an actual cartel
BIP100 is an open framework for miners todecide the limit in a transparent way

thShift to a simple 50 percentile
voting mechanism●●●●Approval from all full nodes is required to increase alimit
In contrast, a majority of miners can enforce a
reduction in the limit by orphaning all blocks above acertain size
The voting mechanism should reflect this power
balance. Otherwise a 79% vote for a decrease could
serve as a catalyst for the formation of a mining cartel
to enforce the will of the majority and undermine thevoting
Therefore 50% of votes should be able to enforce areduction

BIP100 is far from perfect●●●The blocksize limit will be “sub optimal” asminers vote to maximise their revenue, notutility for users. However the optimal level issubjective
In exceptional cases, miners may benefit from alower Bitcoin price and could vote to reduce thelimit and price to drive out competing miners
The economics of BIP100 are attractive, there
are other more technical reasons for the block
size limit

There are no perfect solutions,
therefore lets be pragmatic
BIP100, BIP102 & BIP103 seem
somewhat reasonable interim
proposals