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Okay so why do we need inflation to keep the money working?

Alright. Let me take a deep breath real quick.

So, miners are rewarded for securing the network. If they're not, they don't do it.

In bitcoin, they're rewarded by the block subsidy, the coinbase transactions, and by the transaction fees of people moving money around. I'm going to call these "users" as opposed to holders, which are also users but I'll distinguish between them in that way.

The block subsidy is like a tax on all holders and users in the network, just as monetary inflation (which I refer to as "debasement" because that's what it is) is a hidden tax on all of us who work for and buy things with fiat.

Holders benefit from the security of the network. That is bitcoins entire value proposition, that's what gives it value, that it is infeasible for anyone to just steal your money without tying you up first. A coin with a supply of 1 and no security is valueless. Scarcity isn't the end all be all of value, as you can see from countless other supply capped altcoins, other considerations are, demand being the big one, but none of that matters if you can wake up to your money gone. The security of bitcoin is it's primary value proposition.

Network security is a commons in game theory parlance, to the bitcoin network, and a situation where some group can benefit from the commons without contributing to it leads to what is called a tragedy of the commons. Those people in game theory parlance are called "free riders", they benefit from it without any cost incurred to them, and for the commons to continue to exist, the cost must be incurred by someone else. That someone else in bitcoin is the users, those actually sending bitcoin and paying transaction fees.

There's a block subsidy right now in bitcoin, but since the supply cap is known, we can treat that yet to be issued subsidy as existing and just not being spent yet. It is "priced in" as you might say. It can be treated as if it already exists, just like satoshis coins can be treated as if they don't exist. Consider your share of the debasement via the block subsidy paid, consider your share of bitcoin as being out of a total supply of (slightly under) 21 million coins, that's what most people do anyway.

So what happens is, there's an incentive built into this game theoretical system that is bitcoin, where people are incentivized to hold and not to spend. They benefit from the security paid for by those who have to spend, and their wealth is secured for free. So as time goes on, more people do this. The more people that do this, the more users have to pay to spend money, the more pressure they feel to just hodl and spend something else, and so on. It has a compounding effect.

The end result of this is of course, a world where nobody or almost nobody spends bitcoin on chain, and where miners have to reduce cost and therefore security. And as security goes down, so does the value of the network, and therefore so does the value of your bitcoin holdings.

A solution to this is a tax on holdings. But that's messy, you need a way to just take money from people when mining a block, keeping track of everything and knowing what everyone has.

A simpler way to do this is to just create some press determined number of new coins every block. It taxes everyone equally in proportion to their holdings, everyone pays for security of their wealth in exact proportion to the benefit they derive from the security of the network. Simple, elegant, problem solved, as long as this money only goes to miners and nobody else.

This could be done on any number of schemes. You can do it on a geometric scale, 2% or 3% as central banks do (even though they don't need it to pay for security. They're just scammers), or you can do it on a linear scale, like Monero does with a set per block emission number that we call a tail emission. I could go into the reasons why this is optimal even though on the surface it may not appear to be viable long term as opposed to geometric debasement, but that's a whole separate thing.

Do you see it? It's not about "the miners have to be paid", it's about who pays the miners and who benefits from mining. The two have to be one and the same, and in proportion to their benefit, or any network is doomed to fail. Incentives are outcomes, always, with anything social in nature.

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Discussion

Comte de Sats Germain 1y ago 💬 1

I don't think the people paying for security have to be the same as the people benefitting from it.... But backing up, thank you for writing all that. I think I understand and have had similar worries.

Actually I think the hodlers, who aren't the active users, are paying for security indirectly. By hodling, they constrict supply, which keeps value high, which keeps the miners happy with what they get paid. If you push the scenario to the opposite extreme, where nobody keeps savings long term and spends their while income as fast as they get it, then you would effectively have in increase in supply of btc, which would bring the value of each sat drastically down. Then you would be in a similar miner death spiral, just from the other direction. This would be the same effect that the "velocity of money " currently has in economic calculations - that is, the bank reserve ratio is the inverse of the multiplier of the absolute number of dollars loaned - so if the reserve ratio is 10%, and a bank makes a loan of $1 million, then the money supply effrctively increases by $10 million. Therefore, not spending btc assists in retaining its value, which is good for mining.

I think the solution is similar to this - just as constricting money supply keeps value up, also constricting block size keeps fees up. If, after the coinbase drops to zero, the miners can't stay in business and it appears that hash rate will fall below a secure threshold, then the fix is to decrease block size. IMO it should never have been increased to begin with.

Does that make sense? Maybe there's something I'm still not seeing. An aside, but I think there's a point where increasing block size becomes genuinely dangerous, if it causes miners to stop mining honestly and instead attempt a reorg. You can always make blocks smaller without danger, but not bigger. I hope we don't see any more of that.

mister_monster 1y ago 💬 1

Well, they're not paying anything; they're not incurringna cost to cover the security they derive.

Take this idea to an extreme. If *everyone* holds, then the value goes to infinity, right? Well no, because miners stop mining entirely because they won't get paid. There's a curve here, it's not a linear relationship. It's not long term viable, pressing the price up only generates more miner revenue for the same number of coins to a point, and there's a point at which that upward price pressure is outpaced by reduced number of transactions. This is like a cold staking scheme and is not stable or long term viable at all.

Ultimately, the only way to pay for the ongoing cost of security is to have an ongoing cost to holding.

As far as block size... The goal is to secure the network by creating blocks with high difficulty, as well as to process transactions. The smaller the block size, the less transactions you can process. This accelerates what I talked about above since transaction fees double if the block size is half, and as I explain above, constricting supply isn't enough to make sure miners are paid well enough forever. Take this to the extreme too: a block size of 0, in a supply capped coin, will ensure that all miners stop mining forever because there will be no transaction fees. Unstable, not long term viable, similar math and incentives as above.

I don't understand how a bigger block size incentivizes miners to attempt a reorg. If you can explain to me how that would work I'd like that, maybe I'm missing something but I don't see it.

Comte de Sats Germain 1y ago 💬 1

Increasing block size could incentivize a reorg because fees per block fall, so some number of miners become unprofitable - the most expensive/least efficient miners. They're still hitting nonces at the same rate as before, butwity the payout lower, it could make sense to start turning off the miners with the highest cost per hash. At some point, you could have a lot of hardware sitting around, and at some point its enough to attempt a reorg. I'm not super familiar with this stuff, so I'm just conceptualizing. Idk for sure but I think the bigger the reorg (further back in time), the more hash is required. So if hash is coming offline because fees are low, then there's a curve you could plot where hash profitability is negatively correlated with the depth of a potential reorg. So expanding the block size has to be done very carefully, at a slower pace than new hashrate coming online.

The opposite would be no problem - reducing block size increases profits per hash, so previously unprofitable miners could be profitable again. Of course there are limits, like if the economy is dependent on opening and closing lightning channels and block size constricts the possible throughput regardless of fees.

mister_monster 1y ago 💬 1

So block size increase doesn't necessarily reduce fees paid per block, unless demand for block space is lower than block size. Ideally you want blocks to always be full.

But a blockchain where new transactions are in the mempool waiting for a long time, if you double the block size, all the miner will do is add those in this block. It increases his income because he gets more transactions per block. The payout per block goes *up.* Fees go down so more people transact on chain.

This is what dynamic block size in Monero is for, block size is only increased if it is profitable to do so, that way blocks stay full but can grow dynamically if demand increases. This is a queuing theory problem, you should look into queuing theory.

The opposite can raise block fees, but can reduce profitability for miners, for the same reasons as above. Also, note that a primary reason for mining is processing transactions. Reducing block size doesn't make the network more useful and therefore valuable. Halving the block size doubles fees, doubling the block size halves fees, the miners make the same either way, but the utility is reduced when block sizes are smaller. It may be the case that it enables regular people to run nodes because the blockchain size increase is less, but again, unless you have to store the entire history of the chain to get 100% security guarantee, that's a non issue, a protocol like we talked about with MW doesn't need a block size at all.

Comte de Sats Germain 1y ago 💬 1

It's actually not ideal for all transactions to get into blocks. Bidding balances times preference, so we get a equilibrium fee rate for different times. If the whole mempool goes into the next block, there's no reason to pay higher fees, so the miners lose.

If we get to a point where all times have the same fees, then I can see a need for variable block sizes. Currently, you can cheap skate through if you don't mind waiting till the middle of the night for a north american.

mister_monster 1y ago

Yeah, that's true. You want there to be at least equilibrium price pressure on transaction fees. If the block size is say a steady state mean of the average block demand, you'll get optimal but you'll get swings in price and fullness during low demand, and the opposite in high demand. On average the miners will do fine, but they'll have volatility in their returns.

But demand isn't steady state, so there's no real way to calculate that ahead of time.

Consistently lower than demand sizes just dicincentivizes use. It reduces utility. Consistently higher than demand size disincentivizes mining. Always close to the mark size to demand ratio optimizes miner income (and therefore security) and increases utility.

The Monero dynamic size accounts for this need for always wanting slightly higher demand than supply, it has a function where block size increases *cost miners* to do, so they only do it if the mempool back up is big enough to make up for that and then some. The block size only goes up when your concern isn't the case, it is always profitable in Monero to raise the size, or the size doesn't go up. You should really really learn the details of it, it is very interesting, I think you'd love it. Also queuing theory, it's a bit complex but very important to understand on this topic, you don't have to understand it in detail, just the basics.

Comte de Sats Germain 1y ago 💬 1

I'd be interested to learn more. But my base position is, even if its amazing, bitcoin is still what matters - Cryptos are, ideally, for testing ideas in a trial run before moving the idea to bitcoin. And this is what I'm trying to get you onboard with - invest all that energy where it can make a difference, bitcoin.

Sleep time. Goodnight. Will resume tomorrow if you're up for it

halalmoney 1y ago

A really interesting thread! Thanks.

JackTheMimic 1y ago

As far as block subsidy, it will likely maintain the value it has now indefinitely. Most people seem to think that the Satoshi will be the smallest denomination forever. It won't. As a matter of fact if a penny is worth anything by the time Bitcoin hits 1 million and 1 dollars a coin, we have a denominational issue. So extrapolating from there the more the value climbs from both inelastic supply and rising demand, the more decimals become commonplace. The blocksize now is pretty much perfectly designed to handle 5000 countries worth of settlement transactions per 10 minutes.

As the incentives of bitcoin kick in at the national level, states that hodle first become more powerful than the nations that encompass them. Making the cultural separations more important and further dividing the current sub 200 countries into more. This also decentralizes mining and distributes block fees among smaller parties. The cost of a large mining op just won't be able to compete with hundred of thousands to millions of individuals running 10TH/s systems at 15-17J/TH.

As far as economic velocity, that never gets handled by an asset layer. That is the final settlement for when the trust of economic actors falls or conflict arises. It is utterly staggering how many billions of transactions happen on the back of "trust me, I'm good for it." With layers like lightning it's more like "Trust the code that you can read for yourself, I'm not going to force close the channel while you're offline with a previous channel state (If I get caught I'd lose all my sats)." Much more complicated but, much less trust is necessary. The restricted block size simply makes securing the network way more cost effective. What do you think is easier auditing every ounce of gold in the world or validating the bitcoin timechain? Now THAT'S security.