Bitcoin, the first and best-known digital currency, has specific limitations that may put its sustainability at risk, according to a report by the Bank of International Settlements (BIS).
Drawbacks with bitcoin’s proof-of-work concept uncovers significant economic problems, said Raphael Auer, principal economist in the monetary and economic department at the BIS, in a working paper titled “Beyond the Doomsday Economics of ‘Proof-of-Work’ in Cryptocurrencies.”
Proof-of-work is the protocol that bitcoin
uses to confirm transactions on the blockchain. Its primary purpose is to deter bad actors or spammers from attacking the bitcoin network and double spending.
Because immutability is an important part of bitcoin’s allure, proof-of-work is inherently expensive. “If the incentives of potential attackers are analyzed, it is clear that the cost of economic payment finality is extreme,” said Auer. “For example, to achieve economic payment finality within six blocks (one hour), back of the envelope calculations suggest that mining income must amount to 8.3% of the transaction volume — a multiple of transaction fees in today’s mainstream payment services.”
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Furthermore, Auer argues that as mining income deteriorates, more people will leave the system causing a participating problem and “as a result, liquidity is set to deteriorate substantially in years to come.” In addition, he says the network could reach a place where it could take months before a bitcoin payment is final.
While the Lightning Network—a second layer solution for the bitcoin blockchain that takes some traffic to a side contract—is a possible solution, Auer says even it would face scalability issues — the ability to process more transactions at a faster pace.
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But, he said the best solution to date is to shift the confirmation process to proof-of-stake, the protocol that the ethereum network and its primary digital currency, Ether
Under the proof-of-stake protocol, miners are randomly selected to confirm a transaction, but to do so they must commit a certain number of cryptocurrency to the blockchain. By pre-determining the miners, the race to solve the complicated puzzles, which proof-of-work uses, reduces high electricity and hardware costs and discourages illicit behavior such as double-spending and controlling the network.
“Cheating is deterred by the threat of losing the pledged cryptocurrency in the case that one user’s verified update differs from that of others,” Auer said.
Read: Here’s how much it costs to mine a single bitcoin in your country
But for now, under the current regime, the limitations of the proof-of-work protocol cloud the future of digital currencies such as bitcoin, according to Auer. “In sum, with the current technology, it is not even clear whether such cryptocurrencies can keep functioning as they do at the time of writing,” he wrote.
Auer added that his conclusions are not based on other discussed limitations of cryptocurrencies such as volatility.
Read: BIS warns that wide bitcoin adoption could break the internet
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