What Proof-of-Work Is Used for (in Bitcoin)

Date: 2020-08-18

Source: https://craigwright.net/blog/law-regulation/what-proof-of-work-is-used-for

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Proof-of-work has become fetishised and overly worshipped by some in the ‘cryptocurrency communities’ and when it comes to Bitcoin. Their fixation is unfortunate, because proof-of-work is little more than a tool. Using a hammer in the wrong manner will lead to destruction. Proof-of-work is not the consensus mechanism within Bitcoin; it is the issue of the costly signal between nodes that allows them to act when dissenting nodes do not follow the rules.

First of all, I shall reiterate that Bitcoin

nodes produce blocks. The consensus mechanism within Bitcoin relies on the

propagation of validated blocks. Each node on the network creates its blocks,

and verifies the completed blocks produced by other nodes. Nodes do not vote on

rules; they enforce the rules.

Proof-of-work acts as a signal to other

nodes. It does not act as a signal to general users of the network, or most

parties who are not running nodes. Some entities are interested in the respective

proof-of-work. Law enforcement, courts, and those seeking to enforce judgements

against dishonest nodes, nodes that do not enforce the rules, can easily detect

the presence and location of all nodes on the network. It allows users to

ensure that ownership of their tokens can be maintained and that courts and law

enforcement can act upon Bitcoin. There cannot be an infinite number of nodes;

in fact, based on the nature of the distribution, the number of nodes that

matter to the network will never exceed double digits. Proof-of-work is not the

security mechanism in Bitcoin; the publicity of the hash chain is. Proof-of-work

presents an economic signal, acting game-theoretically to incentivise the

players’ honest behaviour and, alternatively, provide a punishment mechanism.

Nodes do not merely find a block solution

and get paid. Once a block solution has been found, the block needs to be

propagated to all other nodes, and the majority of nodes needs to accept the

block and build upon it. To be able to spend the payment associated with the

consideration paid for its part in verifying transactions and propagating the

validated blocks of transactions, the node that has discovered a block needs to

ensure that it will gain a level of depth of at least 100 blocks.

If a node were to hide, the increased

inefficiencies place it at a distinct disadvantage over nodes that are not

seeking to remain hidden. Tor exit points and other anonymity mechanisms

severely degrade block propagation. Such degradation of performance and thereby

profitability is significant even in broken systems such as the BTC network.

Nodes do not compete for revenue; they contend for profitability.

In business, a difference in percentage

points of revenue leads to massive changes in profitability. Here, a shift from

a few percentage points in profit can quickly lead to a substantial loss.

Implementing the use of Tor networks can, at scale, impact the earning capacity

and revenue associated with a node by 4.5 to 7 per cent. The decline in income needs

to be accounted for and measured against the cost of running a node. As Bitcoin

scales, it is likely that profitability will never exceed 5%. A hit to revenue

will decimate profit. As Bitcoin is used, and as it becomes vital to capture

transactions and associated fees, rather than merely taking the subsidy, it

will become more and more critical for nodes to earn and act profitably.

Proof-of-work does not act to demonstrate that an entity is playing by the rules or that they should be trusted. It is merely a signal in a larger game. Just as a peacock cannot maintain a large tail without fitness, Bitcoin miners cannot maintain high levels of proof-of-work without engaging in the underlying system. That is, the nodes need to process transactions and act to enforce the rules. As with the peacock, the implementation of a proof-of-work mechanism, a handicap, only acts within a defined set of participants. The peacock’s tail is only of interest to the peahen and the tiger. The monkeys and the bullfinches, that also reside in the forest, do not care. It is only the nodes as the peahens and peacocks that directly care about the results of proof-of-work, and they do so only because of the tiger.

In the handicap principle, it is not the

peacock’s tail that sets the equilibria. The length of the tail against the

fitness of the animal is a function of the external control, the tiger.

In Bitcoin, the tiger is played by law

enforcement and courts. With peacocks, the peahen will always seek the most

extended tail. In the same manner, nodes will try to implement the most

significant proof-of-work rate that they can profitably support. The cost of

doing so is compared to fitness. It is both a combination of the amounts of

inputs that go towards such a process and the cost of remaining honest. In Bitcoin,

a dishonest node is equivalent to an unfit peacock. Even with a long tail, such

a peacock is unlikely to succeed.

Bitcoin

has grown to the point where proof-of-work, the proverbial tail, is

significantly noticeable. Such demonstration is, ultimately, not made to the

other nodes, but rather to the proverbial tiger: law enforcement.

Proof-of-work in Bitcoin is the part of a system that is designed to ensure that nodes can never be anonymous and significant. A node can remain somewhat private, but as such can never be a significant player, and in a Stackelberg game will never be the leader. As a Stackelberg follower, the private or anonymous node cannot dictate the nature of the blockchain. All such an actor can do is choose to follow the leader. The most significant nodes will always be publicly visible. The investment required to be a node on the Bitcoin network is beyond levels that are substantial. Capital investment of such size presents an outlay in the real world. With the investment that comes with them, leader nodes are readily determinable.

The result is that both commercial action

and criminal sanctions may be applied to the primary nodes on the Bitcoin

network. Such nodes are subject to a variety of legislation, and will implement

validly issued court orders. The failure to meet such actions would instantly

leave a node subject to sequestration and the seizure of its assets. Exchanges

who choose to fight such actions would be cut off from global banking. It is the

combination of both factors that makes it economically infeasible for nodes to

act dishonestly. It is not the proof-of-work function that secures Bitcoin; it

is the threat of the proverbial tiger. Proof-of-work simply makes nodes visible

to the tiger.

Nodes differ from users in the Bitcoin

network. Proof-of-work in Bitcoin is designed to ensure that the nodes cannot

be anonymous. The nodes may come and go, but any node with a significant

investment in the network can easily be held to account. The entire purpose of

proof-of-work, in Bitcoin, is to remove anonymity from nodes. Individuals’ identities

present a separate factor, and are not stored on the blockchain. When users

interact, they can follow existing cash rules to ensure that they remain

compliant. To enforce the fiduciary controls that are required to be

implemented in Bitcoin, nodes need to be accountable. To be held accountable

and to be responsible, nodes need to be detectable. There are never more than

four or five nodes on any proof-of-work blockchain network. The consequence is that

as the agents of the network, the network nodes may be held to account.

Proof-of-Work Removes Anonymous Nodes

The primary reason for the attack on proof-of-work,

alongside the attempted implementation of proof of stake and related systems, stems

from the desire to remove accountability and allow anonymous actors.

With proof of stake, the principal investor can secretly own and control more than 50% of the network—without being detected. Removing the propagation methods within Bitcoin reduces the cost of such a system, and allows the creation of a stock-based or securities-based model. Here, the stakeholder provides capital in consideration for voting rights. Such a perspective is diametrically different from one that comes with Bitcoin. Without identity, such bearer steaks are bearer shares as they more effectively allow the controlling investor to split their controlling share into multiple smaller amounts that vote based on an algorithmic link, hiding the manipulation created through the system.

Proof-of-work, on the other hand, provides

the ability to find out the location, the where, and who runs a node. It is the

threat of action, the ability for law enforcement to step in that maintains

security in the Bitcoin network. I have said it many times: Bitcoin is an

economic system and not a cryptographic system. Bitcoin uses simplified payment

verification (SPV) to segregate users and nodes, allowing both to coexist.

Neither can exist without the other.

Those who said that Bitcoin, when I released it in 2009, was broken did not see the protocol as being broken; they saw the system I implemented as being incompatible with the goals they sought to achieve. Bitcoin is not a system that is out of the reach of government, law enforcement, and control. In 2011, the Electronic Frontier Foundation said that Bitcoin was censorship-resistant. I ignored them, because I thought very little of them. I failed to understand how their lack of comprehension concerning Bitcoin could be problematic in the future. To me, the system I had designed was simple to understand. To others, it became difficult because they sought to twist it into something else.

Proof-of-work in Bitcoin is designed to

ensure that any significant nodes cannot—and I mean CANNOT—be anonymous.

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