Bitcoin Mechanics: Proof-of-Work (PoW) Blockchain = a chain of - - PowerPoint PPT Presentation

Bitcoin Mechanics: Proof-of-Work (PoW)

• Blockchain = a chain of blocks; Block = validated transactions
• Many miners (record keepers) are competing for the right to add a block
• Miners are involved in hash computation = Lottery draw
• Win the lottery → Add a block and get reward (fixed amount of Bitcoins)

Difficulty Adjustment Algorithm (DAA)

• Hash rate, the total amount of hash computation, may vary across time.
• Bitcoin system cannot observe the hash rate, so needs to estimate it.
• DAA first estimates the hash rate, and then sets the winning rate of the

lottery to keep the block arrival rate (10 min/block in Bitcoin).

• Problem: Bitcoin DAA implicitly assumes that hash rate will not change

after the winning rate changes, ignoring miners’ incentive.

• Hash supply is increasing in

winning rate.

• Miners respond to the

adjustment and changes the hash supply.

• If the aggregate supply is

elastic enough, Bitcoin DAA cannot stabilize the economy.

Bitcoin Cash DAA is much more “robust”

• The hash supply will be elastic if (1) the price of Bitcoin

is low, and/or (2) the number of miners is large.

• Our empirical analysis suggests that the Bitcoin system

was about to face a crisis in November 2018.

Miners may disagree with the upgrade

• Bitcoin can stabilize the system by upgrading DAA to Bitcoin Cash

DAA, and the upgrade is beneficial to users.

• However, such an upgrade may be difficult to implement.
• The majority of miners, who has

relatively large electricity cost, can enjoy more rewards under an unstable DAA.

Stable DAA → Always low winning rate (= low reward) → Never turn on machine → Enjoy no profit Unstable DAA → Can enjoy profit in easy-to-win epochs. Full paper: https://ssrn.com/abstract=3410460