The attraction of Bitcoin and similar cryptocurrencies is that they are produced largely without a central bank. They can be bought and sold without a bank account. What makes the system come to life is a decentralized structure based on technical protocols and costly calculations between the participants.
The most important innovation Nakamoto introduced with the Bitcoin article in 2008 was to ensure that the network structure was reliable by offering incentives to ensure that the records were correct. The reward mechanism offered through the system prevents fraud. Miners compete effectively using computing power to solve a mathematical problem. Providing a solution proves that they do a certain amount of computational work. This Proof-of-Work enables the miner to add new blocks, earn rewards (Bitcoin) for added blocks, and charge fees for those transactions.
At this point, we must ask two questions; First, how effective is architecture to prevent fraud through costly proof of work? Second, can the structure generate enough rewards for continuity of transactions?
Analyzing these two elements reveals key economic constraints that blur the future of proof-of-work cryptocurrencies. In summary, it is currently not clear whether the logic of such cryptocurrencies will continue to work continuously. This is not related to scaling or unbalanced valuation issues in cryptocurrencies. Rather, it is about the fundamentals of the new block adding process developed by Nakamoto.
The first limitation is that proof of work requires high transaction costs to ensure payment accuracy. For this reason, attackers can first generate bitcoin blocks that they spend and then delete these blocks with a stronger fork that they will create retrospectively. This transaction could theoretically yield 8.3 percent of the transaction volume of current mining revenue. At this point, attackers can earn a much higher bitcoin income than an honest miner. While honest miners only collect block rewards and transaction fees, fraudsters get not only any block rewards and transaction fees in the fake chain, but also twice the amount spent (i.e. the value of invalid transactions).
The second main economic constraint is that the system cannot generate transaction fees in order to guarantee payment security. If the system is running below capacity, transaction commissions may be reset and the income motivation of miners other than rewards to maintain the system may disappear. The important underlying reason for this is that the structure that determines the proof of work and therefore the security level is determined at the block level.
With the interaction of these two constraints, I draw the following conclusion: proof of work can only ensure payment security if mining revenue is high. As a result, liquidity will suffer greatly in the coming years.
The majority of miners' current income is made up of block rewards. However, the block rewards are halved over time. As block rewards decrease, the security of payments decreases and transaction fees become more important to guarantee the accuracy of payments. However, the economic design of the trading market is moving to a point where it cannot generate sufficiently high commissions.
In order to prevent liquidity from melting, Bitcoin and other cryptocurrencies should stop using Proof-of-Work and adopt other methods for blockchain updates. Although there are structures such as Proof-of-Stake that stand out among the many proposed developments, a definitive and long-term solution has not been presented yet.
The general conclusion that can be drawn based on current technology; In the digital age, money is likely to protect its social structure rather than a completely technological one. The current structure of cryptocurrencies shows us that they are in a doomsday economy structure. The key question for future research should be how technology-driven decentralized change will contribute to existing monetary and financial infrastructure.
