New Research Raises Questions About Cryptocurrency’s Economic Value

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University of Chicago Booth School of Business Economics Professor Eric Budish has published a paper that calls into question the limits to a cryptocurrency’s economic importance. The analysis focuses on how a cryptocurrency’s vulnerability to attack increases as its value rises.

Budish examines the amount of computational power needed to maintain the “anonymous, decentralized blockchains” central to cryptocurrencies and the conditions that must be present for the system to reach equilibrium. The anonymous, decentralized trust promised by the blockchain is both ingenious and expensive, he notes.

Not only that, the security of the blockchain demands that the proof-of-work chain that rewards crypto mining come from the largest pool of computing power working on the network nodes. Budish cites Satoshi Nakamoto’s 2008 description:

As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the
network, they’ll generate the longest chain and outpace attackers.

Several successful 51% attacks have shown that once the balance of CPU power tips toward attackers, millions of dollars of a cryptocurrency’s value can evaporate in a so-called double-spending attack. To defend against a 51% attack, a cryptocurrency’s hashing function must make the attack so expensive in terms of computing power that the value of a successful attack is not worth the effort.

In Budish’s terms, in order for “trust to be meaningful requires that the flow [i.e., recurring] cost of running the blockchain is large relative to the one-shot value of attacking it.” If, however, an attack is launched with the goal of sabotage, the intention to “harm the subsequent value of the attacker’s own Bitcoin holdings,” the payoff to the attacker may be quicker and cheaper. There are at least two reasons an attacker might have to launch a sabotage attack: first, to lower trust in the blockchain in order to keep established systems in place; and second, to earn a profit from a short position in the cryptocurrency.

Whether the goal of attacking a cryptocurrency is financial gain or sabotage, the results, says Budish, “place potentially serious economic constraints on the use of the Nakamoto … blockchain innovation.” He continues:

[T]his paper suggests skepticism and caution about larger-scale uses of this technology, such as Bitcoin as a “store of value” akin to gold, or the use of the Nakamoto (2008) blockchain by businesses and governments. Most businesses and governments presumably have access to cheaper forms of data security, e.g., distributed ledgers or databases that require a trusted party (e.g., the business or businesses themselves), rather than having to pay the high costs of the trust that is emergent from a large network of untrusted computers coordinating on maximum proof-of-work.

Budish’s paper is available at the Booth School of Business website. The paper is written by an economist for other economists but is (mostly) accessible to general readers.