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Author Topic: The Balance of Power in the bitcoin ecosystem. Feedback appreciated!  (Read 819 times)
Brandsen
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February 22, 2017, 08:48:48 PM
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Introduction:

Miners are the rulers of Bitcoin...
At least, this is what people seem to believe..
After all, miners are the ones who create our beloved magic money…

But what happens if, let’s say 75%, of the miners (by hash-power) decides to change the rules of the protocol?

It turns out that miners are not the sole decision makers in bitcoin.

...There is a certain Balance of Power in the ecosystem…

In this post I will focus on the following participants:

Miners (including Hashers and Pool-operators)
Developers
Merchants
Users (including HODLers and traders)
Exchanges
Node Operators
Wallet providers

This balance of power becomes particularly interesting in the event of a hard fork.

As we have learned from Ethereum;
A hard fork that is not supported by everyone; can result a network split.
Effectively creating two different blockchains / networks with two different coins.

This can also be categorized as a “Coin-Split”
(the total amount of units will double)

Both coins are likely to have its own supporters, and both sides are likely to claim to be
“the real bitcoin”



Miners:
 
(including Hashers and Pool-operators)

Miners are thermodynamically securing the network with proof of work.
They are rewarded with new coins in addition to transaction fees. But high operational costs are forcing the miners to sell off the majority of this reward.
 
Miners produce blocks that are mathematically linked in a blockchain.
These blocks contain transactions between the bitcoin users.
The blockchain represents the history of all transactions.

Miners are on the supply side in the market, and are therefore putting downward pressure on the price of bitcoin due to inflation.

Pool-operators construct blocks.
Hashers are payed by Pool-operators to perform PoW on these blocks.

Hashers can leave or join any pool at any time.
A misbehaving Pool-operator risk that Hashers will leave the pool.

Let’s say that a miner successfully finds block X:
The miner will be rewarded with newly created bitcoin in addition to all transaction fees that are included in block X.
However, this money does not become spendable until the blockchain have been extended with an additional 100 more blocks that must be build on top of block X.

If other miners don’t agree that block X is valid, then they will reject the block by not building on top of it.
 
But what if a majority, let’s say 75% of miners (by hash power) have decided to change the existing consensus rules?
They may now see block X as valid, even if the remaining minority (25%) of miners disagree.
 
The minority miners (the ones who does not want to change the rules) are only going to build on top of what they see as the “most work *VALID* chain”
A new and otherwise valid block, will also become invalid (in the eyes of this minority) if it is build on top of block X.

This is where the blockchain will split into two different chains / networks.


Developers:

Developers write the code that makes bitcoin work.
New code only serve as suggestions for improvements.   
Developers cannot force anyone to run new code.

Different types of suggestions are:

Soft Forks:
Suggestions to add new consensus rules.

Hard Forks:
Suggestions to remove (or replace) existing consensus rules.

Changes that do not affect consensus:
Suggestions to add functionality that will effect how the network handles transactions that are not yet mined into a block (transactions that are held in the mem-pool while waiting for a confirmation)
Replace By Fee (RBF) and Child Pays For Parent (CPFP) are examples of this kind.


Merchants:

Are amplifying the perception (amongst users) that bitcoin is valuable. They do this by accepting bitcoin as payment for goods and services.

In the event of a coin-split;
The different merchants must decide whether to accept both coins as payment, or to only accept the coin that he/she like the most.


Users
(including HODLers and traders):

Users give bitcoin its value by;
A) Perceiving it as money, and using it as money.
B) Being willing to exchange their hard earned fiat money for the return of bitcoin. 
C) Acting (for the most part) as the “demand side” in the market, and are therefore putting upwards pressure on the price of bitcoin.
D) Ultimately decides what the value of bitcoin should be, as a product of how much fiat money they are willing to pay per bitcoin.
E) Having confidence that bitcoin will continue to be a good store of value.

If other participants act against the interest of users:
Users have the power to strike back on everyone in the ecosystem; simply by loosing confidence in bitcoin as money.
Loss of confidence by users will put downward pressure on the price of bitcoin, and therefore directly harm the profitability of miners.   

In the event of a 75% Hard Fork:
Users will now suddenly own 2X the amount of units/coins. An equal amount of coins will be held on each side of the fork.

Let’s distinguish between the two coins by calling them b1 and b2:

Users will collectively decide the value of b1 and b2. 

They can choose to:
Save both b1 and b2
Sell both b1 and b2
Sell b1 and save b2
Sell b2 and save b1

Selling will put downward pressure on the price of the coin being sold.
Buying will put upward pressure on the price of the coin being bought.

Users will establish an exchange rate between the two different coins. This means that users can buy b1 with b2, and vice versa.

Users are likely to first spend the coin they perceive as least valuable. And they are likely to save the coin they perceive as being the best “store of value”

Ultimately, users are going to give more value to one side of the fork compared to the other.

These actions made by users, will directly affect the incentive structures of miners.
As the coin with the highest market value will be more profitable to mine.
Economically rational miners will migrate to the coin with the highest value.

Theoretically there may be variations during time on which of the coins (b1 or b2) that holds the highest market value.


Exchanges:

Provide platforms for price discovery where people can buy and sell bitcoin.
In the event of a coin-split an exchange can decide whether or not to allow trading of both coin-types, or to only allow trading of the coin they like the most.
The latter may be risky, since users might be able to sue the exchange. Many users hold coins on exchanges, and this users are likely to demand access to both types of their coins.

Despite the risk of lawsuit, an exchange could technically just confiscating one type of coin, while claiming that this coin is a “fake bitcoin”
They could then choose to dump the coin into the market, thereby crashing the price of the coin they don't like.

Some exchanges may have written into their “terms and conditions” that they can decide what coin its users can access.

There may also be some delay before exchanges can offer the new coin after a coin split. Since the exchanges must adapt their infrastructure to allow trading of a new coin.

When both types of coin are traded on the same exchange, this will quickly result in an exchange rate between the two different coins.


Node Operators:

Nodes are independently validating transactions and blocks in accordance with the current consensus rules.
When a node considers a block to be valid, it will forward the block to other nodes, and the other nodes will repeat the same behavior.   
Nodes can be seen as accountants who validate the transactions created by users and the blocks constructed by miners.
 
Node Operators may download new software if they want to support a change of the current rules
(hard fork)

Nodes that do not want support a hard fork; will simply ignore all blocks that do not comply to its current ruleset. 

Even if these blocks represents the “most work chain” they will still be ignored (seen as invalid) by all nodes who have not download the software that constitutes the rule-change.
Wallet providers

Let’s say that a hard fork leads to a permanent coin-split (similar to ETH/ETC)…
Users will now own coins on both sides of the fork (on both blockchains / both networks)

Users are in need of new software that can handle the two different coins.

Wallet providers decides if they want to develop the needed software.

Wallet providers also decide how they want to display the two different coins in the a wallet.
Depending on which coin they like best, they may decide to display the coins as primary and secondary.
This may influence the perception among some users.

Users who fail to upgrade their wallet-software are likely to loose money.
This is because they lack the tool to handle both sides of the fork (both coins)
When spending money; the transactions are likely to be valid on both sides, so the risk is to loose money on the opposite side of the fork.


FINAL NOTE TO READER:
Thank you for reading!
I’m hoping for feedback to improve this post.
Please tell me if I missed something or got something wrong..
The final product will be posted on Medium.
This is the same technique that I used when I was working on my Lightning FAQ. The final result of that project may be found here: https://medium.com/@AudunGulbrands1
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February 23, 2017, 02:47:13 AM
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Very well written, easy to understand and for the most part I think it is very accurate.

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February 23, 2017, 05:51:18 PM
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Bitcoin ETF's, while technically outside of the Bitcoin ecosystem could also be incentivized to exert influence. The Winklevoss Bitcoin Trust as its written now would allow the operators to defraud investors in the event of a hardfork / coin split . 

(I am a 1MB block supporter who thinks all users should be using Full-Node clients)
Avoid the XT shills, they only want to destroy bitcoin, their hubris and greed will destroy us.
Know your adversary https://www.youtube.com/watch?v=BKorP55Aqvg
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February 24, 2017, 05:44:52 PM
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Like Smiley Should be stickied and linked to all newbies that want to understand Bitcoin. (I would add a bit of formatting, but agree to most parts)

I would add two things:

- Node operators can also theoretically exercise influence about soft forks. As soft fork signalling is visible in the version information, they can refuse to relay blocks from miners with a certain configuration (e.g. miners that don't accept Segwit, CSV etc.). If many node operators agree to do this, that gives miners an incentive to follow the majority of the node operators. (This scenario is discussed here.)

- Then I would add the following point about merchants: Merchants that accept a fixed price for goods and services are helping to stabilize and "back" Bitcoin's price and value. So I think they aren't only amplifiers but can opt to have a more fundamental role. (Edit: That would be most easy for pure "digital product" vendors, as they have no marginal costs and could even profit from crashes because Bitcoin holders would have a strong incentive to buy from them "to the old prices")

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Brandsen
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February 26, 2017, 04:34:12 PM
 #5

Here is a link to the final product:

The Bitcoin Balance of Power Poster

https://medium.com/@AudunGulbrands1/the-bitcoin-balance-of-power-poster-91271ab31b86#.nv1zoeqmp

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March 03, 2017, 04:26:36 PM
 #6

Here is a link to the final product:

The Bitcoin Balance of Power Poster

https://medium.com/@AudunGulbrands1/the-bitcoin-balance-of-power-poster-91271ab31b86#.nv1zoeqmp



Very well written  Smiley,

but I think the "users" of BTC (merchants and users) are the most important part here, because if they stop using it it will die, you can hire other developers, set up a new node, etc..

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March 04, 2017, 02:03:02 AM
 #7

This is a well composed overview of the Balance of Power in the Bitcoin ecosystem and a well written poster.
 
If I were to mention any places of expansion it would be in developing scenario cases related to the balance of power:
One example that comes to mind would be looking at Bitcoin nodes and how we put more weight towards miners than nodes in the system.

Other coins value nodes and miners an example can be seen in some Proof of Stake coins, or the role of Master-nodes and Proof of Work in two-tiered networks such as Dash. There are some interesting development paths that could happen in a Bitcoin fork and cases related to these type of developments that might be worth a bit of detail.

Related notes:
https://aakilfernandes.github.io/soft-forks-vs-hard-forks
https://www.dash.org/masternodes2/
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