Bitcoin was the first system to achieve this. In this module, we will discuss a combination of incentives.
Bitcoin Achieves Decentralization
Before getting started, its important to understand that decentralization is a continuous process. A decentralized system such as email is based on an open protocol. Most email users, however, access the system through centralized providers such as Google.
Use technical signals to maintain discipline– Antoroy
Centralization vs. decentralization
In order to remove Scrooge, five decentralization questions must be answered:
- Who keeps the ledger?
- Who decides whether a transaction is valid?
- How are new coins created?
- How are rules changed?
- How do coins gain exchange value?
In technical terms, de-Scroogeifying Scroogecoin is decentralized consensus. Computer science deals with how to ensure that networked computers record the same information consistently. Twitter, for instance, might deploy dozens of servers around the world to collect tweets. Twitter needs to ensure that every new tweet is recorded by all of its servers or none of them. Users would otherwise see different streams depending on which server they connect to.
By disintermediating a variety of services, including email, stock trades, domain name lookups, and many others, a general solution to this problem would be possible.
We need a technical definition of a distributed consensus protocol before we can move forward. The goal of a distributed system with a certain number of nodes is that all nodes arrive at the same state. State is a broad concept that could mean different things in different contexts. The only requirements are:
- Each node decides on the same state.
- At least one node must propose the ending state.
The state of Bitcoin is the set of transactions that have been accepted and their order. The Bitcoin protocol ensures that every node produces the same transaction log.
It might be tempting to introduce the notion of global time. It wouldn’t work due to a number of factors, including network latency and the impossibility of synchronizing system clocks without a central authority.
By bending the rules in two ways, Bitcoin solves this problem.
Blockchain consensus without identity
Based on the technical definition of consensus, Bitcoin requires a way for a node to propose the next block, and for the rest of the nodes to approve or reject it. We can’t introduce trust by using real-world identities, and we need to make it difficult to game the system.
One way to choose a winner is through a lottery. It is a continuous lottery that picks a winning node at random points in time. Each winner publishes a block that contains a list of transactions and the unique ID (hash value) of the parent block.
In most cases, a given block will only be extended by one block. It is possible, however, for multiple blocks to claim the same parent. Bitcoin must choose the winning block. Nodes do this by extending the valid block that was seen first.
If you want to assess the security of a system, consider the attacks it has faced. A malicious node might attempt to:
- Coins are stolen. The reason this wouldn’t work is that public key cryptography ensures that signatures cannot be forged.
- Suppress transactions. It might work temporarily. In the end, another node would propose a block with the censored transaction.
- Respend the coin. The attack would succeed, but only under certain conditions.
Double spending is the most important of these attacks to understand.
Proof of work and incentives
Since nodes will always be incentivized to double spend, how can this behavior be discouraged? There are two options: penalizing dishonesty and incentivizing honesty. As used here, “honesty” refers to a node that follows the Bitcoin protocol, specifically the rule that in the event of sibling blocks claiming the same parent, the one whose block was seen first will win.
To encourage honest behavior, Bitcoin uses two economic incentives: block rewards and fees. With a special transaction in a generated block, a node claims the incentive. The video incorrectly states that block rewards will be exhausted in 2040.
The incentive payment is only valid if the block is accepted by the rest of the network. It will only happen if it’s valid and consistent with the first-seen rule.
There are still two problems:
- To generate the next block, a random node must be selected; and
- block generation must be controlled.
Proof-of-work (PoW) is the solution to these problems. A PoW participant hashes a message until it falls within a predetermined range. The solution is easy to verify, but difficult to discover. PoW can only be produced by trial and error.
The speed of finding a solution is proportional to the hash power applied to PoW. As a result, our lottery can assign a winner based on the relative hash power of participants. It is also possible to regulate the rate of block generation by making the PoW more or less difficult to find.
PoW introduces a new security assumption: double spending attacks are impossible when a majority of network hash power follows the protocol.
What is the purpose of ten minute blocks? In the video, the answer is touched on, but not fully explained. It is more likely that two nodes will generate a block at the same time if block time is shortened. When this occurs, the network must choose a winner. It’s possible, if this happens a lot in a row, that the winning sibling block will not be resolved for a long time. Bitcoin minimizes this problem by setting the block time high enough that simultaneous block generation is very unlikely. Bitcoin nodes produce fewer than one sibling block per month in practice.
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Completing the picture
In this lesson, the main points of the unit are emphasized.
Bootstrapping is an important topic to keep in mind. Specifically, any new cryptocurrency must have three properties to succeed:
- Block chain security
- and mining incentives that are aligned
- with a high currency valuation
Deficiencies in any of these properties can result in other deficiencies, and ultimately failure of the system. When currency valuations are low, weakness is most pronounced in the early phases. Since miners have little incentive to mine, security against majority hash rate attacks is low.
Bitcoin made it through the bootstrapping phase with flying colors. Block chain security depends on well-aligned mining incentives to ensure its continued success.