Graduation Year

Spring 2014

Document Type

Campus Only Senior Thesis

Degree Name

Bachelor of Arts

Department

Economics

Reader 1

Brock Blomberg

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© 2014 Matthew Taylor

Abstract

The Bitcoin currency relies on a transaction verification system run by a decentralized network of miners. This paper evaluates the long-term economic stability of Bitcoin mining. Specifically, I analyze the incentive structure surrounding transaction fees, which are part of the reward miners earn for verifying transactions in the Bitcoin network. My method of investigation is to first construct a visual model representing miner incentives, then input current and estimated data into that model, and finally determine how individual miners and pools will behave based on the key variables included in the model and industry trends. I conclude, under the current protocol rules, Bitcoin mining is not economically sustainable in the long-term due to the impending centralization of the network. Centralization in itself will not necessarily destroy the network. However, it will lead to unsatisfactory outcomes that will greatly lower the value of the entire system. Therefore, I recommend two potential solutions to the centralization issue, namely the requirement of either P2Pools or a proof-of-stake mechanism. The development of future applications on the Bitcoin protocol depends on the success of the Bitcoin currency application. These future technologies, along with the Bitcoin currency, have the potential to disrupt many industries. But, if miner incentives are not aligned with maintaining decentralization, then none of this potential will be realized.

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