Proof of Stake — the “humans are rational beings” assumption

ℹ️ Blockchains need mechanisms for their different participants to reach a consensus. The most famous one is called Proof of Work and involve mining: people dedicating computational power to solve a mathematical challenge in order to verify transactions, and being rewarded for doing so. Proof of Stake (PoS) is another take to solve this problem: instead of the computing power, this time people lock “stakes” (coins of the given currency) in order to validate a transaction.

Essentially, we’re making with Proof of Stake the very same mistake economics — as an academic field — has been making from day one: assuming that we are all rational beings who behave logically, always trying to maximize our own best interest.

More specifically, in the case of proof of stake, the whole system holds onto the premise that people don’t want to lose money: so if they start to misbehave (trying to game the system), they will have their “stake” slashed, potentially all of it.

The elephant in the room that is rarely accounted for, as you probably understand already, is that people are sometimes willing to lose money because they act on other motives: love, hate, rage… I can picture dozens of scenarios where a group of people would be willing to burn millions if not billions of dollars just to destroy a chain, but one will be enough:

Let’s say a PoS protocol becomes increasingly popular, to the point where major banks are worried. Three of them realize that by banding together, and with a little disinformation/scare campaign, they can crash the price 30–40%, and then expand barely a fraction of their annual income to progressively take control of the chain. The coins they buy to destroy the chain are accounted as a cost. They’re not motivated by profit: they are motivated by fear, which is potentially the strongest human driver (see reference 2).

ℹ️ There are ways to protect a chain against such an attack, my point is more about the issue of making the assumption that humans are rational while designing this consensus mechanism.

Layer 2 — Getting lost in the tech, losing sight of real usage

Maybe you’ve heard about what we call layer-2 solutions? They are essentially networks built on top of the base network (Bitcoin or Ethereum) to allow faster and fee-less transactions. The most prominent developments include Lightning network, Plasma, Casper and or other state chains. We’ll focus on Bitcoin’s Lightning network as its mains flaws are shared by most others.

The problem is simple: some layer 2 solutions somehow managed to provide a worse user experience than the base layer. Here are the restrictions of the Lightning Network, that will never be lifted because they are due to protocol-level decisions:

A channel must be open to receive/send money (aka you must be “online” to send/receive).

— You don’t have to, on the base layer. A channel must be provided with some currency to be opened. It cannot allow the transit of more currency than what’s in it. Say you open a channel with 1 BTC, someone sends you 10 BTC — doesn’t matter, you won’t be able to get more than 1 BTC out of it.

— The base layer knows no limitations to the amounts you can send (as long as you can face the transaction cost) and receive. Most of the transactions are settled off-chain (except the state update — the settlement when you close a channel), which means they are low-fee and fast, but you also lose the security and accountability provided by on-chain settlements.

So from a very high level perspective, the layer 2 tradoff is as follows: you loose most (if not all) benefits provided by blockchains + you have to face additional significant limitations but your transactions are faster and cost less. Why such a need for speed? An Ethereum transaction currently takes ~20 seconds.

Now, this is where it gets funny: this whole thing has been in development for more than 3 years. So far, there are no real usages or use cases provided by layer-2 solutions that you can’t do better with the appropriate base layer solution. There will never be. Yet we have hundreds of technical papers discussing its potential implementation and crowds getting hyped at the idea of the Lightning Network making small, incremental progress.

If you go a meetup talking layer-2 you’ll meet a crowd of semi-enthusiastic nerds discussing the highly technical details of the different implementations. You can ask them my very question: how do you expect this thing to ever be used if the UX is worse than layer 1? They’ll answer you 100% on the technical side, and miss the whole point completely — breaking through the tunnel vision requires diversity, from within and at an early stage of the development.