Konrad S. Graf: Bitcoin Block Size Political Economy

Bitcoin.com got the chance to sit down with respected Bitcoin thinker Konrad S. Graf and talk about the ongoing Bitcoin block size controversy. By applying the theories of political economy to the issue, Graf argues that the 1 MB block size limit is economically most similar to a government mandated output ceiling. To get the details on where Graf stands, read on.

Also read: Konrad S. Graf: ‘Bitcoin Is Among The Greatest Inventions in History’

Bitcoin Block Size Political Economy

Konrad S. Graf has published articles on Bitcoin monetary theory and action-based legal philosophy and has presented on these topics at conferences in Europe and Australia. In 2015, he published Are Bitcoins Ownable? a monograph on bitcoin and property rights theory. His article, “Commodity, scarcity, and monetary value theory in light of Bitcoin,” appeared in The Journal of Prices & Markets in 2014. His late-2013 monograph On the Origins of Bitcoin was among the final three for a Blockchain Award in 2014 for most insightful academic paper (Satoshi won). His work is collected at konradsgraf.com. You can follow Graf on Twitter @KonradSGraf.

Bitcoin.com (BC): You mentioned to me that you’ve thought a lot about the block size limit, but haven’t publicly spoken about it much before now. Why is that?

Konrad S. Graf (KSG): I’ve been considering this since about autumn 2014 and writing a working draft about it, but just never felt I reached a final product, and my focus alternated with other projects. I am talking about this now mainly because you asked me, but I also think the timing is finally right in my own process to say a few things. I take seriously the principle of seeking first to understand, then to be understood (Covey’s Habit 2). With this issue, there is no shortage of “seeking first to understand” to be done—there is much new here—but at some point in any such process, it is also important to do some “seeking to be understood.”

BC: Let’s get straight to it, then: Where do you stand on the block size scalability issue?

KSG: Where I stand derives from how I look. I recently talked with someone who characterized the debate as between business people looking to keep expanding now and technical people being cautious about the long-term system architecture. I said, “Right, and then there’s me,” meaning there is also at least a completely third way to look at this.

My focus is on economic and legal analysis of social structures and institutions, close to what used to be called “political economy.” Bitcoin is a new blend of service, product, business, culture, and institution. It has multiple technical, business, and economic layers. That makes it interesting but can also lead to confusion. So if that person was right and many others tend to see primarily either a technical system to be fine-tuned or business models to be optimized, I see a market, and that is quite a different creature. Economics is not business and it is not engineering; it is a third thing.

If a market itself somehow becomes subject directly to engineering-style or business-style treatment (see crony capitalism, “picking winners,” and similar boondoggles), there are certain implications, none of them good. In the wider world, this looks, for example, like “engineering the economy,” fine-tuning interest rates and exchange rates for “stability” (how’s that working out?), cartelizing industries and killing competition through regulation, and so on.

When engineering methods and mindsets are applied to market factors through government, it is called economic intervention. One problem with such economic engineering, and there are many, is that it treats people as among the moving parts in the planner’s model. But those people have other plans of their own. And despite the typical planning narrative, the master plan may well not “really” be better for them.

A major contribution of the economics discipline over the past centuries has been to explain that, and how, market interventions produce waste, shortages, unemployment, dislocations, and lost wealth in society. And those are just the direct effects. “The economy” is no machine or product or service. It is not even one giant “business.” It is an ever-evolving order of voluntary interactions among conscious, learning, and adapting beings. Enforced limits distort those dynamic coordination processes, prevent better discoveries from ever happening, and favor less efficient methods over more efficient ones, the known over the not yet known, the status quo over the next innovation.

And then it gets worse. Interventions cannot be “neutral.” They always introduce a win/lose dynamic. This fuels polarization and politicization. Now people feel they must fight to influence the intervention policy in their favor because someone else will surely try to influence it the other way. While market relations are by definition win/win in the sense that no trades take place without mutual consent, any market intervention introduces at least some degree of a win/lose Hunger Games style dynamic. Everybody is handed something to fight over in a zero-sum set-up and then feels some need, or even responsibility, to influence how the intervention measures are implemented.

BC: How would you describe what the market is in relation to the block size limit? People talk about the need for a fee market, for example.

KSG: First, “fee market” strikes me a poor usage. Fees are paid; products and services are bought. So this term already obscures the real product. Users submit transactions with a fee as an open bid in hopes of confirmation. Some research indicates that higher is not necessarily better above a certain going level, but bidding below that certain going level tends to result in increased delay probabilities.

So I describe this as a market for transaction-inclusion services. Users bid to have miners include transactions in candidate blocks. Inclusion in more candidate blocks—especially in relation to the total hashrate mining for those candidates—raises odds of quicker confirmation. Users prefer quicker confirmation to slower, other things equal, so the time element of scarcity is key. It is a market for confirmation priority, a time market.

Including each transaction in a candidate block incurs a certain marginal cost to miners. Each transaction has to be received, validated, and either included in a given candidate block by a certain time or not, all at some non-zero cost. The larger a given miner’s own candidate becomes, for example, the greater the orphan risk. As such costs and risks rise over the years with rising volume, each miner/pool faces ongoing decisions about operating conditions, connectivity, costs, and risk assessments. These inform each miner’s own pros and cons of inclusion at a given time, of deciding to invest in different levels of capacity and connectivity, and so on.

Miners, therefore, compete with one another within a service industry. In providing these services, each miner would like to raise his potential fee revenue (especially as the fixed reward declines over the years), but has to balance this against costs over time. A transaction’s source, by the way—whether from an end-user, a company, or a payment channel system—should not matter, per se, from a miner’s standpoint.

BC: No government controls the block size limit, though, so can the intervention model really apply here?

KSG: If the limit restricts the maximum quantity of services that the mining industry can supply, this begins to operate as a market intervention. It doesn’t matter who is placing that restriction, or why. Intentions and identities do not change the economic effect of a policy. Motives are irrelevant. Market distortion happens due to the policy’s nature, regardless of how it got there or who put it there or who left it there. The more the limit comes to actually limit regular market volume, the more negative the consequences are likely to become.

Let’s take a separate example. Say the average bottom real wage in an economy were around $7, but the government sets a $5 minimum wage. What happens? Well, nothing. It doesn’t matter. Now, however, this minimum is raised to $6 and then $7. Still, not much happens. A few people start to be unemployed who otherwise might have been employed, but this is mostly unnoticed. Now $8. Effects begin to kick in. Then $9, then $10, and more. With each increase, more and more people will be unemployed who might otherwise have been employed at a wage between $7 and the latest minimum. Shrunken, relocated, bankrupted, and unlaunched companies then never provide this non-existent employment.

Similarly, but inverted, the block size limit constitutes an industrywide output ceiling that has remained fixed while data volume has finally risen up to it. This same fixed limit has been in place since September 2010, but it had never before mattered in practice. The more the limit influences real market volume potential, however, the more economic and social cohesion damage can be expected, so this is far from a costless strategy and the full costs are easy to either underestimate or miss altogether.

Bitcoin has been exciting to some as a free-market money. A central theme in my work has been to characterize bitcoin as a medium of exchange that has emerged from non-state, non-compulsory sectors of society. Some Bitcoin observers with a reasonable economics background may have begun from this general image and then assumed that since intervention is something only a government can do, the block size limit could not be considered such because it emerges from the non-compulsory sector.

Nevertheless, in a market with multiple sources of supply and demand and with prices and quantities supplied, a production ceiling still stands between service suppliers and their customers and still prevents new entrants from joining to break the ceiling. The economic analysis of that policy on this market (the on-chain Bitcoin transaction inclusion market) should be the same as if a government agency had imposed it, even though the “normative” (actually, legal theory) status of the two cases differs.

The two cases are clearly separate under legal theory, but not nearly so much under economic analysis. Government action to impose an output ceiling can only succeed through the threat or actual implementation of officially sanctioned violence against any would-be innocent resisters. In contrast, Bitcoin participation remains wholly voluntary regardless of this or that setting within the code. At the economic analysis level, however, the results of a production ceiling are the same regardless of its source and implementation method.

This case also fails to fit the (mythical) model of a stable free market cartel. Such theoretical arrangements are naturally unstable. Absent legal enforcement, any participant can gain by dropping out and exceeding the ceiling. Any new entrant can start producing without ever joining the cartel. In the current case, however, no particular renegade or newcomer alone can make a hard fork happen so as to break the output ceiling.

So the situation, although certainly novel, remains economically closest to a legally enforced industrywide output ceiling. One implication of this, while fascinating, is not especially encouraging: Not only has Bitcoin demonstrated that some good things that many had considered impossible without government are indeed possible—namely the production of money—it is also threatening to show that some bad things some had considered impossible without government could indeed be possible—namely, successful imposition of a cartel-style industrywide output ceiling.

This begins to make Bitcoin that much more a “mixed-economy coin” in this non-normative, but economic sense, and that much less a free-market coin. The advantages of allowing market coordination and innovation processes to function at their best are partially denied. If Bitcoin’s protocol is analogous to “the law” of this new land, then we are witnessing a particular slow-motion conversion from enabling natural market evolution, to implementing a mixed-economy style environment around the transaction-inclusion market.

Continued on the next page.