Ever since monarchies fell to the collective idea that citizenship and voting rights should belong to every individual, decision making has been constrained by a lack of long term thinking and rational irrationality. Of course, monarchy had it’s own drawbacks. Your sovereign can suddenly die and a power struggle between heirs can ensue. Every once in a while, the individual who comes to power might become a tyrant, insane, or incompetent.

These issues are usually what leads to the transformation into some form of democracy. Democracy, however, comes with a couple of insurmountable problems.

Rational ignorance Rational irrationality

Rational ignorance describes the incentives structure for people to even know about or understand the problems which face society collectively. In a democracy, individuals’ ability to change which decisions are made in regards to these problems are infinitesimally small. Additionally, knowing about, much less understanding, these problems is quite expensive. It requires research and thought, both of which take a great amount of time. So when the vast majority of people in a democracy vote, they do so almost completely ignorantly.

Rational irrationality encompasses rational ignorance and goes a step further. It’s not merely that people are ignorant. If that were the case, then the distribution of mistaken beliefs would be random, and intelligent/knowledgeable people could sway the decision making one way or another. But the distribution is not random. There is consistent bias of mistaken beliefs which vastly override what the intelligent/knowledgeable people would decide.

As an example, what if each member of society would gain an additional $10,000 of income or savings because foreign trade was allowed. If any single member of society could snap their fingers, they likely would look into the issue and make the decision to allow free trade. That yet, is not how most societies work. In a democracy, decisions are made through voting. When each member casts their vote to decide an issue, the majority to decides on the outcome.

So each citizen has a decision to make. Each doesn’t know beforehand that they would gain $10,000 from the change in trade policy. They also know that even if they did know how much one would gain, they would be unlikely to cast the deciding ballot. One might expect that any correct policy change they research will average $5,000 personal benefit. Imagine they also live in a small enough society that each has a 1 in 500,000 chance that their ballot will be the deciding vote. According to betting odds, that bet is worth $0.01. Would it be worth it to invest even 1 hour investigating the complexities of a policy to determine the effects of changing it. Would they then accept the conclusion even if it conflicted with their worldview, all for $0.01 of benefit?

All of this is before you add in the ability to create fake votes (Sybil attacks) to overwhelm the voting system. So then, how do we create a system in which the decisions made are the closest to members aggregated interests, but still removes rational irrationality. Ultimately it comes down to increasing the odds of making the deciding vote for the people with the best incentives to make the correct decision.

Monarchy is capable of defeating the issues of rational irrationality because the monarch could indeed snap his fingers, make the decision, and reap the benefits. It also benefits from what is known as a residual claimant, an individual who has claim to additional benefits reaped by the society, and therefore has long term interest in maintaining the value they’ve invested into the society. However, as mentioned before, this system is subject to catastrophic failures due to a single point of failure protected by a persistent lifetime claim to the throne despite incompetence or insanity.

Proof of Stake, or economic majority (a distinction without a difference), is often suggested as a method of removing catastrophic failures which monarchies are prone to create. Whether or not proof of stake can overcome rational irrationality comes down to how concentrated the distribution of stake is. The smaller the concentration, the smaller the benefit knowledgeablity has on the outcome. Furthermore, stake is slow to shift to the competent over time, and causes decision making power, much like monarchy, to rest in a family for generations after competence has regressed to the mean. So Proof of Stake actually suffers from both the weaknesses of monarchy and Democracy, though to a lesser degree than both.

Is there a solution to these issues? To summarize, our system needs to reduce catastrophic decision making, which means termination of decision making abilities for those who are incompetent. It needs incentivized value creation, which means residual claimants benefit for their decisions which create utility for others. Lastly, it needs a small network of decision makers, such that the probability of making the deciding vote is high enough to incentivize being informed about all subjects relevant to the networks creation of utility. How are these problems solved then?

Proof of Work.

Bitcoin has not only a unique way of solving the Byzantine Generals problem, but also the selection method to decide who the Generals are. By not leaving the selection of Generals up to inheritance, stake, or voting, Satoshi Nakamoto created a new class of decision makers. By making the Generals entities who command the most hash power, Bitcoin effectively removes rational irrationality from the decision process. It does this without the catastrophic failures of monarchs, while maximizing the incentives of stake holders to be informed about the decisions which create the entire network’s utility. A miner who goes insane or suddenly becomes incompetent is guaranteed to lose hash power. There is no inheritance of rank, no resting on your laurels. You compete, forever, or you fail. The only realistic way to compete is to be competent and knowledgeable. Any deviation and your profit margin suffers. If that happens long enough, you’re forced to sell your capital to someone more competent, or become obsolete as you fall behind technologically.

This is what Nakamoto Consensus is. Not watching the price on exchanges (likely to have false information). Not seeing who adds to the noise on social media what they’re going to do. Its who goes out of business or acquiesce first, and which chain remains functional (and therefore provides utility) during the course of a dispute among Generals. Ultimately, of course, the utility the blockchain provides to users is the metric by which we measure its success, but this can only ever be after the fact.

Exchange markets have only ever been able to answer the question “what do I think is going to happen, and how will that play out”. The expertise in the market is noisy and can’t be used to drive decisions. If that became common (as is sometimes the folly of companies), competitors could easily make these signals noisy through exchange market manipulation in order to drive your decisions toward error, and then only after the consequences are felt, a correction occurs. Nakamoto Consensus however, is the first time a market has ever driven the decisions, before the consequences, toward a solution which is beneficial to the network… And it’s likely the single greatest invention in the history of man since agriculture gave way for civilization to create societies and hierarchy was formed. Ever since then, the question of the optimal way society makes decisions has been searching for an answer.

Well here it is.

Proof of Work.