A river runs through it

Moving from the world of restricted flows of currents into the world of charts and diagrams, let’s see if we can get a deeper understanding of what is going on.

Life is easy, everyone meets in the market place

The image above illustrates the ideal world, the one we as people of the cave only see as vague shadows on the wall. In this world no one puts themselves between the supplier and the consumer. Everyone trades as their heart desires and value is created in the exchange.

Producers provide supply, consumers provide demand and the curves meet in the equilibrium, where the ideal exchange occurs. No one benefits more from it than the other. Everything that is green in the chart is value created. On the upper side of the dotted line is the value created for consumers, on the lower side of the dotted line is the value created for producers.

In the world of Bitcoin specifically, the value created on the upper green side is transactions being performed for users of Bitcoin. On the lower green side the value created for miners, rewards in bitcoins in the form of fees and block rewards, is shown.

There is a vertical dotted line, indicated with Q*. This is the ideal blocksize, where supply and demand for transactions are in balance.

If you don’t let me sell my carrots inside the city walls, I’ll go elsewhere. Or forget about it altogether. Who knows.

Once a quota is introduced, a lot of things change.

A new point, Q-max, is now sitting on the block size axis. This is the artificial production quota that is imposed on the network. There’s still the ideal point on the curve, Q*, where supply and demand meets. This point, however, can never be reached. The system is not in balance. The artificial restriction is causing demand to be unmet because the supply simply cannot be there due to the production quota.

So what happens then?

A lot of things, as it turns out. The most notable of them being a big red triangle, sitting to the right of the production quota line. This represents lost opportunity, value never created. It’s called deadweight loss. The artificial restriction on supply has a very real and limiting effect on how much value can be created from the network. An unfulfilled promise sitting there out of reach, unattainable.

Another notable thing is the separation of the green areas by a big yellow rectangle. The value created for the consumers and the value created for the producers have been separated by something.

This something, the big yellow rectangle, is the quota rent. The quota rent is the heart of the matter. This is why the men in hats are so desperate to keep the artificial limit.

The quota rent is wedged in between the value created on both sides. There’s still value there alright. It’s just that it is taken from both sides of the transaction. Consumers loose, producers loose. Men in hats, sitting on the sidelines, gain. They provide the solution for an artificial limit, a stranglehold designed to enrich a few and take from everyone else. This is not a very desirable state.

A central take away from this diagram is that value is destroyed, the red triangle, to enable someone external to gain from the transaction, the yellow rectangle. Rent-seekers wedge themselves in between producers and consumers, to siphon off what they can from both sides. Value destroyed you say? Not that we know of, we get ours. Others don’t miss what they never knew existed.

In the world of Bitcoin, this quota rent caused by rent-seeking is now manifesting at a large scale. The network is suffering through its worst crisis yet in its eight year lifetime. How big is this suffering? How much is the deadweight loss, the unrealised potential? How large is the quota rent, the value taken from the producers and consumers by shady men in hats?

Have a look just a bit below and you’ll see.

There’s a big dam sitting in the way. Why, oh why?

This is the state that the Bitcoin network is in today.

The unrealised potential, the deadweight loss, is eating the system. And has been doing so for the last two years. The dotted quota line in the image above is the 1MB block size limit, enforced onto the network. Not because the network needs it. Absolutely not. The network needs to get rid of it.

The ones that need the limit are the men in hats, described in the picture drawn on a paper towel two years ago. Without the limit, they will have no way of extracting rent from the network, and their grand plans of global rent-seeking will wither away.

The limit is killing the system and almost no one benefits from it. The consumers have almost completely lost the value the system is supposed to bring, the producers are being stolen from. Shady characters hiding behind concerns of network health are as a recommended cure slowly bleeding the network to death.

These characters have no motivation to preserve the network others have built. If they can’t extract rent from it, they care not if it lives or dies. In fact, they probably prefer to see its demise if they can’t have their way.