Academics Spy Weaknesses in Bitcoin’s Foundations

Game theory suggests the rules governing Bitcoin may need to be updated if the currency is to endure.

One thing cannot be disputed about the person (or persons) responsible for creating Bitcoin: they were skilled in math, and expert at coding. Five years after the Bitcoin software was first released, no major fixes have been needed to the core code, which uses cryptography to generate and transfer virtual money.

Yet signs are emerging of more subtle flaws in the vision of Satoshi Nakamoto (which may or may not be a pseudonym), with analysis suggesting the rules governing how Bitcoin operates as a currency may be far from perfect. Some researchers claim that these rules leave room for cheats to destabilize Bitcoin. Others have concluded that major changes to the currencys rules will be needed as the number of bitcoins in circulation increases.

In the real world, people dont always follow the rulesthey do whats best for them, says Joshua Kroll, a researcher at Princeton. Understanding this is the key to understanding whether and how Bitcoin survivesit tells you whether the system can last for a long time, [and] how robust is it in the face of shocks.

Kroll and others are exploring possible problems using game theory, a way to mathematically calculate how individuals might choose to coperate, compete, or cheat given the options available to them and the strategies of others.

One conclusion drawn by Kroll and his Princeton colleagues Ian Davey and Ed Felten is that those rules will have to be significantly changed if Bitcoin is to last. Their models predict that interest in mining for bitcoins, by downloading and running the Bitcoin software, will drop off as the number in circulation grows toward the cap of 21 million set by Nakamoto. This would be a problem because computers running the mining software also maintain the ledger of transactions, known as the blockchain, that records and guarantees bitcoin transactions (see What Bitcoin Is and Why It Matters).

Miners earn newly minted bitcoins for adding new sections to the blockchain. But the amount awarded for adding a section is periodically halved so that the total number of bitcoins in circulation never exceeds 21 million (the reward last halved in 2012 and is set to do so again in 2016). Transaction fees paid to miners for helping verify transfers are supposed to make up for that loss of income. But fees are currently negligible, and the Princeton analysis predicts that under the existing rules these fees wont become significant enough to make mining worth doing in the absence of freshly minted bitcoins.

The only solution Kroll sees is to rewrite the rules of the currency. It would need some kind of governance structure that agreed to have a kind of tax on transactions or not to limit the number of bitcoins created, he says. We expect both mechanisms to come into play.

That kind of approach is common in established economies, which tame things like insider trading with laws and regulatory agencies and have central banks to shape economies. But many backers of Bitcoin prize the way it currently operates without centralized control, and would likely rebel at any suggestion of changing the rules.

Researchers from Cornell claim to have found another problem with bitcoin mining. At the Financial Cryptography conference this month, they presented work suggesting that so-called selfish miners could exploit the current rules to gain more than a fair reward for their work.

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Academics Spy Weaknesses in Bitcoin’s Foundations