• Ping He, Dunzhe Tang and Jingwen Wang

Proof-of-Work (POW) Blockchain Network and its Viability as a Payment System

Blockchain Technology and Blockchain-Based Cryptocurrency market have proliferated over the past 10 years. Started with only bitcoin on 2009, there are now over 2000 cryptocurrencies trading on more than 19000 markets all over the world. Regardless of furious debates on whether it is a life changing financial innovation or just a brilliant Ponzi game, cryptocurrency is surviving well. Essentially, blockchain-based cryptocurrency is a payment method, therefore understanding the economic environment created by blockchain is key in helping us deciding whether it we should widely accept it for daily use.

From a technical perspective, all cryptocurrencies share similarities and distinctions. Among the fundamental components that define a blockchain-base cryptocurrency, consensus algorithm is the most essential one. A blockchain network’s consensus algorithm determines how it achieves agreement on its input value and secures its existing data. Among the ten biggest cryptocurrencies (measured by market capitalization), six of them adopts PoW consensus algorithm, and the well-known bitcoin launched by Nakamoto (2008) is the first successful application of PoW-based blockchain network.

To this end, our paper constructs a general equilibrium model of PoW protocol based blockchain networks and analyzes the sustainability and stability of the economic environment created by it. We build our economic framework based on the optimization problem of two major participants of a blockchain network, namely, users and miners, and use it to capture three key endogenous elements: network hashrate, transaction fee, and token price. These elements help us to understand the fundamental mechanism and value of blockchain networks. Our paper identifies the inter-temporal feedback loop between network hashrate and user behavior, and examines a blockchain network’s impulse response to short-term exogenous hashrate (supply side) shocks.

Given the equilibrium pricing model, we then investigate the long-term sustainability of a blockchain network and highlight the benefits of technological progress on blockchain networks. Finally, we study the stability of a blockchain network system by examining its short-term impulse response to exogenous hashrate shocks. We demonstrate that a positive shock, under reasonable assumptions, drives the blockchain network to a new steady state with both higher network hashrate and token price. We also find that a negative shock has to be sufficiently large to sabotage the blockchain network.

We believe our paper is the first to study the structure of transaction fee and the short-term stability of a PoW-based blockchain network. Previous research and papers written contemporaneously with ours mostly focus on equilibrium cryptocurrency price and user adoption issues. We hope that our general equilibrium model and analysis may help us understand the viability of PoW-based blockchain networks, and serve as a guide for future developers, policy makers and economists.

Ping He - Tsinghua University

Dunzhe Tang - Tsinghua University

Jingwen Wang - Tsinghua University

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