Monday, August 7, 2017

BTC Is Dead, Long Live BTC - Updated and Explained ELI5

I asked to be proven wrong but sadly nobody did. Blinded by the rise in price of both BTC and BCH nobody cared enough to look back to take stock. Let me explain as clearly as I can.

1) Mining Difficulty Adjustment.

Bitcoin mining recalculates and adjust the mining difficulty so that it produces a block every 10 minutes on average. This recalculation and adjustment is done after every 2016 blocks. Approximately every 13 days.


2) What happens if there is a sudden drop of hashing power?

Imagine that we have 10 computers contributing computing power to solve a problem every 10 minutes. If 1 of the computer fails then the problem will be solved every 11 minutes because there are only 9 computers working on the problem.

If there is a catastrophic failure such as 9 computers failing then it would take at least 100 minutes for the remaining computer to solve the problem. This was the situation when BCH forked, where it took from 12 to 15 hours in the beginning to find a block instead of the expected 10 minutes. Fortunately for BCH the developers knew of this problem and built in an Emergency Difficulty Adjustment (EDA) which adjusted the difficulty down by 20% if less than 6 blocks were found in the last 12 hours.

3) How does a loss in mining power affect the current situation?

Before the fork
Block times would get longer but after 2016 blocks the difficulty will adjust and block time will get back to the normal 10 minutes.  Miners will keep mining BTC because their equipment can only work on this coin. They will continue mining until their equipment is no longer profitable. They don't have a choice.

After the fork
The miners now have a choice. Should they be mining BTC or BCH and we can assume that they will make this profitability calculation and decision everyday. So the miners will be keeping an eye on the price, difficulty and transaction fees. At 3300 dollars for BTC and 300 dollars for BCH it is just about 55%  more profitable to mine BTC.  Mining profitability of BCH is getting close to BTC and can flip any time, especially with the enormous potential for BCH price to approach BTC.

If BCH is less profitable, why are any miners mining on that chain?

Well, for every chain there are miners who mine at a loss because they want to support the chain or they believe that the coins will be worth more in the future. These are the supporter miners and they exist on both chains.

Now what if there is a drop in mining power because some miners decide to switch chain for whatever reason or if there is a power failure ( hydro dam goes dry or fire at power plant taking it out for several months) that wipes off 10%  of mining power on that chain.

If it happens on the BCH chain, EDA will kick in and readjust the difficulty downwards by 20% to arrive at the targeted 10 minutes block time. In addition to EDA, BCH also allows up to 8MB blocks, which means that the transactions in the mempool can be cleared at the rate of 8MB per block if necessary.

If it happens on the BTC chain, there is no EDA built in, so block time will get longer than 10 minutes. How much longer depends on the amount of hashing power lost. It will have to complete the whole 2016 blocks cycle before the difficulty can be readjusted to bring the block time back to 10 minutes. Instead of 13 days to readjustment it could take much longer. If the block time gets to 20 minutes it could take about a month before the difficulty is readjusted. This increase in block time affects the mining profitability. At the same time the transactions in the mempool are backing up and users will be getting increasingly frustrated with long confirmation times and high fees because of competition to get into the next block, and only 1MB of the mempool can be cleared at a time. ( At time of writing BTC mempool is 45MB ) This decrease in the profitability of mining may cause miners to switch to mining on the BCH chain because they now have this option. As more miners leave the problem gets worse and this can result in the dreaded Chain Death Spiral.

That can never happen? Well if the price of BCH goes up by another 300 dollars it will become more profitable to mine and miners will switch. This is real and not hypothetical. 600 dollars for BCH is not an unreachable figure. After all it is closer in design to the original Bitcoin.

Transaction fees

     On the BTC chain, transaction fees gets higher as competition to get into the block intensifies. Miners are happy to earn this extra revenue but users are not. We can say that the BTC chain is elitist and only those who can afford the fees are welcome to use it. Those that can't or wont pay are encouraged to leave, and leave they will, perhaps for the BCH chain which is cheaper and faster.

On the BCH chain transaction fees are kept low because there is ample space in each block to accommodate all users. We can make an argument that if users don't have to pay a fee, they wont. However in reality the majority of users will pay and it appears that most people consider 5 cents to be a reasonable fee. Some are happy to pay more and some will pay less and in this way the BCH chain caters more for the masses. The rich don't mind subsidising their poorer cousins in India and Africa.

What about the lightning network where the users need only pay very small fees to use the network. Firstly the lightning network is not here yet. Secondly the miners don't get this fee and so will not be concern with the fees collected there.

Remember that more users means more value. This means that in the long run the BCH chain will gain users and grow value faster.

User Economics

Now we will switch to the investor point of view. A majority of users treat BTC and BCH as a store of value. Most are investing hoping that the value of their investment will increase over time.

Whether you can afford to invest 100 dollars or 1 million dollars it probably represents a significant part of your wealth and you want to invest it as wisely and as safely as you can.

So these are the questions you should ask

1) "Can miners leave the chain you want to invest on?" 
   
       The answer to both BTC and BCH is YES.

2) "What happens to the chain in question if miners leave?"
     
       The explanation is above. On the BCH chain nothing much. It will slow down awhile but will adjust and get back to normal. However on the BTC chain it is possible and not a non zero possibility, that the chain could come to a grinding halt and become unusable.

It is your hard earned money so the thought of it being subjected to loss, even if it is only a small chance, should sway you to the safer choice or not invest at all. If you are investing for your family and friends or your investors, the question of risk and safety becomes more acute as reputations and legal implications are involved.

3) What happens if you are already invested and you just found out about this existential risk?
   
        If it is your own money you could decide to accept the risk and remain invested. However if it is not your money then you have a legal duty of care. You have a fiduciary duty to make sure that the funds you are entrusted to look after are safe. You have been made aware of the risk, and even a small amount of known risk cannot be acceptable for you legally. If you are invested in BTC, you will be waking up everyday checking BCH prices, the mempool and difficulty and mining profitability, to see if any miners have or could possibly leave initiating the Chain Death Spiral.

If you are invested in BCH you have peace of mind because the dreaded Chain Death Spiral is not a possibility.

4) What would you do if you are heavily invested say hundreds of millions or billions and you decided that the risk is unacceptable and you need to get out?

If you had both BTC and BCH at the time of fork then your position is neutral.

If you have sold your BCH allocation or if you invested in BTC after the fork, it gets interesting. Because if you were to sell quickly you will crash the market. So you will need to do it slowly and at the same time keep the conditions as "normal" as possible until you exit completely. To do this you will have "manipulate" the market directly or through user forums, to keep the BTC price high and the BCH price low until you exit your positions.

Wonder why the BTC price is so high and bullish. It is not just because of demand and the selling of BCH to buy more BTC but those that did, now have a mission to keep BTC prices high with rosy predictions like 5000 and 25000 soon. They are now bias and invested in BTC price staying high. Be wary.

Conclusion

Do not be fooled. By now the people invested know what is happening. Before the fork it was hard to see. But now they can clearly see the implications and how events will unfold and play out. Some will see it before others. Some will take advantage of what they see to make a profit. Arm yourself with knowledge so as not to be caught at the wrong end of the stick.

There is a continuing competition for the services of miners to secure their chain. In this scenario the BTC chain always carries the possibility of going into a Chain Death Spiral. The BTC chain is doomed because it does not have the protection of EDA and the problem is magnified by the 1MB limitation. It is only a matter of When and not If.

How do you know if I am not favoring one side against the other?

I am telling it like it is. I am not comparing the technical merits of each technology or the capabilities of their developers. If the chain fails these merits do not matter one iota. The fact is one side, BCH has immunity against loss of hashing power. The other chain does not, When the "disease" hits, the chain without the immunity will get "sick" and can even die. When it does the chain that survives, BCH becomes the new "Bitcoin". This is the reality.

So why can't the developers of the BTC chain program in EDA or something similar?

It is a hard fork! And therefore not really in their control. It took nearly 4 years to get BCH to hard fork to bigger blocks and only really made possible because a soft fork UASF threaten to split the chain. The miners promised to support and not to attack the new BCH chain as insurance and security against UASF to which they were oppose. It is actually an unexpected bonus that the BCH chain has immunity against the dreaded Chain Death Spiral, and only because that protection was built in from the outset out of necessity.

If you are wondering why this was not a problem for ETH and ETC, it is because unlike Bitcoin, their mining difficulty is calculated and adjusted after every block.

Link to the previous article BTC is Dead, Long Live BTC