Posted: 30.06.2021 | 08:16
UNDERSTANDING THE BITCOIN INCENTIVE MECHANISM
The Bitcoin incentive mechanism is a carefully designed game. In order for the blockchain network to remain in a decentralized ecosystem for a long time, the interests of the parties must be compatible with each other. If the parties are not sufficiently rewarded financially, cheats will occur and the overall welfare of the network will decrease.
This is an obvious problem in cryptocurrency mining. The parties hope to create blocks and turn their investments into income by investing high amounts in electricity and special devices. Miners try to maximize their income and the best thing to do is to play the game by the rules.
If a miner links the block he produces to the chain, he gets the full fee paid for all transactions that pass through that block, except for newly generated coins. We call this the block reward and every time 210,000 blocks are produced, the amount of the coin reward earned is halved. We recently experienced a bitcoin halving and saw the reward amount drop from 12.5 BTC to 6.25 BTC. While there is a financial incentive to mining, it is actually quite competitive. This competitiveness increases the decentralization and security of the network. A game is also hidden in this incentive mechanism. In this article, we will take a look at this game, namely selfish mining.
WHAT IS SELF MINING?
In the article published by Ittay Eyal and Emin Gün Sürer in 2013, they put forward an interesting thesis: “The incentives of Bitcoin mining are flawed and eventually lead to the centralization of the network”. As an example, let's assume that the total hash rate is split evenly for 4 miners (25%). Let's say 3 out of 4 people follow the rules, but 4 out of 4 want to abuse the system for their own gain. Normally, we expect miners to work together to create a block and link it to the chain. The first 3 people acted honestly and jointly added the block to the network. However, if the 4th person finds a block and he hides (retains) it, he has a chance to add the second block to the network before anyone else. Suppose 20,000 blocks are mined and the top 3 honest friends are 20,001. they are trying to add the block to the network. 4. Friend 20001. Found the block but keeps it private. Now there are two chains; the first is in the public domain, the second is confidential. 3 honest friends now 20001. While he thought he had found the block, friend 4 found the 20.002 block.
Thanks to the block of the 4th person, the chain he created is ahead of the others. We call this rule in the Bitcoin protocol the longest chain rule. The Proof of Work mechanism allocates mining power according to the longest chain. In this state, the chain created by the 4th dishonest friend becomes public and the other 3 friends see/realize it. In this case, the 4th friend who is dishonest will receive all the rewards.
So, Is Selfish Mining a Threat to Bitcoin?
It is the most reasonable solution for all miners to behave as expected of them. Selfish mining creates a huge amount of waste. But this does not change the fact that selfish miners create a strategic advantage over other participants. In their article, Eyal and Sirer saw this as a significant risk. Indeed, selfish mining causes an increase in hash rates from time to time, and even worse, it allows the formation of pools/unions that cause the majority to seize power, called the 51% attack. So selfish mining is a good opportunity to increase their income for miners who travel together and intend to do it systematically. However, this incentive mechanism is an element that harms the Blockchain ecosystem in terms of trust and threatens decentralization.