Economic Implications of Scaling Blockchains: Why the Consensus Protocol Matters
37 Pages Posted: 25 Feb 2021 Last revised: 24 May 2021
Date Written: December 16, 2020
This paper examines the economic implications of scaling blockchains under two different consensus protocols: Proof-of-Work (PoW) and Proof-of-Stake (PoS). We study an economic model whereby agents can store wealth through the blockchain's cryptocurrency but may face a costly delay when liquidating due to the blockchain's finite transaction rate. Agents may expedite processing by paying fees to the blockchain's validators. Within such a model, we study the ability of a malicious agent to compromise the security of the blockchain. We show how improved scaling alleviates congestion, leading to a decrease in equilibrium fees. Under a PoW protocol, this leads validators to earn less revenue and thus spend less on computational power, lowering the cost of a successful attack and therefore the security of the PoW blockchain. Scaling has the opposite effect for the PoS protocol as alleviating congestion increases the demand and therefore the market value of the blockchain's cryptocurrency. That increased market value increases the cost of acquiring enough cryptocurrency necessary for a successful attack and thereby improves PoS blockchain security.
Keywords: Blockchain, Proof-of-Stake, Proof-of-Work, Scale, Security, Fees
JEL Classification: G0, O3
Suggested Citation: Suggested Citation