Re-examining Bitcoin: Excessive prices will lead to the emergence of a new alternative chain

Original author: Fu Shaoqing, SatoshiLab, Wanwudao BTC Studio

Preface

As the price of Bitcoin continues to rise, we, the technical developers in the Bitcoin ecosystem, feel constant pressure. Every time we design a new function based on the Bitcoin ecosystem and perform an operation on the Bitcoin chain, we have to pay an increasing economic cost (handling fee). However, other roles in the Bitcoin ecosystem, such as investors and miners, generally do not have such troubles and expect the price of Bitcoin to continue to rise.

Is there any way to prevent the price of Bitcoin from rising wildly? Let’s analyze the factors that affect the price of Bitcoin to see if we can find the answer.

1. What can suppress the price increase of Bitcoin?

It is very difficult to predict how high the price of Bitcoin will rise. There are many factors that affect the price change. Let's look at the factors that affect the price of Bitcoin from two perspectives: one is the economic perspective, and the other is the technical perspective.

1.1. Economic perspective

In economics, there is a conclusion that the price of a commodity will not rise or fall indefinitely. There are several related economic knowledge: price elasticity, market supply and demand, marginal utility and price adjustment mechanism theories.

**Price Elasticity Theory: **Price elasticity is a measure of how sensitive the demand for a good or service is to changes in price. When the price changes, the elasticity of demand determines the relationship between price and quantity. If the elasticity of demand tends to infinity (perfect elasticity), a small change in price will result in a large change in quantity, thus preventing the price from rising or falling without limit.

The role of substitutes in price elasticity is to affect the degree to which consumers respond to changes in commodity prices. When price elasticity is high, consumers are more likely to look for substitutes to replace the original commodity, and are therefore more sensitive to price changes. If the existence and availability of substitutes are high, consumers may be more inclined to turn to substitutes, thereby reducing demand for the original commodity. Therefore, the existence of substitutes can reduce the price elasticity of the original commodity. On the other hand, if the availability of substitutes is low, consumers may find it more difficult to find substitutes, resulting in less response to price changes and lower price elasticity. Therefore, **the availability and degree of substitution of substitutes play an important role in influencing price elasticity. **(This article mainly thinks from the perspective of substitutes)

**Market supply and demand relationship: **Market supply and demand relationship refers to the relationship between the supply and demand of goods or services. When the market supply and demand are unbalanced, the price will be adjusted to achieve a balance between supply and demand. When the price rises, the supply will increase and the demand will decrease, thus limiting the continued rise in prices. Vice versa. (This factor has a small impact. The big aspect is that the total number of bitcoins is fixed, and the number of new bitcoins generated each year is limited. On the other hand, even if people who hold bitcoins are willing to sell them, the total number of bitcoins is a relatively small supply for the global population, and it is difficult for the supply side to have a large change.)

**Marginal Utility Theory:**Marginal utility theory holds that consumers experience diminishing marginal utility for goods or services. That is, as consumption increases, the satisfaction from each unit of consumption decreases. This means that the price consumers are willing to pay for each unit of goods or services will also decrease, thus limiting the unlimited rise in prices. (Marginal utility has a significant impact on people who use Bitcoin and is more attractive to investors.)

Price adjustment mechanism: The price adjustment mechanism in the market can ensure that prices fluctuate within a certain range. Price increases will stimulate suppliers to provide more goods or services while reducing consumer demand. Price drops will reduce suppliers' supply while increasing consumer demand. Through the feedback mechanism of supply and demand, prices in the market will adjust accordingly to avoid unlimited increases or decreases. (In the absence of a way to increase supply, the only way is to reduce consumption. If consumption cannot be reduced, then look for substitutes.)

These theories help us understand the formation and changes of commodity prices with economic knowledge, and provide some guiding principles for market participants. However, the price in the market is affected by many factors, especially for Bitcoin, which is a new thing. It is not a simple ordinary commodity, and we cannot simply draw conclusions based on a single factor or a few factors.

But economics knowledge gives us an important thought: as long as we can find substitutes, we can suppress the rise in the price of commodities ("Bitcoin").

1.2. Technical perspective

Can we find a substitute? Let’s start with the characteristics of Bitcoin. The following figure is my summary of Bitcoin and related systems in the second-layer construction in the article “Observing Bitcoin’s second layer from the perspective of the state machine can reveal the architecture and construction path of future Web3.0 applications”.

First, from the perspectives of blockchain systems, distributed systems, and centralized systems, the blockchain system has the ability to be a trustless ledger that the other two systems do not have. If there is a substitute for Bitcoin, it should also come from the blockchain system.

Secondly, when we compare the Bitcoin system with other blockchain systems, we will find that the Bitcoin system is very strong in terms of decentralization, security, privacy, and anti-censorship capabilities. Currently, there is no blockchain that can match it in these aspects. If we can find a blockchain system that can replace Bitcoin in these basic features, it can technically replace the Bitcoin system.

It should be noted that a large amount of funds have been deposited in the Bitcoin system, which is often referred to as Old Money. Even if Bitcoin can be replaced technically, it will be difficult to shake Bitcoin's dominant position in the field of digital currency in a short period of time.

Summary: From an economic perspective, if we conclude that as long as we find a substitute for Bitcoin, we can suppress the rise in Bitcoin prices. From a technical perspective, if we want to find a substitute for Bitcoin, we need to look for it from the system structure of the chain, and the basic characteristics must be comparable to Bitcoin. We have not seen such a system emerge yet. Even Ethereum, which is currently the second largest cryptocurrency in terms of market value, cannot replace Bitcoin in terms of basic characteristics. This is part of the reason why Bitcoin is the only dominant currency, and it is also the reason why Bitcoin has become the center of attention again as soon as the Bitcoin ecosystem has achieved some results (inscriptions, Bitcoin Layer 2).

Why are decentralization, security, privacy, and anti-censorship capabilities among the basic characteristics of blockchain so important? Professor Hong Shuning has given a relevant explanation from the perspective of currency, that is, if it can become a digital currency accepted worldwide, it must have security, privacy, and anti-censorship capabilities. At a higher level, it needs to be analyzed from a sociological perspective, which is beyond the scope of this article and the author's ability. But it is indeed very important, and many people pursue the benefits brought by these characteristics.

2. Re-examining Bitcoin

In order to find a replacement for Bitcoin, we need to re-examine Bitcoin. Let’s first look at the basic characteristics of Bitcoin and its main problems. Then, from the perspective of layered design, we will look at the positioning of Bitcoin in the web3.0 application architecture (a layer of network).

Before discussing the basic features of Bitcoin, we need some basic knowledge of consensus protocols.

2.1. Basics of consensus algorithms (or protocols)

Here, we mainly use PoW and PoS as examples, and we will compare the differences between PoW and PoS in the introduction. This will make it easier to understand the characteristics of the consensus algorithm required by the alternative chain.

(1) Differences between synchronous and asynchronous algorithms

PoW is an asynchronous algorithm. In the PoW world, all nodes are in competition, and the fastest node will produce blocks. It improves the robustness of the entire system by sacrificing the overall efficiency of the system. As long as there is a node in the system, the system can continue to run. Therefore, PoW can be freely scalable, and there is no upper limit to the number of nodes that can be supported in theory.

All PoS algorithms are synchronous algorithms. The PoS algorithm emphasizes the collaboration between nodes. In terms of efficiency, or in other words, its block generation speed, it is higher than PoW. But what it sacrifices is the degree of decentralization, because it requires collaboration, so it needs to attract enough nodes to vote for candidate blocks. As long as enough node votes are not collected, the block cannot be issued, so it is a synchronous algorithm. In the PoS system, the efficiency of block generation is determined by the slowest node among the nodes that participate in and successfully vote in the entire system.

(2) Algorithm complexity and communication complexity

PoW is widely criticized for its high power consumption. From the perspective of algorithm theory, it reduces communication complexity by sacrificing computational complexity. Hash computational complexity is relatively high (and repeated hash calculations consume a lot of electricity). However, PoW's communication complexity can be said to be the lowest among all consensus algorithms. PoS algorithm, because the nodes are in a collaborative relationship, it does not need to consume a lot of electricity to calculate Hash, so the computational complexity is relatively low. However, since PoS voting communication collaboration is required, its communication complexity is often proportional to the square of the number of nodes. For example, the communication complexity of the traditional PBFT algorithm is O(N^2).

PoW has the lowest communication complexity and the highest degree of decentralization, which is well adapted to the current situation of the limited Internet network environment. This is why Bitcoin has been able to survive and grow for so many years. In fact, there have been hundreds of different attempts before, but only Bitcoin has developed with the help of the PoW algorithm.

(3) Comparison of economic capabilities

PoS does not require the consumption of large amounts of electricity to secure the blockchain (it is estimated that Bitcoin and Ethereum 1.0 consume over $1 million per day in electricity and hardware costs as part of the PoW consensus mechanism.)

Due to the lack of high electricity consumption requirements, not as many tokens need to be issued to incentivize participants to continue participating in the network. In theory, it is even possible to have negative net issuance, where a portion of transaction fees are consumed as fuel, thereby reducing the money supply over time.

PoS opens the door to a variety of techniques designed using competition theory mechanisms to more effectively prevent the formation of centralized giants, which, if formed, would allow harmful ways of the network to occur (for example, private mining based on PoW).

PoS reduces the risk of centralization because there will be no problems with economies of scale. $10 million of digital currency will bring you $1 million, and $100 will bring you a return of 10 yuan, both 10% returns, without any other disproportionate benefits. Unlike Proof of Work PoW, participants with more financial advantages can buy or produce better equipment and get rich returns, while ordinary participants are weak and basically cannot get any returns.

Economic penalties can be used to prevent various forms of 51% attacks, and this ability of PoS is much more costly than Proof of Work PoW. To paraphrase Vlad Zamfir: "If you participate in a 51% attack, it's like your ASIC farm is burned down." PoW will only result in no income, but will not have the effect of burning mining machines and mining farms.

2.2. Basic characteristics of Bitcoin

We will no longer describe the general blockchain characteristics of Bitcoin. Those characteristics are possessed by all blockchain systems, and are also the reason why blockchain systems are irreplaceable among the three system structures (blockchain system, distributed system, and centralized system).

(1) Remarkable capabilities brought by consensus protocols

We pointed out in Section 1.2 that the Bitcoin system is very strong in decentralization, security, privacy, and anti-censorship capabilities. Currently, there is no blockchain that can match it in these aspects. These characteristics are basically due to the consensus protocol. Because the consensus protocol of Bitcoin Pow is an asynchronous algorithm with low communication complexity, any node can join and exit, so that the Bitcoin network can accommodate countless nodes. The numerous nodes make Bitcoin highly decentralized, secure, private, and anti-censorship. From the table in Section 1.2, we can see that if we put aside the limitations of the system structure, distributed systems can easily have such capabilities, but unfortunately distributed systems do not have the ledger capabilities of blockchains.

Why have other Pow blockchain systems not reached the status of Bitcoin? Although there are many reasons, Pow has an important Matthew effect, that is, the more valuable the blockchain system is, the more computing power it attracts. This results in the lack of sufficient computing power, and the security of other blockchain systems cannot be guaranteed.

(2) Now we can understand that the imperfections of Bitcoin are due to the need for a layered design

From Vitalik's imperfect summary of Bitcoin in Ethereum's white paper (UTXO's accountless system, non-Turing completeness of the execution language, poor scalability, etc.), we can see several other significant aspects of Bitcoin. Features:

1. Bitcoin’s account system UTXO

In current blockchain projects, there are two main ways of keeping records: one is the account/balance model, and the other is the UTXO model. Bitcoin uses the UTXO model, while Ethereum, EOS, etc. use the account/balance model.

In a Bitcoin wallet, we can usually see the account balance, but in the Bitcoin system designed by Satoshi Nakamoto, there is no concept of balance. "Bitcoin balance" is a product derived from the Bitcoin wallet application. UTXO (Unspent Transaction Outputs) is an unspent transaction output, which is a core concept in the generation and verification of Bitcoin transactions. Transactions form a set of chain structures. All legal Bitcoin transactions can be traced back to the output of one or more previous transactions. The source of these chains is mining rewards, and the end is the current unspent transaction output.

So there is no Bitcoin in the real world, only UTXO. Bitcoin transactions consist of transaction inputs and transaction outputs. Each transaction spends an input and generates an output, and the output generated is the "unspent transaction output", or UTXO.

If you want to implement smart contracts, the UTXO account model has a very big problem. Gavin Wood, the designer of the Ethereum Yellow Paper, has a deep understanding of UTXO. The biggest new feature of Ethereum is smart contracts. Because of the consideration of smart contracts, it is difficult for Gavin Wood to implement Turing-complete smart contracts based on UTXO. The account model is naturally object-oriented, and each transaction will be recorded on the corresponding account (nonce++). In order to facilitate account management, a global state is introduced, and each transaction will change this global state. This corresponds to the real world, and every tiny change will change the world. Therefore, Ethereum uses an account system, and later public chains are basically implemented based on various types of account systems.

Another serious flaw of UTXO is that it cannot provide fine-grained control over the withdrawal amount of an account. This is explained in the Ethereum white paper.

2. Bitcoin’s scripting language is not Turing complete

Although Bitcoin's scripting language can support a variety of calculations, it cannot support all calculations. The main deficiency is that Bitcoin's scripting language does not have loop statements and conditional control statements. Therefore, we say: Bitcoin's scripting language is not Turing complete. This leads to certain limitations in Bitcoin's scripting language. Of course, due to these limitations, hackers cannot use this scripting language to write some dead loops (which will cause network paralysis) or some malicious code that can cause DOS attacks, thus avoiding DOS attacks on the Bitcoin network. Bitcoin developers also believe that the core blockchain should not have Turing completeness to avoid some attacks and network congestion. However, it is precisely because of these limitations that the Bitcoin network cannot run more complex programs. The purpose of not supporting loop statements is to avoid infinite loops when confirming transactions.

Without the layered design theory, the reason for not supporting Turing completeness for security is not sufficient. Moreover, non-Turing complete languages can only do so much, which will limit the development and growth of blockchain.

3. Other imperfections of Bitcoin: security and scalability

The centralization problem of mining. The Bitcoin mining algorithm basically lets miners slightly modify the block header thousands of times until the hash of the modified version of a node is less than the target value. However, this mining algorithm is vulnerable to two forms of centralization attacks. First, the mining ecosystem is controlled by ASICs (application-specific integrated circuits) and computer chips that are specially designed and thousands of times more efficient for the specific task of Bitcoin mining. This means that Bitcoin mining is no longer highly decentralized and egalitarian, but requires the effective participation of huge amounts of capital. Second, most Bitcoin miners no longer actually complete block verification locally, but rely on centralized mining pools to provide block headers. This problem can be said to be very serious. Currently, the top three mining pools indirectly control about 50% of the processing power in the Bitcoin network.

The scalability issue is an important issue for Bitcoin. With Bitcoin, the size grows by about 1 MB per hour. If the Bitcoin network processes 2,000 Visa transactions per second, it will grow by 1 MB every three seconds (1 GB per hour, 8 TB per year). The lower number of transactions has also caused controversy in the Bitcoin community. Although a large blockchain can improve performance, the problem is the risk of centralization.

From the perspective of the product life cycle, some minor imperfections of Bitcoin can be improved in its own system, and the improvement methods are limited by the current system. If these problems can be solved in a new system, the limitations of the old system can be completely ignored. Since a new blockchain system is to be built, these minor functional improvements can also be designed and upgraded together when designing the new system.

Most of the imperfections of Bitcoin described in the Ethereum white paper are reasonable from the perspective of layered design. These imperfections will be addressed in the second layer construction of Bitcoin.

2.3. Bitcoin’s Achilles’ heel

Here, we use Professor Hong Shuning’s definition of the Bitcoin ecological problem, the “Achilles’ heel”: Bitcoin is halved every four years, and the reward for blocks will gradually decrease until it reaches zero, which will cause major problems and threats to the security of the Bitcoin network.

The solution to Bitcoin's Achilles' heel is to develop a large number of applications on Bitcoin and inject continuous value into the network again, so that the substantial increase in handling fees can offset the reduction in block rewards, so that the miners who maintain the network will not only receive rewards from blocks, but will also gradually receive more of their income from handling fee rewards. This will not only benefit miners, but also project parties and application users who use Bitcoin ecological technology, and will form a win-win situation for various roles in the ecosystem. This win-win situation can solve Bitcoin's Achilles' heel problem.

Because important contributors in the Bitcoin community are relatively conservative (some people call it Bitcoin fundamentalism), in the early days, some people had strong resistance to the application of Bitcoin. However, with the development of technology and applications, after asset issuance functions such as inscriptions have been used by more people on Bitcoin, more and more people have begun to accept the idea of developing applications on Bitcoin, and further improve this idea, forming a systematic idea and construction path for Bitcoin's second-layer network construction or off-chain construction.

2.4. Further discussion on layered design and Bitcoin’s suitability for layer-one network construction

In order to better understand the basic characteristics of Bitcoin and the application construction of Bitcoin in Section 2.2, we also need to use the theory of layered design. As for why we need layered design, I have a relatively detailed introduction in Section 1.3 of the article "A Basic Knowledge System for Bitcoin Layer 2 Construction". Here we simply quote the relevant content: Layered design is a means and methodology for humans to deal with complex systems. By dividing the system into multiple hierarchical structures and defining the relationship and functions between each layer, the modularity, maintainability and scalability of the system can be achieved, thereby improving the design efficiency and reliability of the system.

From the perspective of layered design, the imperfections of Bitcoin (UTXO's accountless system, non-Turing completeness of the execution language, and poor scalability) are no longer a problem, but rather a necessary feature of the layer 1 network. Blockchain systems that are overly well designed are more suitable to survive as Bitcoin's second-layer construction technology or other test chain technologies.

From the application architecture level of Web3.0, we can also see the status of layered design and Bitcoin's first layer network. I have introduced this content in more detail in the article "Observing Bitcoin's second layer from the perspective of the state machine, we can see the architecture and construction path of future Web3.0 applications". Here we quote the system architecture diagram of large-scale applications in the Web3.0 era to briefly explain.

From the structure diagram above, we can see the system structure of Web3.0, including the first layer, second layer, third layer, and even higher layer applications. The other blockchain systems on the far left of the diagram can be considered as layer 1.5, because they do not have the characteristics of the Bitcoin mainnet, but can independently complete certain system functions.

This diagram gives us a thought: should we look for an alternative chain to replace Bitcoin on the first layer? Or on a higher layer? I personally think that it is very difficult to replace Bitcoin on the first layer. If we look at the existing second layer of Bitcoin, it is unlikely to become an alternative chain if it meets the requirements in several important features. There can be a 1.5-layer alternative chain between the first and second layers of Bitcoin, but the characteristics of this alternative chain must be stronger than other blockchain systems, and it must be almost equivalent to Bitcoin in terms of decentralization, security, privacy, and anti-censorship capabilities. After finding this position, let's describe the other contents of this alternative chain in more detail.

3. Alternative chains to Bitcoin

3.1. If an alternative chain is bound to emerge, what are its characteristics?

In Section 1.2, we cited a chart showing the basic characteristics of Bitcoin's first layer and the characteristics of the second layer. We want to find a blockchain system with similar characteristics to Bitcoin that can improve the poor performance of Bitcoin (it must be a blockchain here because the ledger function needs to be trusted). To sum it up in one sentence: we hope that this new chain will have these excellent characteristics of Bitcoin (openness, transparency, decentralization, security, and anti-censorship), and will be improved in computing power, performance, and economic cost, especially the economic cost can be reduced. If computing power and performance cannot be improved, it is completely acceptable to only reduce the economic cost.

The new blockchain we hope to obtain will have the following features:

If we want to get the characteristics of the new chain in the table above, what will the technical implementation elements of this new chain look like? A rough summary is as follows:

(1) Encryption algorithm: Keeping Bitcoin's encryption algorithm can meet the requirements. It may be better if Shnorr signature is used directly.

(2) Consensus protocol: In order to maintain sufficient decentralization and accommodate more nodes, it can only be an asynchronous algorithm with low communication complexity. What are such consensus algorithms? Is it some kind of PoW algorithm? Or other PoW-like algorithms?

(3) Block time: It cannot be too fast. Refer to the design considerations of Bitcoin block time. This involves the issue of algorithm difficulty adjustment.

(4) Blockchain size: This can take into account the design factors of Bitcoin and the empirical factors that have been formed, as well as the development factors of software and hardware after technological development. The storage size of 4M can be used as a reference.

(5) Account type: Should we use the UTXO model or the Account model? Because we need to support high-level construction and distributed systems (similar to the Lightning Network), the UTXO model will be more referenceable and reduce the difficulty of engineering implementation. Because the Lightning Network on Ethereum (Account model) may be a case where progress is not smooth.

(6) Computing power: Since the role of the alternative chain is at the bottom layer, it is very likely that Turing completeness is not required. Because the current technical development of Taproot, MAST, and Tap in the Bitcoin field has been seen to meet the needs of the bottom layer chain. And if the maximum security is guaranteed, Turing completeness may also be abandoned.

(7) Economic model design: This is a relatively complex issue. If the consensus protocol can be determined and the relevant stakeholders are identified, then clearer design requirements can be obtained.

Other issues such as programming languages and transaction structures are relatively detailed and can be considered during the implementation phase. They do not affect the judgment of the main features of the alternative chain.

3.2. Where will the alternative chain be born?

Will such a system be born from scratch? I personally think it is difficult and may not be necessary.

Referring to the application architecture diagram of Web3.0, it is highly likely to be born in other blockchain systems or distributed systems. What is meant by being born in a distributed system here is to use the existing architecture of the distributed system to give birth to a blockchain system built on this architecture. Would it be easier to use Lightning Network or Nostr? Because the structure of these networks already has many nodes, if some kind of consensus protocol can be generated to let these nodes do something and complete the work related to the ledger, would it be easier to complete? Will there be more win-win situations? As shown in the two areas in the red circle below:

3.3. What kind of team is suitable to create this alternative chain?

If the two birth areas we described in the previous section are feasible, then project teams with experience in both areas are likely to be builders.

On the one hand, we look for similar systems from other blockchain systems, and we can see that some chains meet the characteristics in Section 3.1. There is one thing that needs to be explained. The consensus algorithm of such a chain cannot be a PoW algorithm that competes with the Bitcoin main network for computing power. Otherwise, due to the Matthew effect, it is difficult for such a chain to ensure security. It is suggested that asynchronous algorithms also have proof algorithms based on space and time, and their communication complexity is not high. Therefore, asynchronous consensus algorithms based on UTXO, with block times and block sizes similar to Bitcoin, may become potential candidates. Such blockchain systems already exist, and in order to avoid suspicion, the names of the projects are not quoted. If we can use certain characteristics of the Bitcoin main network, will it be easier for such alternative blockchain systems to emerge?

On the other hand, if we consider using the current Lightning Network nodes or Nostr nodes to redevelop an alternative chain that meets the asynchronous consensus algorithm of UTXO, it will also be a feasible idea. We have not seen explorers in this regard, but it should be theoretically feasible.

If there is a team that can start from the first principles like Elon Mask, they can completely not rely on the original experience and traditional concepts. Using the first principles to do things, you can follow the relevant steps: define the problem, decompose the problem, determine the basic principles, practice, and verify the results. It is also very likely to become the builder of this alternative chain.

4. Conclusion

This article is a reflection of the continued rise in Bitcoin prices when our project team was developing Bitcoin ecological technology. The description and content in the article are not perfect yet, and it is more to contribute some thought materials for people who are interested in this field.

I try to analyze the possibility of creating a Bitcoin alternative chain from an economic and technical perspective. Then, from the perspective of Bitcoin's basic characteristics and layered design, I summarize the characteristics of Bitcoin that can serve as a layer of network infrastructure. Finally, I describe the characteristics of the alternative chain and the possible fields of birth, as well as the possible construction team. I hope that this can promote the creation of a blockchain system that replaces Bitcoin to a certain extent, or attract more people to pay attention to this direction.