A new working paper by the Bank of International Settlements (BIS) argues that Bitcoin, and a few other cryptocurrencies, face a rather significant problem regarding its proof-of-work (PoW) algorithm – it is not sustainable long-term and ultimately needs to be replaced.
The paper, published this month, is written by Raphael Auer, a principal economist for BIS’ monetary and economic department. BIS is what Coindesk describes as“the central bank of central banks”.
Auer believes there are 2 crucial economic setbacks to the PoW algorithm that restrain it from being fit for long-term use. Firstly, Bitcoin is constantly at risk from 51% attacks or double spending, thus needing to rely on “extremely expensive” PoW.
Secondly, the transaction market cannot generate an adequate level of “mining” income from fees because users freeload on fees from elsewhere on a block or the blockchain, leading to block rewards making up the bulk of mining income to date.
“Looking ahead, these two limitations imply that liquidity is set to fall dramatically as these block rewards are phased out. Simple calculations suggest that once block rewards are zero, it could take months before a Bitcoin payment is final.”
Solutions like the Lightning Network might offer some, but limited, help. Another possibility would be to find ways to accelerate payment finality and keep the liquidity of crypto afloat.
However, Auer concludes that the best way could be to entirely “do away with proof-of-work and embrace a different consensus model”, as the efficiency of decentralised exchange solely by PoW is “much lower than would appear at first sight, and alternative technologies still need to demonstrate that they can function without institutional backing”.