Working Paper: CEPR ID: DP16752
Authors: Raphael Auer; Hyun Song Shin; Cyril Monnet
Abstract: Blockchain technology breathes new life into the classical analysis of money as a substitute for a ledger of all past transactions. While it involves updating the ledger through a decentralized consensus on the unique truth, the robustness of the equilibrium that supports this consensus depends on who has access to the ledger and how it can be updated. To find the optimal solution, Buterin’s “scalability trilemma” needs to be addressed, so that a workable balance can be found between decentralization, security (i.e. a robust consensus), and scale (the efficient volume of transactions). Using a global game analysis of an exchange economy with credit, we solve for the optimal ledger design that balances the three objectives of this trilemma. We characterize the optimal number of validators, supermajority threshold, fees and transaction size. When intertemporal incentives are strong, a centralized ledger is always optimal. Otherwise, decentralization may be optimal, and validators need to be selected from the set of users of the system.
Keywords: Market Design; Money; Distributed Ledger Technology; DLT; Blockchain; Decentralized Finance; Global Game; Consensus
JEL Codes: C72; C73; D4; E42; G2; L86
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Centralized ledger is optimal when intertemporal incentives are strong (D15) | Centralized systems achieve higher levels of scalability (P11) |
| Weak intertemporal incentives (D15) | Decentralization may become optimal (H77) |
| Selection of validators from the user pool (C52) | Achieving a balance among decentralization, security, and scalability (H77) |
| Higher supermajority thresholds for validation (D79) | Increased rents for validators (R21) |
| Increased rents for validators (R21) | Affects overall gains from trade (F11) |
| Insufficient rents for validators (D33) | Validators may not be incentivized to validate transactions (D82) |
| Validators not incentivized to validate transactions (D82) | Failure in reaching consensus (D70) |
| Optimal design of a ledger system must account for costs associated with verification and incentives of validators (D47) | Complex interaction between these variables (C39) |
| Validator incentives directly influence the efficiency and integrity of the ledger system (E42) | Efficiency and integrity of the ledger system (E42) |