Rent-seeking. There is a word you don’t use everyday.
That is, unless you’re an economist interested in market efficiencies, in which case it is something to hunt down and eliminate. Or if you are a company trying to establish a stranglehold on a multi-billion dollar network, in which case it is the primary tool you use to establish a permanent position from which you can tax everyone that the network reaches.
Yes, that includes you.
What is rent?
In the world of economics, rent has a different meaning than in the real world where you pay a monthly fee for an apartment or a reasonable amount to get a car for your weekend trip.
Economic rent, of which we are talking, is any extra return above production costs, that someone can acquire through positional advantages. This could come from being the owner of a patch of land upon which a factory is built, the classical definition, but it could also be any other factor that isn’t directly contributing to the output of production.
As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land ….
— Adam Smith : The Wealth of Nations
In monopolies, there’s ample opportunity to extract economical rent, which causes some companies to strive to establish themselves in such a position. Since market rules have been put out of play, it can often be a very lucrative place to be in. This is especially common in the digital world due to the strong winner-takes-all effects of digital networks. Notable examples of real world de facto monopolies are Apple and Intel. Another example of a company aspiring to establish such a monopoly is Uber.
There’s an especially nasty form of economical rent, called quota rent, that occurs when circumstances impose an artificial limit on how much can be produced of a specific good, a production quota. In practical terms, this means that a middle man in a privileged position can insert himself in the flow of goods and services between consumer and buyer, and take a cut or charge an extra amount on top of the real value of the transaction.
On dams, hollow trunks and shady men in hats
A long long time ago, 1st of July 2015, the monopolistic attack that Bitcoin was facing was summed up in one silly and funny picture, drawn on a paper towel.
Oh. Didn’t you know that the system is being attacked? Such a shame. It has been since three years. All in plain sight, and not a pretty one at that.
The picture drawn two years ago was far more accurate than anyone could have possibly known at that time. Neither could they have known how firmly the shady men in hats had established themselves in the Core of the network.
The image above shows the quintessential example of extracting quota rent. The river is the normal flow of transactions. When all is good and well, the river flows its normal course, the ecosystem around it thrives and there’s a natural balance and efficiency within.
Once a dam is erected, the one that says Blockstream in the picture, things start to change. The natural balance shifts, actors within the eco-system starts to die out. A mounting pressure starts to build. How do we release that pressure? Well, the easiest way is to remove the dam. The men in hats will not accept that. They are busy extracting rent from the system by letting a side-flow of transactions pass on the side of it. For a small fee, of course. A living has to be made, right?
Why does the dam have the word Blockstream written over it? Blockstream is a company created by the currently most influential developers of Bitcoin Core, which is the most well-known software client that is used to connect to the Bitcoin network. They have their sights set straight on converting the naturally flowing river into a constrained and controlled version of it. Nature does not organise itself, they say.
Why do the money spouting hollow trunks say Sidechain and Lightning? These are technologies that Blockstream intend to provide somewhere in the future. They claim it is the only reasonable way to control a difficult river, and that they are the only ones that have the skill-set to construct these solutions. It’s a promise to solve the troublesome situation with the dam.
The names on the hollow trunks don’t really matter. The business plan isn’t those specific trunks.
It’s the dam itself.
The only thing that the picture didn’t get right is the flow of transactions as a river, a natural force. It isn’t. Once the dam is erected, it’s just a matter of time before the river disappears altogether.
Well, this isn’t a problem you say. Now that we know, let’s just stop the men in hats from erecting the dam. Yes. Well. Unfortunately, we are a bit late.
They already have.
A river runs through it
Moving from the world of restricted flows of currents into the world of charts and diagrams, let’s see if we can get a deeper understanding of what is going on.
The image above illustrates the ideal world, the one we as people of the cave only see as vague shadows on the wall. In this world no one puts themselves between the supplier and the consumer. Everyone trades as their heart desires and value is created in the exchange.
Producers provide supply, consumers provide demand and the curves meet in the equilibrium, where the ideal exchange occurs. No one benefits more from it than the other. Everything that is green in the chart is value created. On the upper side of the dotted line is the value created for consumers, on the lower side of the dotted line is the value created for producers.
In the world of Bitcoin specifically, the value created on the upper green side is transactions being performed for users of Bitcoin. On the lower green side the value created for miners, rewards in bitcoins in the form of fees and block rewards, is shown.
There is a vertical dotted line, indicated with Q*. This is the ideal blocksize, where supply and demand for transactions are in balance.
Once a quota is introduced, a lot of things change.
A new point, Q-max, is now sitting on the block size axis. This is the artificial production quota that is imposed on the network. There’s still the ideal point on the curve, Q*, where supply and demand meets. This point, however, can never be reached. The system is not in balance. The artificial restriction is causing demand to be unmet because the supply simply cannot be there due to the production quota.
So what happens then?
A lot of things, as it turns out. The most notable of them being a big red triangle, sitting to the right of the production quota line. This represents lost opportunity, value never created. It’s called deadweight loss. The artificial restriction on supply has a very real and limiting effect on how much value can be created from the network. An unfulfilled promise sitting there out of reach, unattainable.
Another notable thing is the separation of the green areas by a big yellow rectangle. The value created for the consumers and the value created for the producers have been separated by something.
This something, the big yellow rectangle, is the quota rent. The quota rent is the heart of the matter. This is why the men in hats are so desperate to keep the artificial limit.
The quota rent is wedged in between the value created on both sides. There’s still value there alright. It’s just that it is taken from both sides of the transaction. Consumers loose, producers loose. Men in hats, sitting on the sidelines, gain. They provide the solution for an artificial limit, a stranglehold designed to enrich a few and take from everyone else. This is not a very desirable state.
A central take away from this diagram is that value is destroyed, the red triangle, to enable someone external to gain from the transaction, the yellow rectangle. Rent-seekers wedge themselves in between producers and consumers, to siphon off what they can from both sides. Value destroyed you say? Not that we know of, we get ours. Others don’t miss what they never knew existed.
In the world of Bitcoin, this quota rent caused by rent-seeking is now manifesting at a large scale. The network is suffering through its worst crisis yet in its eight year lifetime. How big is this suffering? How much is the deadweight loss, the unrealised potential? How large is the quota rent, the value taken from the producers and consumers by shady men in hats?
Have a look just a bit below and you’ll see.
This is the state that the Bitcoin network is in today.
The unrealised potential, the deadweight loss, is eating the system. And has been doing so for the last two years. The dotted quota line in the image above is the 1MB block size limit, enforced onto the network. Not because the network needs it. Absolutely not. The network needs to get rid of it.
The ones that need the limit are the men in hats, described in the picture drawn on a paper towel two years ago. Without the limit, they will have no way of extracting rent from the network, and their grand plans of global rent-seeking will wither away.
The limit is killing the system and almost no one benefits from it. The consumers have almost completely lost the value the system is supposed to bring, the producers are being stolen from. Shady characters hiding behind concerns of network health are as a recommended cure slowly bleeding the network to death.
These characters have no motivation to preserve the network others have built. If they can’t extract rent from it, they care not if it lives or dies. In fact, they probably prefer to see its demise if they can’t have their way.
It begins with a trickle
So what is the best way out of this sad state of affairs?
Easy. Remove the artificial limit. Nobody has asked for a 1MB block size cap. It wasn’t introduced out of concern for an ever growing Bitcoin ledger or to keep bandwidth requirements low. It was introduced as an anti-spam measure, to prevent a theoretical angle of attack. That theoretical flaw has since long lost its relevance.
What the block size limit is nowadays, is a very real and very dangerous angle of attack that has been field tested and proven to work.
It is continually being exploited to its fullest.