Settlement assurances in PoW blockchain networks

CoinMetrics Co-Founder Assesses Blockchain Settlement Assurance

CoinMetrics co-founder Nic Carter remodels how to think about transaction finality in blockchain payment systems. The leading factors playing into transaction finality are identified along with key risk factors.

Quick take;

  • The amount of revenue miners have generated is identified as the leading factor playing into whether a transaction can be considered settled
  • It becomes economically irrational to attempt reversing a transaction past the point where the amount of revenue miners have earned overcomes the value of the transaction

CoinMetrics co-founder Nic Carter (@nic__carter) has taken the first steps in establishing a model to assess settlement assurance in proof-of-work (PoW) blockchains. Settlement assurance is the degree of confidence users can have that a transaction is final. To date, there is no methodology to measure this degree of confidence. Flawed methods such as the number of confirmations, how deep the transaction is in a given blockchain, are widely used.

Variables to Assess Blockchain Settlement Assurance

The amount of compensation miners receive per unit of time is identified as the most important and directly related variable tied to settlement assurance. Labelled “ledger costliness”, the variable highlights why methodology such as waiting for a certain number of confirmations is flawed. The compensation miners receive incentivizes them to act for the health of the network. Although a transaction may have had more confirmations in an altcoin blockchain such as Litecoin, the ledger costliness accumulated will be orders of magnitude greater in Bitcoin over the same timeframe. At the time of Carter writing the article, the ledger costliness for one confirmed Bitcoin block was 14.5 times greater than the ledger costliness for four confirmed Litecoin blocks.

Ledger costliness ties directly with the security of the network. The higher the ledger costliness, the more resources are required to launch an attack on the network. CoinMetrics have previously introduced the term thermo cap which tracks the cumulative revenue generated by miners in an asset over time. Lower ledger costliness means the network is more susceptible to attacks. Less hardware would be required to control 51% of the hash rate and miners will be more susceptible to bribes to reorg the chain as their compensation is lower. 

The Ou Rule

Ledger costliness was not the only variable identified as playing a role in assessing settlement assurance. The size of a transaction plays a particularly important role in how long recipients should wait before considering the transaction final. Larger transactions provide greater incentive to attempt reversing the transaction. A collusion of miners or one actor who can accumulate 51% of the hash rate can work on a chain which will eventually become the longest. In such a chain, they have the ability to double spend transactions which were confirmed in the chain which was previously the longest.

Blockchain engineer Elaine Ou (@eiaine) proposes waiting until the value of the transaction matches the accumulated ledger costliness before considering the transaction final. Dubbed by Nic Carter as the Ou Rule, this is the point where it becomes economically irrational to reverse the transaction.

Other variables are also noted as playing a role in settlement assurance but their relationship is less clear. Some risk factors emerged which result in transaction finality being more questionable. Cryptocurrencies that use a mining algorithm that they don’t effectively hold a monopoly over are highly at risk. For example, miners on Bitcoin could easily redirect their hash rate to the Bitcoin Cash ABC or Bitcoin Cash SV network and have sufficient hash rate to build a longer chain and reverse previously confirmed transactions. The below graphic included in Carter’s post illustrates the share of miner revenue between the three Bitcoin chains.

Relative share of miner revenue in Bitcoin, Bitcoin Cash, and Bitcoin Cash SV
Relative share of miner revenue; BTC (orange), BCH (green), BSV (red).

A scenario where significant amounts of value is tied to assets created on top of the base layer of the protocol represents another risk factor. This so-called “top-heaviness” creates an asymmetry which incentivises attackers to target the base layer of the protocol to disrupt the assets which exist on top of it. Being able to take short positions on these assets can provide a high-profit incentive to launch such attacks.

Rethinking Transaction Finality 

How to think about transaction finality

In the world of centralized payments, transaction settlement is a binary matter. The transaction is either settled or it is not. Transaction finality in blockchain payment infrastructures is probabilistic. The probability that the transaction is settled will approach 1 but it will never reach it.

“Even though transactions are never truly final, the more time that passes without a conflict, the lower the probability a given transaction will be orphaned.”

Elaine Ou