Giacomo Zucco, a famous Bitcoin BTC/USD maximalist intimately familiar with the blockchain's network infrastructure, offered his insights into the world's first cryptocurrency and how governments around the world could stop or limit its operation.
What Happened: Bitcoin is arguably the most decentralized and reliable blockchain, with over 15,509 public nodes as of press time, and an uncompromising community that fights tooth and nail to ensure its protocol retains its original cypherpunk ideals.
This blockchain is not infallible, and powerful actors such as nation-states could be able to severely curtail the freedom of its users or even make it completely useless. But Bitcoin's community is not defenseless against such attacks.
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When asked about how governments could force Bitcoin miners to censor network transactions, Zucco explained two distinct ways they could write their rules. The first would require compliant miners to exclude transactions involving blacklisted unspent transaction outputs (UTXOs) — or, simply put, balances — in the blocks they are mining. In the second, governments could force miners to "orphan" any new blocks that contain outlawed transactions.
The First Scenario
If miners were forced to only exclude UTXOs from their blocks, the impact of such legislation would be relatively limited. That is because even if compliant miners controlled most of Bitcoin's hashrate, occasional uncompliant blocks would still be produced, meaning that blacklisted UTXOs would just move around slower than non-blacklisted ones — how much slower would depend on how much of the hashrate is compliant.
Such a setup would also mean that those sending non-compliant UTXOs would pay higher fees to compete for the reduced block space available for such transactions.
That, in turn, would increase the incentive to process non-compliant transactions. Zucco suggested it would be hard to verify whether even regulated miners occasionally did not temporarily switch how they process non-compliant transactions.
This threat is particularly relevant now that a rapidly growing portion of Bitcoin's hashrate is controlled by publicly-traded companies. In April, Benzinga reported that nearly one-fifth of Bitcoin's hashrate was controlled by publicly-traded U.S. firms, with many planning rapid expansion. It is not unlikely that most of Bitcoin's hashrate will be controlled by publicly-traded — and tightly controlled — corporations.
Another question worth asking is what happens when a blacklisted UTXO gets moved from one address to another: will it stay blacklisted when it changes hands? For how many passages? If it is sent alongside other coins, should those be considered tainted and blacklisted as well?
Some of those scenarios also allow for highly-effective dust attacks, where a malicious actor sends minute quantities of blacklisted UTXOs to a large number of addresses to taint their holdings.
A workaround would be to set a minimum amount of blacklisted Bitcoin that an address can hold without being tainted, but how much "dirty Bitcoin" would be too much? Would this be set in percentage or an absolute value?
Zucco explained that a particularly harsh implementation of such rules paired with dust attacks would result in compliant miners forced to mine empty — or near-empty — blocks, while non-compliant miners include any transaction they can get their hands on. That would create an economic incentive for non-compliant miners, who earn higher and more fees than their regulated counterparts, possibly making smaller-scale operations more competitive with industrial mining operations.
The Dangerous Scenario
In the second scenario, if compliant miners are also forced to orphan new blocks that include blacklisted UTXO transactions, they would invalidate such blocks and continue building on the blockchain as it was before.
If less than half of the hashrate was compliant, then compliant miners would make lesser transaction fees, but their blocks would be considered valid by the rest of the network's participants.
As the portion of the hashrate they control increases, the incentive to be compliant would increase along with the likelihood of non-compliant blocks being orphaned (resulting in all the mining proceeds being taken away from miners).
If most of the hashrate was compliant, non-compliant miners would be forced to comply or shut downm since their blocks would be regularly pushed out of the blockchain — which would mean their fees and block rewards would be also taken away.
Non-compliant UTXOs would be effectively frozen, and there would be no way to move them as any block that included a transaction involving them would be orphaned. Bitcoin would have been successfully censored through what would effectively be a government-mandated soft fork.
Still, Zucco suggests that achieving such a government-mandated soft fork could be harder than it may appear at first. He explained that while the compliant miners would likely have transactions with lower fees than what we currently see, uncompliant miners would have a long list of often outrageously high-paid transactions waiting to be processed.
It is not hard to imagine that out of desperation, blacklisted UTXO holders would offer a fee of 10 BTC to move 5 BTC, or possibly more to process a transaction and thus significantly exceed the block reward. In such a situation, the incentive for non-compliant miners to invest as much as possible to regain control of the majority of the hashrate would be quite significant, making it likely that the government-mandated soft fork would not last for a long time.
Does Regulated Bitcoin Make Sense?
Zucco suggests that the value proposition of a regulated Bitcoin blockchain would not be particularly high as there would be little reason to use it instead of fiat money for compliant transactions.
That is also why he expects the transaction fees of compliant miners to be even lower than what we are currently seeing.
Speculative Bitcoin use does not produce many transactions, with most activity happening on exchanges or by trading derivative contracts. When it does happen, on-chain tolerance to slow transactions suggests that this is a long-term investment and such activity will not generate numerous transactions.
In addition to highlighting how most of the Bitcoin-related activity takes place off-chain, he asked: "If I am paying for a good or service or setting money aside in a way that is completely legal, then why am I not using fiat money?"
Zucco noted that avoiding inflation is a possible answer, but there are fiat-based ways to do so. He also expects the use of Bitcoin to avoid inflation to become illegal in the future, pointing out that the apex cryptocurrency was meant to work against monetary policy and laws, not remedy to the technical limitations of fiat-based money transmission systems.
That's why most of its exclusive use cases are illegal, Zucco said, adding that the value of a regulated Bitcoin is scarce, and the incentive to maintain it as an unregulated system is great.
Zucco cited Eric Voskuil, a Bitcoin-centric software programmer and author of "Cryptoeconomics: Fundamental Principles of Bitcoin," who detailed a governmental intervention scenario in his book. In the first "honeymoon" phase, regulators do not understand the extent to which monetary policy is eroded by Bitcoin and keep it legal. That is followed by a "black market" phase, with Bitcoin being illegal to possess or exchange. The third and final phase involves governments preventing Bitcoin's proliferation by financing a large-scale publicly funded mining operation to ensure the blockchain only mines empty blocks and is useless.
The first scenario could be prevented by bettering Bitcoin's anonymity since governments would be unable to blacklist coins if they were unable to link them to any illegal activity. In the second scenario, miners forced to "orphan" blocks containing illegal transactions can overcome the problem by deploying more hashrate than the governments — motivated by a significant economic incentive.
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