{"id":252,"date":"2014-05-27T05:56:00","date_gmt":"2014-05-27T05:56:00","guid":{"rendered":"http:\/\/blog.holytransaction.com\/what-dogecoin-must-do-to-survive\/"},"modified":"2023-01-14T02:22:42","modified_gmt":"2023-01-14T00:22:42","slug":"what-dogecoin-must-do-to-survive","status":"publish","type":"post","link":"https:\/\/holytransaction.com\/blog\/2014\/05\/what-dogecoin-must-do-to-survive.html","title":{"rendered":"What Dogecoin must do to survive"},"content":{"rendered":"

Tim Swanson is an educator, researcher and the author of \u2018Great Wall of Numbers: Business Opportunities and Challenges in China\u2019. Here, he explores the mining systems of dogecoin and litecoin to show how the dogecoin economy can thrive.<\/em><\/b><\/p>\n

(CoinDesk<\/a>) The key ingredient to the success of any decentralized public ledger, such as bitcoin, is incentivizing its transactional network to simultaneously secure the network from attackers and process transactions.<\/p>\n

In the case of bitcoin<\/a>, and in the case of virtually all other cryptocurrencies, this incentivization process is handled through seigniorage.\u00a0 Every 10 minutes (or 2.5 minutes for litecoin<\/a>, or one minute for dogecoin<\/a>) a fixed amount of bitcoins is paid to the labor force called \u201cminers.\u201d\u00a0 These miners are computational systems that perform never-ending mathematical calculations dubbed hashing.\u00a0 This hashing in turn creates security for the network; so as long as more than 50% of the hashrate is maintained by \u201cgood\u201d systems, bad actors are prevented from manipulating the ledger.<\/p>\n

The other key role these miners also fill is processing and including transactions into packages called blocks. Every 10 minutes, one miner is rewarded for processing these blocks with fixed income. Last month David Evans published a good overview<\/a> of how this process looks from a labor input and supply output perspective.<\/p>\n

For some advocates, one of the purported advantages of cryptocurrencies is that their money supply creation rate is actually deflationary (or contractionary) in the long run \u2013 in the short run, bitcoin\u2019s expansionary rate is quite high, with inflation at 11.1% this year alone. That is to say, it is a hardcoded asymptote, tapering off over a known time period. In the case of bitcoin, the wage for the labor force (miners) is split in half roughly every four years (every 210,000 blocks), for approximately the next 100 years \u2013 until its money supply is exhausted at a final 21 million bitcoins.<\/p>\n

Roughly 12.7 million bitcoins have already been paid to miners.\u00a0 With dogecoin\u2019s 100 billion dogecoins, this process is accelerated, with the mining income dividing in half every two months.\u00a0 While it took about five and a half years for about 60% of bitcoin\u2019s total monetary base to be distributed, as of today 78% of dogecoin\u2019s reward<\/a> (income) has already been divvied out to its workforce in less than six months.<\/p>\n

What now for the workforce?<\/h2>\n

While this frenetically fast money supply has provided a psychological motivation for early adopters to partake in the dogecoin ecosystem, economic law suggests that this network will probably cease to exist in its current form within the next six months probably through a 51% attack<\/a>.<\/p>\n

The reason is simple: with every block reward halving, also called \u201chalvingday\u201d, the labor force is faced with a 50% pay cut.\u00a0 The contractors (laborers) incapable of profitably<\/em> providing hashrate at this level can and will leave the work force for greener pastures. \u00a0This same issue has impacted other altcoins in the past, such as MemoryCoin, which died after nine months due to a combination of factors including diminished block rewards (it attempted to divvy out its entire monetary supply in two years).<\/p>\n

Early advocates of dogecoin like to point to outlier events such as the Doge bobsled team<\/a> or sponsored NASCAR driver at Talladega<\/a> or even a vaunted tipping economy (which is actually just faucet redistribution) as goal posts for growth and popularity, yet after two halvingdays the actual dogecoin block chain has lost transactional volume each month over the past four months and the labor force has also left for new employment elsewhere.<\/p>\n

This is visualized in the following two graphs.<\/p>\n

The first chart shows dogecoin\u2019s collective hashrate.\u00a0 The black lines indicate when the \u201chalvingday\u201d or rather \u201cincome halvingday\u201d occurred. Because the price level of a dogecoin remained relatively constant during this time frame, there was less incentive for miners to stay and provide labor for the network.\u00a0 If token values increased once again, then there may be incentives in the short-term for laborers to rejoin the network.\u00a0 Yet based on this diagram, roughly 20-30% of the labor force left after each pay cut.<\/p>\n

The second chart shows on-chain transactional activity.\u00a0 The first three months are erratic because of how mining pools (similar to lottery pools) paid their workforce (miners).\u00a0 Following the first halving day in February, the network transaction rate fell to roughly 40,000 transactions per day and then leveled off to around 20,000 until 28th April 2014, when another halvingday occurred and the subsequent transactional volume remained relatively flat to negative. It is currently at 12,850 transaction per day, or roughly the same level it was during the first week of its launch five months ago.<\/p>\n

Dogecoin\u2019s falling hashrate<\/h2>\n

Now, some readers may claim that a lot of the transactional volume such as tip services and tip bots are being conducted off-chain and thus the total number of transactions is likely higher.\u00a0 And they would be correct.\u00a0 But that would completely defeat the purpose of having a block chain in the first place \u2013 a trustless mechanism for bilateral exchange that negates the need for \u201ctrust-me\u201d silos (as Austin Hill calls them).<\/p>\n

Also, while this topic deserves its own series of articles, there is little literature that suggests that tipping can grow
\nan economy; it is not<\/i> a particularly good signaling mechanism<\/a> or way to grow a developing economy (i.e., \u201cChina, you need more tipping activity to grow and prosper\u201d).<\/p>\n

However the key issue is this: if the trend continues and the network hashrate continues to fall 20-30% after each halvingday, then within the next two to four months it will be increasingly inexpensive<\/i> for competing mining pools on other ledgers to conduct a 51% attack on dogecoin\u2019s network, destroying its credibility and utility.<\/p>\n

For instance, the chart below is the litecoin hashrate over the past six months. Litecoin<\/a> is dogecoin\u2019s largest competitor based on its proof of work (PoW) mechanism called scrypt<\/a>:<\/p>\n

One of the reasons the litecoin<\/a> hashrate is not rising or falling at a constant rate but is instead jumping up and down erratically is that miners as a whole are economically rational actors.\u00a0 When the cost of producing security is more than the reward (block reward income), the labor force turns towards a more profitable process<\/a> such as another alternative scrypt-based \u201ccoin\u201d (note: bitcoin\u2019s hashing method uses SHA256d whereas litecoin and dogecoin use scrypt). The same phenomenon of hashrate jumping up and down occurs with the bitcoin network.<\/p>\n

For the sake of simplicity, the litecoin network can be viewed as roughly 200 GH\/s versus the dogecoin \u043a\u043e\u0448\u0435\u043b\u0435\u043a<\/a> network which is roughly 50 GH\/s.\u00a0 To conduct a 51% attack on dogecoin today, an entity would need to control roughly 25-26 GH\/s which is roughly one eighth the processing power of the litecoin network.\u00a0 The current \u2018market cap\u2019 for dogecoin is $35 million, assuming marginal value equals marginal cost<\/a>, ceteris parebus<\/i> on paper it could cost $17.5 million in capital and operating expenses to successfully attack the dogecoin network.<\/p>\n

The chart above shows both the hashrate of litecoin (in red) and dogecoin with the vertical black lines representing the dogecoin \u201chalvingday.\u201d What this shows is that while dogecoin, for roughly one month in early 2014 was more profitable to mine than litecoin, the halvingday led to an exodus of labor.<\/p>\n

If current prices and trends continue, which they may not, in two months the litecoin collective hashrate may hit 240 GH\/s and dogecoins hashrate could shrink due to halvingday by another 20% to 40 GH\/s.\u00a0 At this rate a successful 51% attack on dogecoin would require just one twelfth of the hashing power of litecoin<\/a> which at the same prices levels would entail less than $10 million in capital and operating expenses to do.<\/p>\n

Will dogecoin survive?<\/h2>\n

While the development team could theoretically switch its proof of work algorithm (to X11 as used in Dash<\/a>), the doge community is really faced with six options:<\/p>\n

    \n
  1. Merge mine.\u00a0Namecoin<\/a> was (and is) an independent block chain, but since block 19,200 about 80-85% of its network hashrate (and block rewards) are tied to bitcoin mining pools through a process called \u201cmerged mining.\u201d\u00a0 The new sidechains project<\/a> from Blockstream is attempting the same process.\u00a0 Charlie Lee, creator of litecoin explained<\/a> how dogecoin could be \u201cmerged mined\u201d with litecoin in a series of posts last month.<\/li>\n
  2. Transaction fees. Both the development team and mining community could agree to float or raise transaction fees on the doge network, similar to what Mike Hearn has been discussing for bitcoin.\u00a0 In practice however, even if approved, very little actual commerce, and therefore transactions, is conducted on the dogecoin network. Thus it is unlikely that this will compensate the large drop in mining income.\u00a0 Similarly, as Gavin Andresen pointed out in Amsterdam this past Friday, increased transaction fees reduces the participation rate<\/a>. It is important to note the actual transaction costs are much higher than stated \u2013 block rewards (token dilution<\/a>) are usually not factored in.<\/li>\n
  3. Proof of stake. There are several variations of proof of stake.\u00a0 Whereas bitcoin, litecoin, dogecoin and most other cryptocurrency experiments use a \u201cproof of work\u201d mechanism to protect the network from malicious entities, a proof of stake<\/a> system, such as that used in NXT, will randomly assign a \u201cmining node\u201d called a \u201cforger<\/a>\u201d \u2013 a poor marketing term for sure \u2013 to process all the blocks for the next minute.\u00a0 Because all of the other nodes in the network know which miner to trust, this lowers the amount of infrastructure needed to protect the network.\u00a0 In theory this sounds amazing.\u00a0 In practice however, most proof of stake systems end up almost immediately centralized in one manner or the other. Andrew Miller, Andrew Poelstra and Nicolas Houy call it \u201cproof of nothing<\/a>\u201d. \u00a0Perhaps Stephen Reed\u2019s\u00a0version<\/a>\u00a0can work in the future.<\/li>\n
  4. Increase in market price. This would incentivize the labor force to continue providing security of the network with the expectation that the tokens they are given in return for their labor will continually appreciate in value.\u00a0 This is betting on hope.\u00a0 Charlie Lee pointed out the uphill task this would require beginning next year when rewards fall to less than one tenth\u00a0what they are today, stating<\/a> last month, \u201cAt dogecoin block 600,000, only 10,000 coins will be created per block. So in order for dogecoin to keep the same amount of security as today, dogecoin price would need to go up by 25 times. And dogecoin price would need to gain on litecoin by 50 times in order to catch up on litecoin\u2019s security. And assuming everything stays the same, the market cap of dogecoin needs to reach $1.5 billion by January of next year.\u201d\u00a0 For comparison, the \u2018market cap\u2019 of dogecoin today is roughly $35 million (note: it is probably not accurate to call it a \u2018market cap,\u2019 see Jonathan Levin\u2019s explanation<\/a>).<\/li>\n
  5. Migration. Dogecoin could also migrate to a platform like Counterparty and become a fully secured altcoin with a dash of proof of transaction<\/a> thrown in to inflate the coin with ongoing usage that this particular community likes to embrace. It could be fully protected by the bitcoin hashrate with no further need to try to acquire miners to protect it.<\/li>\n
  6. Further experimentation.\u00a0\u00a0While it is unlikely the dogecoin has the resources to create secure production code in the shortened time frame, Robert Sams \u201cgrowthcoin<\/a>\u201d and Ferdinando Ametrano\u2019s \u201cstablecoin<\/a>\u201d could provide a mechanism that enables the network to live on in a different manner.<\/li>\n<\/ol>\n

    While any or all of these may be tried out, it may be too little, too late. With that said, stranger things have happened.\u00a0 A rising tide lifts all boats and thus in the event that \u201cbitlicense\u201d approved exchanges on Wall Street come online this summer and new capital actually flows into bitcoin and other alternative ledgers, perhaps similar speculative funding will flow into dogecoin as well.\u00a0 However, this is not something that can be known a priori<\/i>.<\/p>\n

    I contacted Jackson Palmer, creator of dogecoin for his thoughts on the situation.\u00a0 In his view:<\/p>\n

    \n

    \u201cIt is definitely a challenge that dogecoin (and all current-gen crypto currencies) will face in the future. As we discussed recently, it\u2019s kind of a sad reality that people are purely profit driven and these decentralized networks we\u2019ve built are reliant on profit-mongers to power and secure their viability. I\u2019m very concerned about the impact of centralized mining and reliance on transaction fees could hold for bitcoin as it becomes less enticing to mine \u2013 really, the network can be held at ransom to attach hefty transaction fees if the mining pools are cherry picking as they create blocks. At the end of the day, I think the viability of cryptocurrency really hinges on a move away from PoW-based mining to something new and innovative that doesn\u2019t just stimulate an arms race and put all the power back into the hands of the fiat-wealthy. I don\u2019t have a solution unfortunately, but hopefully someone will find one and bring about a new generation of digital currencies in the coming five to ten years. That being said, cryptocurrency as a space is very unpredictable so it wouldn\u2019t surprise me at all if dogecoin beats the odds and overcomes these challenges in some weird, wacky way. It\u2019s in the community\u2019s hands, and they\u2019re certainly passionate about seeing it reach the moon, as am I.\u201d<\/p><\/blockquote>\n<\/div>\n

    Can this happen to bitcoin?<\/h2>\n

    To be balanced, below is the network hashrate for the Bitcoin network following its first halvingday on November 28, 2012:<\/p>\n

    The following two months, from December 2012 through January 2013, the hashrate stayed flat and in some weeks even declined. There were three reasons why the network did not decline precipitously like dogecoin:<\/p>\n