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How does ADA scarcity relate to Cardano security and governance?

Published 28.2.2023

Every Cardano supporter knows that there will only be 45,000,000,000 ADA coins. ADA is a scarce resource. For many, it is a store of value or the money of the future. The immutability of monetary policy is a fundamental principle for any blockchain. If it were to be violated, it would have fatal consequences on people's trust in the project. There is a direct link between scarcity and blockchain security. The market value of coins determines the quality of blockchain security. If security starts to decline, a change in monetary policy may be necessary as one possible solution. The choice between security or scarcity is a dilemma that would be very uncomfortable for the community. Is it possible to have a long-term economically sustainable blockchain without having to change scarcity? What mechanisms prevent a change in the monetary system and why is governance important?

TLDR

  • Monetary rules can exist forever, no matter what technology is used to enforce and maintain them.
  • In order of importance, rules come first, community second, and technology third.
  • Maintaining scarcity essentially means making a key decision in times of crisis and changing the protocol in time.
  • Scarcity can only be sustained economically in the long run through a sufficient security budget.
  • Those who are able to manage resources more efficiently have a better chance of survival.
  • The choice between scarcity and security is a choice that the community does not want to have, as they may not agree on a solution.
  • All ADA holders together are responsible for both security and scarcity.

How to maintain scarcity?

Change is the only constant we can completely rely on in our universe. This is doubly true for technological progress. Blockchain protocols have the ambition to exist for several decades, perhaps forever. People are not interested in a particular protocol in terms of its design, implementation, or technological maturity, but mainly because of the financial and social opportunity it brings. They want monetary policy, decentralization and its associated features, protocol security, the ability to connect people without third parties, etc. to remain unchanged. Unfortunately, this cannot (very likely) be achieved without changing the protocols and their specific properties. Negative developments may force a change in rules that were intended to remain unchanged forever. To ensure the security of the protocol, it may be necessary to change monetary policy.

Cardano will only have 45,000,000,000 ADA coins forever. This is a rule that can remain in effect forever regardless of how the protocol and possibly other less important rules change. A change in technology may not have a direct impact on the rules. Rules can exist forever, no matter what technology is used to enforce them.

More important than the protocol is the community that expects and oversees the immutability of the rules. In order of importance, rules come first, community second, and technology third.

The scarcity of ADA coins must be preserved forever. At the same time, Cardano must be a secure protocol. One cannot exist without the other. Scarcity cannot be maintained unless Cardano is well-secured and decentralized. The community, together with the team, is responsible for ensuring that a sufficient security budget is in place. If Cardano does not have enough ADA coins to reward staking pool operators (SPOs) and stakers, it may run into existential problems. Of course, with the eventual demise of the protocol, the monetary rules and ADA coins also cease to exist. That is, assuming the rules could not be transferred to another protocol or medium. Is that even conceivable?

No one can say in advance what problems blockchain protocols will face in the future. The only certainty we have is that some problems will arise. It is very likely that we will see a security budget problem sooner or later. That's why we believe the community is more important than the technology (protocol). The community has to decide how to deal with any problems and how to possibly change the protocol, hopefully keeping the monetary rules unchanged.

You might think that the following order is possible. Rules first, protocol second, and community third.

This order could be interpreted to mean that the protocol does not need any major changes and can exist forever as is. That is, both the rules and the protocol will be preserved. The community is in the position of consumers.

Based on historical experience, we know that protocols must change to remain relevant and reflect technological progress. There is no protocol or Internet service that is not threatened with extinction by technological progress. Teams have to constantly catch up with technological progress to keep their project relevant, but no one has a sure thing in this fight.

Maintaining scarcity essentially means making a key decision in times of crisis and changing the protocol in time. If technical issues are unaddressed or the security budget is depleted, the collapse of the protocol is imminent. Both the rules and the coin will disappear. If we agree on this, it is important to ask who can make decisions and how. Governance is absolutely a key part of the protocol for maintaining scarcity.

How to maintain security?

We have said that scarcity (monetary system) can only be sustained economically in the long run through security. In this paper, we will mainly use the term security to mean a sufficient security budget.

The existence of a blockchain network directly depends on the incentive model, which motivates volunteers to take the actions necessary to run the network while preventing them from carrying out attacks.

The quality of network security increases with the market value of coins. The higher the value of ADA coins, the more costly it is to commit a 51% attack. The market value of coins is dependent on many factors including current protocol utility, adoption, network effect, Lindy effect, future potential, speculation, etc. All these factors will change over time, so it is impossible to predict how well Cardano will be secured.

Cardano’s security is not only dependent on the market value of ADA coins. Decentralization, the distribution of coins among users, the quality of the network consensus implementation, the aforementioned governance, and many other things are also important.

Consider a scenario where the security budget is gradually but dramatically reduced and the blockchain does not have enough coins for rewards. It may not be economically viable for people to maintain nodes and run pools. How to deal with the situation?

Economically, the situation is clear. It is necessary to either cut spending or secure more revenue. Reducing the quality of security (and the community's acceptance of this) is a bad choice for a blockchain network.

The community expects that Bitcoin may face security budget issues within about 10 years (after 3 more halvings). Since we cannot estimate the market value of BTC, we cannot estimate when exactly the problem will occur. Increasingly, there are views that the problem can be solved by introducing infinite inflation.

The introduction of infinite inflation is a violation of the promise of immutable scarcity (monetary policy). The protocol would indeed ensure an infinite supply of coins for rewards, but would that solve the problem? We don't know because we can't estimate what impact would have the breaking of the promise of immutable scarcity on people's trust. The consequences can be drastic, as trust overrides everything else. The fall in the market value of coins could be so dramatic that the situation would be even worse than before infinite inflation was introduced.

How much will we need blockchain in the next 10 years? Will it only be settlement processors for transactions made on L2? Will the fees for these services be sufficient? We need blockchain as the main protector of scarcity and security. But how to sustain it economically?

Is it possible to avoid the introduction of infinite inflation and raise revenue in other ways? All blockchains can only be economically sustainable in the long term if they collect a sufficiently large amount of coin in fees. In other words, networks must offer services for which a sufficiently large number of people will be willing to pay an adequate fee.

The usefulness of blockchains is directly related to their technological features. Scalability is important, as well as the possibility of additional functions such as the execution of smart contracts or the minting of custom tokens. But there's a catch. At the moment there seems to be a huge effort devoted to developing the second layer solutions (L2). Most transactions in the near future will not be on the first layers but on the second layers. Blockchain networks can never compete with the scalability of L2.

This essentially means that blockchains may not be able to collect enough coins in fees. The scalability of Cardano will be greatly increased if the community decides to implement the input endorsers feature. Can this help?

Let's be realistic and allow for the fact that networks may not be able to collect more revenue. It is therefore necessary to reduce the cost of running the network. Reducing rewards should be a last resort as it may have the effect of reducing security.

Reducing costs is always linked to increasing efficiency. This principle also works well in nature. Those who are able to manage resources more efficiently have a better chance of survival.

For us, the debate about Proof-of-Work (PoW) and Proof-of-Stake (PoW) is not about design, implementation, or the connection of PoW to the physical world through electricity, but mainly about long-term economic sustainability.

We can talk for hours about how awesome it is to have a PoW blockchain secured through the consumption of electricity, but the absolutely key question is whether this model is sustainable. The choice between scarcity and security is a choice that the community does not want to have, as they may not agree on a solution if there is a problem. Finding a solution can be very difficult. The Bitcoin community, but also the Cardano community and other communities, may one day face that choice.

We are happy that Cardano uses PoS as it is more than 99% energy efficient. This means that the cost of running a PoS blockchain is significantly lower than PoW one. It will be significantly easier for Cardano to maintain a high level of security over the long term and thus ensure scarcity.

Yet it is possible that one day the Cardano community will face a similar question to the one now facing the Bitcoin community. How do we ensure security in the long term and not sacrifice scarcity? Where to get coins for rewards?

Who has the right to decide?

If we agree that the protocol is only a technology that may have existential problems in the future, it is important to ask who should decide on the solution. The goal of decentralization is to eliminate central authority, but that does not automatically mean that no one is in charge. It's just the opposite. Each user bears part of the responsibility.

Depending on the size of their stake, each ADA holder has a part of the responsibility for the future of Cardano. This means that all ADA holders together are responsible for both security and scarcity.

Decentralized governance can be the best protector of scarcity and security. We are talking about decentralized voting, not network consensus. Network consensus is just an algorithm that knows nothing about the security budget problem. They are the people who can predict future problems, know the market value of the coins, and can propose solutions to prevent the problems the protocols may face.

Decentralization is about rules and also about trust. There must be no group that usurps the right for itself. The team is close to the source code but must not solve problems according to their opinion. The team must be in the role of a kind of executor of the community's will.

There must be no group that is in the minority and yet able to make decisions against the will of the majority. Each individual prefers his own selfish interests over the interests of others. We are all greedy. This is why power in a decentralized network must be distributed among as many balanced entities as possible. It is therefore very good that coins can be used for voting in PoS networks.

The work of the miners is crucial for PoW networks. They have a decisive influence on the security of the network. Is it fair for them to decide to introduce inflation (which may be economically beneficial for them), or should the holders of coins also decide? Which governance model is actually best?

The scarcity changes affect all coin holders, so it should be them and no one else who votes on any change. All key changes can lead to an exodus of part of the community. This must be taken into account. The important thing is that the majority will stay and continue to trust the protocol. Trust can be traded for community within the context of this article. Thus, the order of importance can be adjusted as follows. Rules come first, trust second, and technology third.

It can be interpreted as follows. The rules that too many people don't believe in are useless. The rules may change if it is existentially necessary. If the rules are changed by the minority at the expense of the majority, trust is lacking. If the majority decides on changes in scarcity and security, trust will be assured. The ability to make decisions about the system is a key advantage, as the inability to agree on change can lead to extinction. Changes in technology must be subservient to a higher goal, which is to ensure key rules.

Conclusion

Note that there are many unanswered questions in the article. We don't know the future and the best we can do is prepare for it. The ability to make decisions based on a democratic vote can ensure people's long-term trust in the system. If people trust the system, they can change it to suit the majority. Only such a system will survive any crisis.

A surprisingly large number of people believe that in order to ensure the existence of a blockchain network, it is enough to set immutable rules at the beginning and have a decentralized network consensus. How can we ensure that the rules of the protocol are immutable in a world that is constantly changing? Technological progress cannot be stopped. If it is possible to make protocols more efficient, it may be necessary for their existence. People have a need to spend the least possible resources to achieve their goals. They won't pay more fees if they don't have to. Protocols must adapt to the basic laws of nature. A decentralized protocol is like a living organism. At least for Cardano, this will be true once we fully enter the Voltaire era. The community will decide on protocol rule changes. Let's wish we don't have to face the choice between scarcity and security someday. I believe that if we rely on the wisdom of the crowd, that will never happen.

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