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11-economics-or-xpeerchain.md

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11. Economics of XPeerchain

Earlier in this text XPeerchain was called a drop-in replacement for Bitcoin. This label fits because XPeerchain provides a blockchain with an alternative consensus scheme that solves Bitcoin’s major security flaws in a way that allows the chain to operate indefinitely. However XPeerchain diverges from Bitcoin in a major way when it comes to the economics behind the system.

An Unlimited, but Ultimately Scarce Supply

Bitcoin has a maximum supply cap of 21 million coins that can ever be produced and proof-of-work block rewards for miners shrink over time until they hit zero. XPeerchain however has no such hard limit on its supply. Proof-of-stake block rewards do not shrink over time and are distributed to minters proportionally based on the size of their stake at a rate of about 1% per year.

This process is designed to continue forever in order to consistently incentivize stakeholders to participate in the minting process. This means that XPeerchain’s supply is unlimited as it has no end point where production of new coins stops.

To be clear, XPeerchain’s overall coin supply does not increase by 1% per year. Only stakeholders who participate in the minting process will receive this 1% interest on their stake. Stakeholders who refuse to mint will receive no interest at all. For example if a blockchain has a total supply of 1,000,000 coins, 1% on that whole amount would be 10,000 coins.

However this example assumes every stakeholder in the network is minting and every single coin is being minted with. If however only 200,000 coins are being used to mint with out of a total of 1,000,000 coins, then the yearly inflation of the supply from proof-of-stake rewards should only be about 2,000 coins. 10,000 coins could only be produced if all coins in the network were being used to participate in the minting process.

Since the number of coins being minted with by stakeholders is considerably less than what actually exists in total, the yearly inflation that is produced through new coins will also be significantly less. It is not necessary for all coins to be minting in order for the network to be considered secure, however higher participation rates will increase the security and decentralization of the network.

The 1% Standard

XPeerchain developers are often asked why they don’t increase the annual percent from 1% to some arbitrary number like 5% or even 10%. The argument usually provided is that a higher reward percentage will encourage more people to participate in minting. Either that or the person suggesting the idea is just more concerned about earning a profit over what is best for the long-term health of the network.

Increasing the mint reward percentage to higher levels is a bad idea on many fronts. As mentioned already, not all stakeholders participate. There are minters and there are non-minters. Non-minters have made a choice not to participate and have accepted the fact that they will not earn any block rewards.

Refusing to mint however prevents a stakeholder from being able to keep up with yearly inflation and as a result their overall percentage of ownership in the network will decrease over time while those stakeholders who do mint will increase their percentage of ownership. This change of percentage of ownership from non-minters to minters is extremely slow however since the rate of change is only 1% per year.

Adopting a higher mint reward such as 10% would exacerbate this change though. Such an extreme change in the mint reward would end up benefiting minters at the expense of stakeholders that have not begun minting yet. Minters would begin increasing their stake by 10% per year, effectively funneling value much faster from non-minters to minters. The number of coins held by non-minters would remain stagnant from not participating in earning block rewards. At the same time minters would be able to drastically increase the number of coins they own every single year, increasing their control over the network.

Not only does this work to centralize the network, but it does not make for a cryptocurrency that acts as a proper store of value. In order for people to be able to properly store their wealth in a currency, its inflation rate needs to be well regulated to provide enough scarcity. A currency that is not scarce enough will cause any wealth being stored in it to be devalued over time.

So even though XPeerchain ultimately has an unlimited supply that will continue growing forever, its yearly inflation rate is a balancing act between providing enough motivation for stakeholders to mint blocks and keeping it low enough to maintain some level of scarcity so XPeerchain can be used as a vehicle for value storage.

As a principle, stakeholders should not be required to mint if they don’t want to. Forcing them to participate by making them lose significant value every year if they don’t will likely just result in pushing non-minters away to other blockchain networks with more sustainable inflation rates.

Sometimes stakeholders may have a legitimate reason for not participating. For example they may have concerns about the security of their coins or they have temporarily placed some of their coins into another investment and will return to XPeerchain after they are finished with it.

Lastly, increasing the mint reward would also punish the market capitalization and price of XPeerchain. If stakeholders continuously mint and sell lots of coins on the market for profit, this will work to inflate the supply and may result in a situation where the supply of new coins overpowers the current level of demand. Too many coins on the market results in a lack of scarcity and without enough buyers it will negatively impact XPeerchain by driving down its price.

This is why XPeerchain maintains its proof-of-stake inflation rate at a low 1%. Increase the rate too much and it becomes a burden. It may sound attractive at first, but it is short-term thinking and the long-term consequences far outweigh the benefits.

Pure Proof-of-Stake Distribution Problems

A recognized problem in blockchains that are solely run on proof-of-stake is that coins are much more difficult to properly distribute. When first creating a pure proof-of-stake blockchain, the entire supply of coins needs to be created at the same time. This supply is then usually distributed to a number of investors who purchase stake in the network.

This however leads to the creation of blockchains that are owned and operated by a small number of individual investors. Blockchains like these are centralized from the start because the initial coins were not distributed to a wide enough group of people.

In a scenario like this, network security ends up being provided by a small and centralized group of people. In some projects, a large number of coins may even be distributed solely to developers on purpose in order to provide funding for future development work.

These uneven and unfairly distributed blockchains are not representative of a properly decentralized network and thus are not as secure as they could be. They should be avoided in favor of blockchains that have taken proper measures to ensure a wide enough distribution.

Further, in a pure proof-of-stake blockchain newly produced coins from the minting process can only be distributed to existing holders. Because of this, the only way for new coins to enter the market so others have the chance to purchase them is for stakeholders to sell their new coins on exchanges, which is not guaranteed or likely to happen.

With proof-of-work for example, miners are forced to sell a large portion of the coins they earn on exchanges in order to pay for the costs of their mining operations. This selling provides a constant source of new coins on the market for purchase and also increases trading liquidity on exchanges.

Proof-of-stake minting on the other hand is inexpensive to perform, so minters do not necessarily need to sell their newly earned coins. This is because there are no costly electricity bills to pay that require the selling of new coins. This allows minters the ability to hold onto all of their earned coins, which creates a distribution problem where it becomes difficult for new people to be able to obtain coins.

The majority of coins end up being held by stakeholders in personal wallets instead of on exchanges where they can be easily purchased, which hinders adoption. A mechanism which incentivizes stakeholders to sell coins from time to time would help alleviate these distribution problems.

Hybrid Blockchain: PoS Security & PoW Distribution

That is where proof-of-work comes into play. XPeerchain is more than just proof-of-stake. It is also the world’s first hybrid blockchain, utilizing both proof-of-stake and proof-of-work. The hybrid nature of the XPeerchain blockchain allows it to draw strength from both protocols while at the same time minimizing weaknesses.

In XPeerchain, the blockchain is secured only through proof-of-stake minting. Proof-of-work mining also runs in the background however and provides the network with continual distribution of new coins. When the network was initially launched, the majority of blocks were created with proof-of-work in order to bootstrap the network, distribute coins and create new stakeholders. Security then transitioned to proof-of-stake as minters took over security of the blockchain.

Sunny King saw proof-of-work mining as a better way to achieve a more decentralized distribution, rather than simply selling coins to investors. Today the majority of blocks in XPeerchain are created through proof-of-stake while a small minority are created through proof-of-work. To be clear though, proof-of-work plays no part in securing the XPeerchain blockchain. Security is achieved solely through proof-of-stake.

At most, it can be said that proof-of-work assists with security indirectly by providing for a more distributed network. Imagine a flower for example. A flower occasionally releases new seeds, which spread around to new areas over time. Some of these seeds then grow into new flowers. In this example, the original flower is the XPeerchain blockchain itself and the seeds are proof-of-work rewards.

As miners earn rewards in the form of new coins, they sell them on exchanges in order to pay for their expensive mining operations. People all around the world purchase these new coins that have been distributed by miners. Once purchased and transferred to a wallet, the new stakeholder now has the opportunity to become a security provider for the network by engaging in the process of minting new blocks.

So XPeerchain’s proof-of-work does not directly secure the network, but it is designed to do so indirectly by strengthening the decentralization of the network through the creation of new potential minters over time. A pure proof-of-stake system on the other hand is designed to distribute new coins only to existing holders, which does nothing to further decentralization or improve security.

In addition, proof-of-work also adds a bit of randomness to the proof-of-stake process. It was explained before that the selection of the next proof-of-stake block is the result of a mixture of both randomness and coin age. Proof-of-stake is unable to generate that needed randomness alone by itself, so an external source is required. That source of randomness is provided by the mining in proof-of-work and used by the proof-of-stake protocol in the block selection process.

This is why a hybrid system like XPeerchain is superior. It combines the security benefits of proof-of-stake and the distribution benefits of proof-of-work. This combined approach eliminates the long-term security weaknesses of pure proof-of-work and the distribution weaknesses of pure proof-of-stake, forming a superior consensus protocol that only strengthens as it ages.

Dynamic Proof-of-Work Block Reward

XPeerchain’s version of proof-of-work is slightly different from Bitcoin. Besides the removal of the ability to directly impact security, another major change is the way the block reward functions. In Bitcoin for example the block reward is static and reduces over time at certain pre-determined points.

XPeerchain however utilizes a dynamic proof-of-work block reward which is inversely proportional to hashing power. Stated simply, as hashing power increases, the block reward decreases. The opposite is true as well. If hashing power decreases, the block reward increases. The change in the reward occurs automatically.

One major purpose of this dynamic mechanism is to prevent energy overuse. As more and more electricity is being spent, this increase of hashing power is detected by the protocol and automatically used to reduce the block reward. The dynamic reduction in reward causes unprofitable miners to drop out much sooner than they would if the block reward was static.

This drop in profitability works to restrict the amount of electricity being spent. So electricity waste does occur in XPeerchain, however it is designed to be smaller and is relegated to the part of the protocol that deals with distribution rather than security. The security process itself is efficient and does not depend on energy expenditure.

Inheriting the Mining Industry

A fact that many people don’t realize is that XPeerchain is currently positioned to inherit the mining industry from Bitcoin. As mining gear on the Bitcoin network becomes exhausted and better technology is released to replace it, this outdated equipment can find a new lease on life by mining at XPeerchain instead.

This has been shown to be true over time. The hashing power being directed at XPeerchain for example has continued to rise over the years as advances in Bitcoin mining equipment are made. These technological advances in speed and efficiency displace older equipment, causing it to be unprofitable. This older mining equipment must then find a new home where it can still be considered profitable. After some research, miners eventually find this new home at XPeerchain.

This is possible because Bitcoin and XPeerchain use the exact same mining algorithm, which means all specialized equipment that is developed for Bitcoin is 100% compatible with XPeerchain. If Bitcoin ever switches to another mining algorithm or if the network just doesn’t succeed, miners will always be able to find a home at XPeerchain.

In fact it may even be a more favorable environment for miners as they don’t need to worry about the various politics that exist in the Bitcoin community. Since proof-of-stake minters hold all the power, proof-of-work miners would not be required to do any important decision making. Miners can simply mine and distribute new coins for the network without having to worry about the politics of upgrading the network. In XPeerchain no one is depending on them to make vital decisions, which allows for a more stress free environment.

Deflation Through Transaction Fee Burning

The supply of XPeerchain can adjust upward through inflation, but it’s also possible for the supply to adjust downward through deflation. There are three mechanisms in XPeerchain that cause the supply to change. This includes dynamic inflation from proof-of-work, 1% inflation from proof-of-stake minters and deflation from transaction fees.

In Bitcoin it was explained that transaction fees are collected by miners in order to compensate them for the work they do in processing transactions and blocks. In XPeerchain however, transaction fees are burned rather than giving them to minters. When someone pays a fee to transact with their xpeerchain, the coins they use to pay the fee are destroyed, effectively removing them completely from the supply. This creates a tiny amount of deflation by decreasing the number of xpeerchains in existence.

When these coins are removed from circulation, it has the effect of making XPeerchain more scarce. So if current demand stays the same but the supply of XPeerchain shrinks due to a reduction in the overall number of coins, the remaining leftover coins will become slightly more valuable as a result. It is a similar effect to paying everyone in the network a fraction of the fee. The value is effectively transferred from the burned coins to the remaining coins held by other users.

There are only three possible economic models. First, there are blockchains that have a limited supply and transaction fees are paid to security providers. This model is deflationary by nature because new supply will end at some pre-determined point in the future. Once this occurs, as users mistakenly lose access to their wallets through personal error the number of coins in circulation will start to shrink. At this point the only direction supply can go is down. Bitcoin is an example of this first model as it has a maximum supply cap and miners earn fees.

Second, there are blockchains that have an unlimited supply and transaction fees are paid to security providers. This model is inflationary by nature because there is no mechanism to reduce the supply. Proof-of-work based blockchains do exist that are unlimited and do not have a maximum supply cap. These blockchains however lack proper scarcity because the supply is constantly expanding and only ever shrinks due to user error when access to funds is accidentally lost.

The majority of proof-of-stake based blockchains have also chosen an economic model where minters are compensated from transaction fees. This however leads to uneven distributions of coins to minters as some blocks will contain more transaction fees while others have less.

Third, there are blockchains that have an unlimited supply and transaction fees are burned. XPeerchain is the primary example of this type of economic model. It is possible for XPeerchain to be either inflationary or deflationary. This depends on a number of factors, the level of use the blockchain is seeing, the number of stakeholders minting with their coins and the amount of hashing power being directed at the network.

If use of the blockchain is low then there will be a low amount of burned fees. If use is high then the rate of fee burning will rise. If the number of coins being minted with is low then not many stakeholders will be awarded their annual 1% interest. If the number of coins being minted with spikes however then the level of proof-of-stake interest being generated will rise. If hashing power from miners is low, then proof-of-work block rewards will increase. If however hashing power spikes, the block reward will automatically decrease. All of these different mechanisms need to be taken into consideration when determining the overall increase or decrease of the supply.

Therefore transaction fees in XPeerchain provide an essential counterbalance on overall inflation from rewards generated by proof-of-work and proof-of-stake. Over time this deflationary force incentivizes developers to create new use cases for the blockchain. The more use cases that are available for users, the more transactions will be generated by users on the network and the more fees will be destroyed.

This has the effect of eroding existing supply, which makes the remaining xpeerchain more scarce and valuable. As a result of the value rise in their stake from destroyed supply, coin holders will be motivated to fund development projects that will help further increase the level of on-chain transactions and destroyed fees.

Benefits of a Fixed Transaction Fee

The value of transaction fees are also not voluntarily set by the user like in Bitcoin. Instead users in XPeerchain are charged a fixed fee per transaction. This static fee is set at 0.01 PPC per kilobyte. Every transaction uses up a certain amount of blockchain space. Larger transactions take up more space on the chain.

The rule above basically states that for every kilobyte of space a transaction takes up on the chain, the user must pay 0.01 PPC. So for example if it took 5 kilobytes of space to store a user’s transaction on the chain, then that user would be charged 0.05 PPC. This fee is mandatory and if a user tries to pay less than the required amount, their transaction will be rejected by the network.

This is a powerful rule for XPeerchain. The fixed fee basically acts as a filter on the blockchain to weed out low value micro-transactions. If for example the required fee is larger than the transaction a user is trying to send, it simply doesn’t make sense to send that transaction. Instead the user should use a second layer network or wait until they have more xpeerchain to transact with. This filter works to prevent blockchain bloat from transaction spam and helps limit the increase in the size of the chain.

Another important side effect of a fixed fee is that it makes it easier on the user to figure out how much they need to pay to the network to conduct their transactions. It is difficult to do this in Bitcoin for example because fees can change so rapidly. If a block in Bitcoin is filled up then users are forced to start paying more fees in order to get their transactions included in the block.

This negatively impacts the user experience as fee levels fluctuate wildly from day to day. In XPeerchain however the required fee will always be known to the user. If they have 7 kilobytes worth of transactions to send, then their fee can easily be determined to be 0.07 PPC.

In addition to this, transactions in XPeerchain are always first come first served. Because of this, users no longer have to worry if their transactions might get delayed by miners if they don’t send a fee that is attractive enough. In XPeerchain if a user sends a transaction then their transaction will be included in the next available block by minters. It is very straightforward and significantly improves the user experience.

A True Digital Replacement for Gold

Bitcoin is often described as being a digital replacement for gold because the supply is limited and not controlled by any one individual or central authority, however the comparisons ultimately fall short of the mark. Bitcoin is not a suitable digital replacement for gold precisely because of the amount of expended energy required to sustain its network security. It’s a very slow, difficult and expensive process to extract gold from the Earth. This is similar to the process of mining new coins through proof-of-work. However this similarity ends when it comes to simply maintaining the security of gold.

Once the extraction process is complete, very little effort is required to actually maintain and secure gold. In contrast, once new bitcoins are extracted those coins can only be considered truly secure if expensive mining operations continue servicing the Bitcoin blockchain forever. This large and continual cost to simply sustain the Bitcoin network diverges from the small cost to maintain the security of gold.

By comparison, XPeerchain can be considered a true digital replacement for gold. Proof-of-work in XPeerchain imitates the expensive extraction process of gold. However once extraction of new coins is complete, proof-of-stake provides a cost efficient way to actually secure that value similar to the lower cost of securing gold from theft. This two step process of extracting a resource and then maintaining its security in a cost efficient manner is best compared with the XPeerchain blockchain.

The overall inflation rate of XPeerchain can also be compared to gold. During initial launch of the blockchain, the majority of new coins were created through proof-of work distributions to miners. Since 2012 the hashing power being directed to the network has continued to increase. As a result, inflation from proof-of-work block rewards has continued to decrease. The overall annual inflation rate shows a slow downtrend throughout the years. XPeerchain will most likely reach a consistent inflation rate of between 1-2% per year.

A deflationary network like Bitcoin does not make for an acceptable cryptocurrency. As the supply reduces, this causes an upward pressure on the value of the coins over time. Due to its deflationary nature, users of the network are incentivized to hoard their coins in order to achieve gains in value rather than using it as a transactional currency.

A network like XPeerchain that can achieve either inflation or deflation is better suited for use as a currency. If XPeerchain is able to hold its annual inflation rate around 1-2% for example, this would provide users of the network with more of an incentive to transact with their xpeerchain as a normal currency.