Jevons Paradox: What It Actually Means For Bitcoin

From an economic standpoint, Jevon’s Paradox is arguably the foundation of the scaling road we have started walking down for Bitcoin. Pushing things off-chain is attempting to make the use of the scarce resource that blockspace is much more efficient to accommodate a materially larger user base than the blockchain can facilitate on its own. Jevon’s Paradox states that in the presence of elastic demand for something, when the efficiency of using that thing increases, i.e. the cost per use decreases, the aggregate demand for that thing among participants will increase.

The typical example given is the fuel efficiency of cars. If cars suddenly become twice as efficient at using gasoline, people will travel more as the cost of travel has been cut in half. With people traveling more often because the cost to the individual has lowered, the net increase in demand for fuel can exceed the original aggregate demand for fuel before the gain in efficiency was realized. This is the point where the paradox occurs, aggregate demand surpassing what it was before a realized efficiency in the use of that thing.

This is the entire economic thinking behind why second layers are a viable solution. One of the huge contentions from big blockers during the Block Size Wars was that going off-chain will essentially steal money from miners and undermine the game theoretical stability of miners surviving purely off of transaction fees in the distant future. The factor they completely ignored during those debates is Jevon’s Paradox, and many of them still to this day completely ignore this dynamic.

The Contentions

The counter argument, at least the valid one, is that demand rebounding after efficiency improvements does not always exceed the aggregate demand seen before that efficiency gain. It still rebounds in many cases almost to the point it was at, but does not surpass it. This comes down to the inputs that ultimately set a cost on producing something. In the case of the fuel example, the reality is that the cost of fuel is not the only factor in people’s ability to travel with their own car. The cost of producing that car, i.e. the labor, materials, energy for production, etc. and the ultimate cost of the car itself factor into this as well. These factors generally dampen the rebound in demand, preventing it from exceeding the levels it was at before efficiency increases.

Here’s the thing about Bitcoin though: the cost to produce a block is the only factor of “input costs” in producing blockspace. The real kicker is that no matter what happens to that input cost, the available amount of blockspace stays exactly the same on average. This is the entire novelty and value of the difficulty adjustment in Bitcoin, no matter what the price and net hashrate do, the network circles around this Schelling point of the same average amount of blockspace available. The only way that will change is a consensus change to alter the blocksize, or block interval, or other such core variables that will have an impact on the amount of space available.

Therefore the only real factor to consider when applying Jevon’s Paradox to Bitcoin, is how efficiently can users make use of that existing blockspace. One person owning a UTXO on their own and directly transacting on-chain can be seen as a baseline. Lightning, allowing two people to share a single UTXO and conduct numerous transactions off-chain before settling them on-chain, is the first major efficiency gain. After Lightning, something like Ark or a channel factory would be the next level of efficiency gain. In all of these cases, there are no extraneous factors to consider. If you have Bitcoin, and the ability to use that Bitcoin gets cheaper and cheaper, you are more likely to put that Bitcoin to actual use. There are no extra barriers to Bitcoin other than having the Bitcoin. You don’t HAVE to buy a super expensive hardware device to use it, it might be best security practices to do so if you have a large sum of money, but it is not necessary.

Ordinals and BRC-20 tokens kind of prove this point in my opinion. Shoving jpegs into the blockchain, which are pretty big pieces of data relative to the blocksize limit, is a highly inefficient use of blockspace. BRC-20 tokens, which are simply tiny JSON blobs, are relatively efficient relative to jpegs. Which one of these things really drove the demand for blockspace driving up fees lately? The BRC-20 tokens, not the jpegs.

It’s Going To Happen Anyway

The cold hard reality in my opinion is that blockspace use will get more efficient, and we will see Jevon’s Paradox play out regarding the market for that blockspace, regardless of anything we do. If using blockspace directly becomes prohibitively expensive for users transacting, they will find ways to abstract that away. They don’t need covenants, or forks in general, or anything we are building on layer twos to do so.

Custodians.

All they need is custodians. Using blockspace more efficiently comes down to a single thing: people sharing their UTXOs with each other. The trust model of how they do that, whether they can reclaim their money unilaterally without permission, who they have to interact with to withdraw their money, all of these things are completely and utterly irrelevant to Jevon’s paradox playing out.

If blockspace gets too expensive for people, they will stop using it. Demand will drop off, if not in aggregate, then for a class of users. Unless they want to just entirely stop using Bitcoin, they will seek out more efficient ways to use Bitcoin (which inherently requires using blockspace, no matter how abstracted that use is). The only truly scalable way to do this in the long term right now is through custodians.

That means without actually addressing the problem of “what does Bitcoin need to scale in a self custodial way” we are essentially implicitly admitting that the economic incentives of how this system works inherently forces people into custodial platforms and mechanisms for making use of their Bitcoin. To deny that is to deny the realities of what makes Bitcoin work: economics and incentives.

It has been argued quite a lot recently that “spam filtering” is simply another way for Jevon’s Paradox to occur. It is not, and it has no relationship to Jevon’s Paradox at all. Stopping a particular use case from competing with another is not increasing the efficiency of the other use case, it is simply trying to distort and manipulate the market of them both competing for the same resource. That argument fails to understand what Jevon’s Paradox actually is. It doesn’t care about one use case versus another, or which uses are “legitimate”; it is completely agnostic to specific use cases of a resource. It simply speaks to any use case of a resource becoming more efficient, and in the absence of unaccounted for input costs, what the results of that efficiency gain will be on aggregate demand for the use of that resource by that specific use case.

If we are right, this will play its course no matter what we do. The only influence we have on any of this is what the trust model of any efficiency gains in blockspace use are, we have no control over whether those efficiency gains will happen. 

9 January 2024 17:30