The Bitcoin Block Wars: An Austrian-Misesian Analysis

The Economics of Balancing Stability and Flexibility in Bitcoin’s Decentralized System

This post was inspired by the discussion between Robert Murphy and Stephan Livera on The Bob Murphy Show (Episode 365), titled “Stephan Livera Makes the Case for Small Blocks in Bitcoin” (watch here). Stephan provided a solid technical analysis and raised practical concerns worth considering. In this post, I aim to present the theoretical case against the “market determination” of block size, approached from an Austrian perspective.

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The debate surrounding Bitcoin's block size sparks controversy not only from a technological perspective (Back et al., 2015) but also at the fundamental philosophical level (Block & Davidson, 2015). While proponents of block size increase present their approach as 'free market' where rules are determined by temporal demands (Ver & Wright, 2017), it's important to understand that even in a free market-based system, clear rules and synchronization between participants are crucial (Hayek, 1976)

Here, I will attempt to examine the issue through an Austrian-Misesian approach, which values the importance of certainty and rules in human action (Mises, 1949), alongside understanding the market as a dynamic rather than simultaneous mechanism

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Uncertainty: Large Block – Risk or Opportunity?

There's no clear verdict, in my opinion, on whether a large block would cause Bitcoin network collapse or lead to increased centralization. Large block supporters argue that the market will naturally determine the correct block size (Ver & Wright, 2017), while facing criticisms regarding security and decentralization (Back et al., 2015; Todd, 2015). On the other hand, small block proponents face criticism for potentially stifling scalability and user accessibility. A fixed, smaller block size might limit the number of transactions per second, leading to higher fees and slower processing times, which could reduce Bitcoin's competitiveness compared to other payment networks (Rizun, 2016).

My goal is therefore not to determine who is technically right or to validate the accuracy of these claims, but rather to analyze their economic implications in relation to the market process, including discovery, error correction, and learning (Block & Davidson, 2015). Bitcoin, like any complex human system, deals with uncertainty (Shackle, 1972). The fact that there's no absolute technological resolution indicates that this issue must be approached responsibly. In such cases, setting a relatively small block size isn't coercion or socialism, but rather a mechanism ensuring stability and synchronization between participants

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Synchronization vs. Simultaneity: Why Fixed Rules Matter

Theoretically, from a 'bird's eye view,' one might naively say that both rules and human behavior under these rules are determined by the market. However, the key point is that these never occur at the same time, frequency, or intensity. In every human action by individuals, there's an implicit assumption about the rules under which individuals operate (Mises, 1949, p. 22, 25[1]). It's not that 'every moment is a new beginning' as Shackle (1972) stated. While rules can change, they do so at different time scales and intensities.

Therefore, the principle of synchronization describes a relationship where rules and actions under these rules are determined in a coordinated but not simultaneous manner.

To handle uncertainty and create a stable system, participants need to operate based on predefined rules that provide coordination and stable cooperation. Although rules are set within market conditions, while operating under these rules, participants assume they remain constant for a defined period. The neoclassical perspective, which ignores the time required for changes to materialize and necessary learning, assumes that every correction happens immediately and simultaneously.

In practice, learning and changes require time and a synchronous rather than simultaneous process. Synchronization enables dynamic interactions while maintaining stability and preventing conflicts or failures arising from sudden changes. This emphasizes the importance of understanding that solutions like "the market will decide" don't guarantee immediate correction, and therefore, if changes like block size increase lead to centralization, the market correction might come too late.

For a Bitcoin network to remain stable, all nodes must be synchronized to the same rules. If block size changes in real-time based on "market demands," different nodes might operate under different rules — leading to an unplanned fork and system collapse. Therefore, any change in parameters like block size must be synchronized in advance and uniformly, rather than flexibly implemented during operation.

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‘Aren't You an Anarcho-Capitalist? How Can You Oppose “The Market”’?

Large block proponents sometimes argue that opposition to block size increase is opposition to the free market (Ver & Wright, 2017). However, this is merely rhetorical, ignoring the complex reality of economic and technical systems. In fact, the free market operates through ongoing dynamics where different interests compete and balance each other.

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The Lawyers Example – The Market Absurdity

You enter a room where important negotiations over a significant contract are taking place. In this scenario, you expect to see lawyers arguing, presenting arguments, bargaining, and pricing, but instead, they appear relaxed, drinking coffee, and laughing as if it's a social gathering.

Surprised, you turn to them and ask: "Wait, isn't this the negotiation room? Aren't you supposed to be discussing and getting better terms for me through bargaining?"

In response, they mockingly answer: "You're funny. Don't you know how it works? The market will decide! We're a decentralized system."

This response sounds absurd because it's clear that the actions of the lawyers themselves, and millions of other participants, are what actually determine the theoretical "market" price and quantity — not the other way around. Human actions within a framework of rules shape what the market "decides," not an automatic outcome independent of the involved parties' conduct.

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The Security Company Example – The Importance of Time, Space, and Learning Process (Error Correction)

At an upscale nightclub, where a ratio of two security guards per 100 patrons was predetermined, the security company carefully planned staffing for an expected event with 500 patrons — requiring 10 security guards on site. During the evening, as guests continue to pour in and the event proceeds normally, the club owner, seeking to cut costs, demands reducing the number of security guards to just eight.

The club owner confidently declares: "I am the market! I decide! If this number is sufficient in my view, it must be sufficient for you too. If there's a problem, I'll call and request additional security guards immediately!"

However, in a calm but firm response, the security company manager replies: "Are you serious? At 1 AM to send 20 additional guards? It would take them hours to arrive, if at all! By then, the situation would be out of control, the party would be stopped, people could get hurt, police would arrive and shut down your club."

The security manager continues explaining: "Our preparation is based on carefully calculated parameters — like guest numbers, risk level, and operational security needs. If we change these numbers in real-time, we'll lose control of the situation. The staff operates based on predetermined coordination and instruction, and any drastic change could cause communication and execution failures, putting everyone at risk."

This example illustrates the complex dynamics of the "free market." It shows how the actions of each individual in the system — the club owner on one side and the security company on the other — are based on predefined rules that establish the operational framework. The market doesn't operate in a vacuum or automatically, but through coordinated effort of involved parties, influenced by processes of planning, learning, and correction.

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Critique of Neo-Classical Models

Large block proponents sometimes rely on the assumption that the market will quickly correct itself in case of problems, such as centralization or node failure. However, these neo-classical models ignore the time required for problem correction and learning, as critiqued by Austrian economists like Hayek (1945) in "The Use of Knowledge in Society" and Mises (1949) in Human Action. In situations of increased centralization, it might not be possible to bring additional nodes quickly enough to prevent an attack that would undermine network credibility.

As Kirzner (1973) argued in Competition and Entrepreneurship, market corrections are not instantaneous but depend on entrepreneurial discovery and learning processes [Hayek, 1945; Mises, 1949; Kirzner, 1973]. This temporal dimension is critical in understanding the potential vulnerabilities of decentralized systems, where the speed of market response can be crucial to maintaining network integrity.

The market doesn't function as an immediate and simultaneous mechanism; it's a process of trial and error, where learning and error correction require time and resources. Therefore, the solution of "the market will decide" in case of drastic change like block size increase might prove too late.

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Mises, Rules, and the Regression Principle

At the heart of the Misesian perspective stands the regression principle, which explains how money is created and maintained through understanding of the past and expectation for the future (Mises, 1912). This principle can also be applied to the relationship between rules and human actions. When someone acts, they do so under the assumption that the rules they operate under were valid yesterday and will be valid tomorrow. In other words, individual action relies on basic certainty about rules — even if temporary.

As Mises emphasized, people operate under rules with an understanding that these rules are stable enough to allow them to plan their actions. The rules themselves can change, but not simultaneously with action execution but rather in a synchronous relationship. This is the tension between rule dynamism and the stability required for rational action. For example, when participants in a decentralized network like Bitcoin perform any action, they assume that existing rules, such as block size, won't change during the action.

Example - Accounting Balances:

Take, for instance, the process of writing accounting balances. While there's no doubt that expenses and income are amounts determined by market prices, the balance requires certainty. Prices can change every second, but when writing the balance, numbers must be fixed under certain assumptions to reach a final, coherent conclusion. One cannot simply say "the market will decide" for each and every price; there's a need for fixed accounting assumptions to create an accurate document. Similarly in the Bitcoin network — although the market influences decisions, participants operate under assumptions that provide stability for immediate action.

Economic rationality, as defined by Mises, depends on matching means to achieve ends. This matching is only possible when the rules guiding action remain stable over time, even if they might change in the long term. For example, an economic system like Bitcoin cannot operate based on rules that change in real-time — such change would lead to structural failures and inability to coordinate actions between participants. The system requires clear rules set in advance, and any change in them must occur in full synchronization with all participants.

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Summary: Balance Between Rules, Flexibility, and Responsibility in the Free Market

The issue of guiding rules versus required flexibility in a free market comes up a lot when discussing the implications of decentralized systems. The issue demonstrates the complexity of a decentralized economic system and the importance of deep understanding of dynamically synchronized, but non-simultaneous processes.

The Importance of Clear Rules

Network participant synchronization, as well as the certainty they receive, are the foundations enabling rational and coherent action. As we explained through examples like lawyer dynamics and nightclub security management, clear and defined rules aren't just constraints, but fundamental conditions for stability and cooperation. Without these rules, there's a real risk of splits, collapse, or failure in coordination between participants.

The Market Is Not a Magic Solution

The free market is a dynamic mechanism but doesn't operate immediately or magically. Neo-classical models tend to ignore the time and space required for learning processes and error correction. In a system like Bitcoin, where centralization or node failure can cause irreversible damage, one cannot rely solely on the mantra that "the market will correct." The examples provided demonstrate that one must act with responsibility and careful planning, understanding that the market advances in measured steps and depends on existing rules.

The Regression Principle as a Basis for Stability

Through Mises's regression principle, we emphasized how human actions rely on insights from the past and expectations for the future. Momentary certainty regarding guiding rules is a prerequisite for rational action. Rule changes must occur through broad and coordinated synchronization, not immediately or randomly.

Future Implications

The Bitcoin block size debate isn't just a technical matter, but also an examination of fundamental principles in free markets and decentralized systems. Policy makers and network participants should strive for a delicate balance between maintaining stability and adapting to changing needs of technology and users. As we've shown, certainty doesn't contradict flexibility; it actually provides a stable foundation enabling thoughtful response to changes.

Conclusion

In the spirit of the Austrian-Misesian approach, Bitcoin demonstrates how a decentralized system can succeed through combining clear rules with adapted flexibility. The ability to maintain stability, while recognizing free market complexities, is key to ensuring Bitcoin's future as a currency and globally decentralized economic system.

References

Back, A., Corallo, M., Dashjr, L., Friedenbach, M., Maxwell, G., Miller, A., Poelstra, A., Timón, J., & Wuille, P. (2015). Enabling blockchain innovations with pegged sidechains: A technical discussion of interoperability and security. Blockstream White Paper, Version 1.0. https://blockstream.com/sidechains.pdf

Block, W. E., & Davidson, L. (2015). Bitcoin, the regression theorem, and the emergence of a new medium of exchange. The Quarterly Journal of Austrian Economics, 18(3), 311-338.

Graf, K. (2013). On the origins of Bitcoin: Stages of monetary evolution - an Austrian approach to analyzing emergence of money in the digital age. Konrad S. Graf Investigations & Observations.

Hayek, F. A. (1976). Denationalisation of money: The argument refined. Institute of Economic Affairs.

Mises, L. von. (1912). The theory of money and credit [Theorie des Geldes und der Umlaufsmittel]. Chapter 3: The Various Kinds of Money. Jonathan Cape.

Mises, L. von. (1949). Human action: A treatise on economics. Yale University Press.
Page 22: "Man is in a position to act because he has the ability to discover causal relations which determine change and becoming in the universe. Acting requires and presupposes the category of causality. Only a man who sees the world in the light of causality is fitted to act."
Page 25: "The category of action is the fundamental category of human knowledge. It implies all the categories of logic and the category of regularity and causality. It implies the category of time and that of value."

Rizun, P. R. (2016). A transaction fee market exists without a block size limit: Notes on the stability of Bitcoin's fee market under constrained and unconstrained block space. Bitcoin Unlimited Research, Technical Report 1.0.

Shackle, G.L.S. (1972). Epistemics and Economics: A Critique of Economic Doctrines. Cambridge University Press.

Todd, P. (2015). Scaling Bitcoin: Problems with big blocks - analysis of centralization risks and network security under increased block sizes. Bitcoin Core Development Technical Report.

Ver, R., & Wright, C. (2017). A vision for global adoption: The case for on-chain scaling of Bitcoin. Bitcoin.com Technical Research Series, 1(1).

Hayek, Friedrich A. 1945. "The Use of Knowledge in Society." *American Economic Review*, 35(4): 519-530.

Kirzner, Israel M. 1973. “Competition and Entrepreneurship”. Chicago: University of Chicago Press.