Re: [bitcoin-dev] Hardfork to fix difficulty drop algorithm

["David A. Harding" <dave@dtrt.org>]

On Wed, Mar 02, 2016 at 02:56:14PM +0000, Luke Dashjr via bitcoin-dev wrote:
> To alleviate this risk, it seems reasonable to propose a hardfork to the 
> difficulty adjustment algorithm so it can adapt quicker to such a significant 
> drop in mining rate.

Having a well-reviewed hard fork patch for rapid difficulty adjustment
would seem to be a useful reserve for all sorts of possible problems.
That said, couldn't this specific potential situation be dealt with by a
relatively simple soft fork?

Let's say that, starting soon, miners require that valid block header
hashes be X% below the target value indicated by nBits. The X% changes
with each block, starting at 0% and increasing to 50% just before block
420,000 (the halving). This means the before the halving, every two
hashes are being treated as one hash, on average.

For blocks 420,000 and higher the code is disabled, immediately doubling
the effective hash rate at the same time the subsidy is halved,
potentially roughly canceling each other out to make a pre-halving hash
equal in economic value to a post-halving hash.

Of course, some (perhaps many) miners will not be profitable at the
post-halving subsidy level, so the steady increase in X% will force them
off the network at some point before the halving, hopefully in small
numbers rather than all at once like the halving would be expected to do.

For example, if the soft fork begins enforcement at block 410,000, then
X% can be increased 0.01% per block. Alice is a miner whose costs are
24BTC per block and she never claims tx fees for some reason, so her
profits now are always 25BTC per block. During the first difficulty
period after the soft fork is deployed, the cost to produce a hash will
increase like this,

    0: 0%           500: 5%         1000: 10%       1500: 15%       2000: 20%
    100: 1%         600: 6%         1100: 11%       1600: 16%
    200: 2%         700: 7%         1200: 12%       1700: 17%
    300: 3%         800: 8%         1300: 13%       1800: 18%
    400: 4%         900: 9%         1400: 14%       1900: 19%

Somewhere around block 417, Alice will need to drop out because her
costs are now above 25BTC per block.  With the loss of her hash rate,
the average interblock time will increase and the capacity will decrease
(all other things being equal). However, Bob whose costs are 20BTC per
block can keep mining through the period.

At the retarget, the difficulty will go down (the target goes up) to
account for the loss of Alice's hashes. It may even go down enough
that Alice can mine profitably for a few more blocks early in the new
period, but the increasing X% factor will make her uneconomical again,
and this time it might even make Bob uneconomical too near the end of
the period. However, Charlie whose costs are 12BTC per block will
never be uneconomical as he can continue mining profitably even after
the halving. Alice and Bob mining less will increase the percentage of
blocks Charlie produces before the retarget, steadily shifting the
dynamics of the mining network to the state expected after the halving
and hopefully minimizing the magnitude of any shocks.

This does create the question about whether this soft fork would be
ethical, as Alice and Bob may have invested money and time on the
assumption that their marginal hardware would be usable up until the
halving and with this soft fork they would become uneconomical earlier
than block 420,000. A counterargument here is such an investment was
always speculative given the vagaries of exchange rate fluctuation, so
it could be permissible to change the economics slightly in order to
help ensure all other Bitcoin users experience minimal disruption during
the halving.

Unless I'm missing something (likely) I think this proposal has the
advantage of fast rollout (if the mechanism of an adjusted target is as
simple as I think it could be) in a non-emergency manner without a hard
fork that would require all full nodes upgrade (plus maybe some SPV
software that check nBits, which they probably all should be doing
given it's in the block headers that they download anyway).

-Dave

P.S. I see Tier Nolan proposed something similar while I was writing
     this. I think this proposal differs in its analysis to warrant a
     possible duplicate posting.