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Rich (in Bitcoin) do get richer than others, analysts say

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Posted July 19, 2014
Public nature of transactions in the Bitcoin network allowed researchers to finally test the hypothesis that rich get richer over time in a detailed manner. Image credit: Robert Howlett via Wikimedia Commons.

Public nature of transactions in the Bitcoin network allowed researchers to finally test the hypothesis that rich get richer over time in a detailed manner. Image credit: Robert Howlett via Wikimedia Commons.

There is a truism which says that richer always get richer and poorer get poorer. Despite its strong emotional charge, the claim is often difficult to test out empirically. This is largely due to scarcity in available data, since transaction details are often considered to be highly sensitive and thus generally not available.

But – for better or worse – it is not so with the increasingly popular Bitcoin cryptocurrency.

Bitcoin is a decentralized digital cash system that is remarkably innovative in that it does away with any kind of central authority to prevent currency fraud. Instead, it assigns hard computational labor to some of the Bitcoin network users to authenticate and verify others’ transactions, thus rendering central banking authority redundant. And for this to work, every transaction must be publicly available to each network node.

Availability of transaction data is good news for Dániel Kondor, István Csabai and Gábor Vattay of the Budapest University of Technology and Economics, and Márton Pósfai of Eötvös Loránd University, Budapest. This group of researchers set out to test how certain Bitcoin network characteristics change over time.

The term standing for “rich get richer” in network theory lexicon is preferential attachment. It means that those nodes in a network that have more incoming and outgoing connections with other nodes tend to grow faster. Although generally this only describes the number of connections, in case of Bitcoin, these very connections make up the flow of money itself. “[Hence,] in the case of Bitcoin, this is more than an analogy: we find that the wealth of already rich nodes increases faster than the wealth of nodes with low balance”, note the researchers.

And indeed the researchers have plotted the average balances of each node as a function of their degree – or number of connections – and got adequate results, meaning that the growth of hub wealth is proportional to their degree.

How unequal is the wealth distribution of Bitcoin, given that rich clearly get richer much faster compared to others? The answer is: very and increasingly unequal. According to an imprecise rule given by an Italian economist Vilfredo Pareto, generally the top 20% of the population controls 80% of the wealth. “The proper Pareto-like statement for the Bitcoin system would be that the 6.28% of the addresses possesses the 93.72% of the total wealth”, the researchers observe.

Economists often use something called the Gini coefficient to measure the inequality of population’s wealth distribution. The Gini coefficient of 1 means that all the wealth belongs to one entity, while 0 means that everyone has an exactly equal share.

The Gini coefficient of the Bitcoin network used to be rather high in the beginning, probably because there were very few users with few opportunities to trade. With the emergence of more mainstream Bitcoin trading practices, the coefficient dropped notably and has been growing since. At the moment the Gini coefficient of the Bitcoin network is estimated to be around 0.98, which indicates a very high level of wealth inequality.

Such kind of detailed analysis of the Bitcoin network contributes greatly to the emerging field of econophysics, where social scientists aim to apply techniques invented by physicists – such as network theory in this case – to solve problems in economics. It also presents for the first time a detailed account of wealth distribution dynamics within a network – something that has been allowed solely by the open nature of Bitcoin itself.

Research article: The PLOS ONE Staff (2014) Correction: Do the Rich Get Richer? An Empirical Analysis of the Bitcoin Transaction Network. PLoS ONE 9(5): e97205. doi: 10.1371/journal.pone.0097205, source link.

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