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How much does it cost to secure Bitcoin and who should pay for it? Because that’s precisely what this week’s much-discussed “halving” event for the largest cryptocurrency is about.
For those lucky enough to be unaware, likely on Friday the total bitcoins miners receive for securing the network and validating new transactions will be cut in half, from a share of 900 per day to just 450. This occurs every four years. and this is an important fundamental principle for Bitcoin.
Its pseudonymous creator, Satoshi Nakamoto, envisioned bitcoin in part as a hedge against inflation and decreed that only 21 million coins would exist. To ensure its scarcity, Nakamoto also decided that the amount of coins distributed by the Bitcoin protocol would be halved every four years. Why 21 minutes and why every four years is a mystery. Regardless, the fourth half is upon us.
Almost everyone in cryptocurrency land seems to agree that this is ultimately a good thing for the price of Bitcoin in the long run, as it increases the scarcity of the coin (even though 19 million of the 21 million available have already been mined and the availability of coins has never been a problem). . Most Bitcoin enthusiasts look at the trends of previous halvings, in 2012, 2016 and 2020, and it is true that the price then increased over time.
However, this is not a good thing for crypto miners as their rewards decrease. As Andrew O’Neill, Managing Director of S&P Global’s Digital Asset Research Lab, noted yesterday:
Some operations will become unprofitable and will therefore be closed, particularly those with higher energy costs. The most profitable BTC miners, with lower energy costs, will remain.
By the next halving in 2028, reward and payment issues could also become a more serious problem for the Bitcoin network.
Satoshi’s bitcoin white paper offers an answer to a problem that has plagued Internet crypto pioneers like David Chaum for years: In a digital world where things can be reprinted endlessly, how do you know you’re not only spend money once?
There are many things to say about Satoshi’s 2008 white paper (as 14+ years of FTAV coverage shows), but one of them is that it elegantly offers a truly effective solution to this issue. At the heart of this system is the proof-of-work system, which depends on crypto miners to verify transaction blocks.
In a network designed to bypass a traditional centralized institution like a bank or exchange, it is the miners who provide assurance that you are not being defrauded. Miners receiving bitcoins are the main reward for this effort. Until now, they have collectively shouldered the cost of securing the Bitcoin network.
But it’s also the part of the Bitcoin system that has to pay actual bills. Processing power consumes energy and space. Many mining companies are just recovering from an era of rapid overexpansion and debt. But this is becoming increasingly costly, especially as AI now competes for resources.
Some miners have already felt like they are being paid by local governments NOT to mine cryptocurrencies. The United States is taking a closer look at the amount of energy consumed by bitcoin mining in local areas of the United States and trying to assess how that compares to other uses, such as keeping computers warm. houses. Cutting the reward in half will make it harder for miners to do what they do.
If they don’t get paid enough and drop out, that becomes a problem. There are issues related to network security and centralization of mining (like the so-called 51% attack), but the bottom line is that there are no miners, no bitcoin.
The debate will therefore likely turn to how miners can continue to operate in sufficient numbers to both secure the network and decentralize it. S&P’s O’Neill expects mining companies to look at energy efficiency, particularly the economics of renewable energy projects.
But that might not be enough. In its late February annual report, Marathon Digital, one of the largest U.S. mining companies and seen by the market as a likely survivor, presented two options:
This transition could be accomplished either by miners independently choosing to record in the blocks they resolve only transactions that include payment of transaction fees, or by the digital asset network adopting software upgrades that require the payment of minimum transaction fees for all transactions.
Neither will appeal. Until now, miners didn’t really rely on transaction fees, paid by users every time they made a transaction, to cover the cost of computation. The fee is optional at the moment and is really just a way to ensure your offer is checked first, much like priority boarding on an airline.
On the other hand, not changing Bitcoin’s software code is something of an article of faith for Bitcoin followers, so at first the system may informally try to determine what the market will bear in fees .
How much could be the next sticking point? As another miner, Riot Platforms, pointed out in its annual report:
High Bitcoin transaction fees may slow the adoption of Bitcoin as a payment method, which could decrease demand for Bitcoin and future Bitcoin prices could suffer.
Widespread adoption of bitcoin as a payment method couldn’t really be much slower, but certainly adding friction to a system only makes it less efficient.
The transition to transaction fees has arguably already begun. Last year, the crypto market saw the emergence of fungible tokens, which work around the limitations of the Bitcoin protocol but generate at least some transaction fees. (No, of course, there isn’t a broader use case yet.)
Last year, Marathon generated 7.7% of its annual net profit from transaction fees, up from 1.3% in 2022. It is almost inevitable that this ratio will increase significantly in the coming years. This, not endless bullish forecasts, is the biggest consequence of this week’s halving.