Miners need a Bitcoin use case to stick | Opinion

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As a seasoned crypto investor and researcher with a background in finance and engineering, I’ve closely followed the developments within the Bitcoin ecosystem. The upcoming halving event is an essential aspect of the network’s design that impacts miners’ profitability and the overall health of the network.

The security of the Bitcoin network relies on the process of adding new blocks to its chain, which is financially motivating for miners to accomplish. In return, their income comes from both the transaction fees linked to all transactions contained within the block they mine, and a reward in the form of a block subsidy.

The block reward subsidy for Bitcoin mining won’t be permanent; it gets reduced by half every four years, last being done so on April 19, 2024. This gradual decrease aims to eventually let transaction fees sustain miner profits.

Halving hits miners’ profitability and may drive consolidation 

As a researcher studying the mining industry, I would suggest that miners can counteract the decrease in revenue per block by expanding their share of mined blocks. This can be achieved through various means such as upgrading current equipment or acquiring new technology, exploring new mining locations, or even merging with other entities. Miners who have been more profitable thus far and possess significant Bitcoin reserves that have appreciated in value are ideally situated to execute these investments.

On the flip side, certain mining operations may no longer be financially viable and will close down due to higher energy costs. Miners, in response, are pursuing collaborations to help balance energy grids. By ramping up mining rigs during periods of excess renewable energy supply and turning them off when demand is high, miners can enhance the profitability of renewable energy projects and stabilize energy consumption. The ability of miners to effectively manage their energy expenses and maintain sufficient liquidity to cover debt and operational costs will be a significant factor in assessing their creditworthiness.

How is transaction activity developing?

As a crypto investor, I’ve witnessed an exciting development this year: The Securities and Exchange Commission (SEC) gave the green light to spot Bitcoin Exchange-Traded Funds (ETFs) in the US. This approval ignited a sharp rise in Bitcoin’s price and significant increases in transaction volumes as new institutional investors jumped at the opportunity to invest in the asset.

As a crypto investor, I’ve noticed an intriguing observation from a recent IMF working paper – Bitcoin plays a substantial role in facilitating cross-border transactions. However, data from Coin Metrics reveals that the average transaction fees during the period between January’s ETF approval and April’s halving accounted for merely 6% of miner revenues. Consequently, miners continue to be heavily reliant on the block reward as their primary source of income.

Bitcoin’s limited scalability and functionality, relative to other blockchains, have contributed to its slow acceleration in transaction fees. Bitcoin is not designed to enable smart contracts; therefore, it does not benefit from trends such as decentralized finance, tokenization, and stablecoin payments that are boosting activity on other chains, such as Ethereum and Solana. Bitcoin’s primary use cases to date have been peer-to-peer bitcoin payments and trading, and neither of these has proved to sufficiently drive revenues on a continuous basis.

New use cases are emerging, but miners need something to stick

The design of Bitcoin’s blockchain remains unchanged, necessitating new functionalities to emerge from technological advancements within its ecosystem. An illustrative example is the Runes protocol, which debuted alongside the halving and promptly resulted in increased transaction fees due to its introduction of capabilities for fungible tokens.

In 2023, fees grew due to the introduction of Ordinals inscriptions, which brought non-fungible token capabilities to Bitcoin. Transactions centered around speculative trading of created tokens have resulted in higher fees. These advancements could help Bitcoin compete with other blockchains by enabling tokenization in financial markets. Additionally, layer-2 chains, capable of processing multiple transactions as a single batch before settling on the main Bitcoin blockchain, may alleviate scalability concerns and facilitate DeFi or tokenization applications. Discovering a sustainable use case prior to the next halving is essential for these emerging applications to leave a lasting impression.

As a researcher exploring the future of Bitcoin, I believe that in the long run, it is anticipated to transform into a new global reserve asset and eventually function as a reliable means of exchange among a global network of advanced AI-driven economic entities. However, in the interim, it’s essential for the network to generate consistent and stable transaction fees for miners to keep it operational. Therefore, the advancement of concrete technological developments is crucial to ensure sustainable revenue streams for the Bitcoin ecosystem.

Miners need a Bitcoin use case to stick | Opinion

Andrew O’Neill

Andrew O’Neill spearheads research at S&P Global regarding digital assets and their influence on financial markets. He initiated his focus on crypto and decentralized finance risks around early 2022, with a primary concern for rating implications and broader market impacts. Additionally, he contributed to the creation of S&P Global Ratings’ Stablecoin Stability Assessments, which were introduced in November 2023. Prior to joining S&P Global Ratings, Andrew worked as an analyst within J.P. Morgan’s Investment Banking, Acquisition, and Leveraged Finance division. He joined S&P in 2009, initially serving as a covered bond ratings analyst before progressing to develop rating methodologies for Structured Finance ratings. Andrew holds the Chartered Financial Analyst designation and a Master’s degree in Aerospace Engineering from the University of Bath.

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2024-05-19 13:12