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Miners need a Bitcoin use case to stick
Disclosure: The views and opinions expressed herein are solely those of the author and do not represent the views and opinions of the crypto.news editorial.
The security of the Bitcoin network relies on adding new blocks to the chain, which miners are financially incentivized to produce. In turn, miners’ revenues include transaction fees for all transactions included in a block they mine, as well as a subsidy for the block.
However, the block grant will not last forever: it is halved every four years (most recently on April 19, 2024) and will tend to zero. It aims to support the profitability of miners until such time as the fees generated by transaction activity on the Bitcoin network are sufficient to do so.
Miners can mitigate the reduction in revenue per block by increasing their market share of mined blocks. They can do this by upgrading existing equipment or acquiring new equipment, locations or entities. Miners who have seen higher profits thus far, as well as those who have accumulated BTC reserves that have increased in value, are best positioned to make such investments.
Conversely, some operations will become unprofitable and shut down, particularly those with higher energy costs. Miners will continue to seek partnerships to provide load balancing to energy networks, improving the economics of renewable energy projects by stabilizing energy demand (by ramping up mining facilities at times of oversupply and shutting them down at times of excess demand) . How miners optimize energy costs and manage liquidity to cover fiat currency-denominated debt and operating costs will differentiate their credit risk.
After SEC-approved Bitcoin spot ETFs in the United States earlier this year, the price of Bitcoin rose sharply and transaction volumes increased as new institutional investors sought exposure to the asset. In a recent report, Chainalysis highlights that the Lightning Network (a scaling solution built on the Bitcoin blockchain) saw a three-fold increase in its open channels over the course of 2023, illustrating some growth in the network’s usefulness.
Also a recent IMF working paper highlights Bitcoin’s significant role in cross-border flows. However, between the ETF’s approval in January and the halving in April, transaction fees represented, on average, just 6% of miners’ revenue, according to data from Coin Metrics. Thus, miners remain heavily dependent on the block subsidy.
Bitcoin’s limited scalability and functionality, compared to other blockchains, have contributed to its slow acceleration of 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 spurring activity on other chains, such as Ethereum and Solana. Bitcoin’s main use cases to date have been payments and peer-to-peer bitcoin trading, and none of these have been proven to sufficiently generate revenue on an ongoing basis.
The design of the Bitcoin blockchain will not change, so new features must come from technological developments in its ecosystem. The Runes Protocol, which introduces functionality for fungible tokens, launched on the same day as the halving and immediately led to an increase in transaction fees.
Fees were also increased in 2023 by the launch of Ordinals memberships, which introduced non-fungible token capabilities. These innovations have so far led to an increase in fees resulting from transaction activity focused on the speculative trading of the tokens they have allowed to be created. These new features could allow Bitcoin to catch up with other blockchains by supporting tokenization efforts in financial markets. Additionally, emerging layer 2 chains (which process multiple transactions in batches before settling them as a single transaction on Bitcoin’s main blockchain) could mitigate Bitcoin’s scalability limitations and layer functionality to develop defi or tokenization use cases . Identifying a use case that “sticks” before the next halving is critical for these nascent use cases to have lasting impact.
In the long term, Bitcoin supporters expect it to become a new global reserve asset and to one day become a credibly neutral medium of exchange within a global network of economic agents powered by artificial intelligence. Meanwhile, higher and more stable transaction revenues for miners are crucial to sustaining the network, making the advancement of concrete technological developments crucial.
Andrew O’Neill
Andrew O’Neill leads S&P Global’s research on digital assets and their potential impact on financial markets. It began focusing on crypto and deffi risks in early 2022, with an emphasis on understanding their potential impact on ratings and financial markets more generally. He also participated in the development of S&P Global Ratings’ Stablecoin Stability Assessments program, which launched in November 2023. He joined S&P in 2009 as a covered bond ratings analyst before taking on a role in rating methodologies development, primarily for credit ratings. structured finance. . Prior to joining S&P Global Ratings, Andrew worked as an analyst in Investment Banking, Acquisitions and Leveraged Finance at JP Morgan. Andrew holds a CFA charter and a master’s degree in aerospace engineering from the University of Bath.