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The security of the Bitcoin network relies on the addition of new blocks to the chain, which miners are financially motivated to produce. Miners earn revenue from transaction fees included in the blocks they mine, as well as a block subsidy.
However, the block subsidy is not a permanent feature and is halved every four years, with the most recent halving occurring on April 19, 2024. Eventually, the block subsidy will diminish to zero, and miners will have to rely solely on transaction fees for profitability.
The halving event reduces miners’ profitability and may lead to consolidation within the mining industry. Miners can mitigate the decrease in revenue by increasing their market share through equipment upgrades, acquisitions, and expanding their operations. Miners who have been more successful in the past and have accumulated Bitcoin reserves are in a better position to make such investments.
On the other hand, some mining operations may become unprofitable, especially those with high energy costs. Miners will continue to seek partnerships to balance the load on energy grids, which can improve the economics of renewable energy projects. By adjusting mining activities based on energy supply and demand, miners can optimize their energy costs and manage their liquidity to cover operational expenses and fiat-denominated debts.
In terms of transaction activity, the approval of spot Bitcoin ETFs by the SEC in the United States earlier this year resulted in a significant increase in the Bitcoin price and transaction volumes. Institutional investors seeking exposure to Bitcoin contributed to this growth. The Lightning Network, a scaling solution built on top of the Bitcoin blockchain, also experienced growth, with a three-fold increase in open channels in 2023, indicating increased utility.
A recent working paper from the IMF also highlights Bitcoin’s role in cross-border flows. However, data from Coin Metrics shows that transaction fees accounted for only 6% of miner revenues on average between the ETF approval and the halving in April. This emphasizes the continued dependence of miners on the block subsidy.
Bitcoin’s limited scalability and functionality compared to other blockchains have hindered its progress in transaction fees. Unlike other chains like Ethereum and Solana, Bitcoin does not support smart contracts, decentralized finance, tokenization, or stablecoin payments, which have driven activity on those platforms. Bitcoin’s main use cases have been peer-to-peer payments and trading, which have not consistently generated sufficient revenues.
New use cases are emerging, but it is crucial for them to gain traction before the next halving. The Bitcoin blockchain’s design is unlikely to change, so technological developments within its ecosystem are necessary to introduce new functionalities. The launch of the Runes protocol, which enables fungible tokens, and Ordinals inscriptions, which introduced non-fungible token capabilities, have led to increased transaction fees. These innovations have primarily driven speculative trading of the tokens they enable. By supporting tokenization efforts in financial markets, these new functionalities may help Bitcoin catch up with other blockchains. Layer-2 chains that process multiple transactions before settling them on the main Bitcoin blockchain could also address Bitcoin’s scalability limitations and enable the development of decentralized finance and tokenization use cases. Identifying a use case that gains widespread adoption before the next halving is crucial for these emerging use cases to have a lasting impact.
In the long term, Bitcoin proponents anticipate it becoming a new global reserve asset and a neutral means of exchange within a network of AI-powered economic agents. However, in the meantime, higher and more stable transaction revenues are vital for sustaining the network. Therefore, the progress of concrete technological developments is of utmost importance.
Andrew O’Neill is the lead researcher on digital assets and their potential impact on financial markets at S&P Global. He has been studying crypto and decentralized finance risks since 2022 and has contributed to the development of Stablecoin Stability Assessments at S&P Global Ratings. Prior to joining S&P, Andrew worked in covered bond ratings and rating methodologies at J.P. Morgan. He holds a CFA charter and a Masters degree in Aerospace Engineering from the University of Bath.