Opinion
The existential threat to bitcoin
Stephen Bartholomeusz
Senior business columnistThe “halving” of bitcoin last week has produced a relatively modest rise in its price. It has also led to a huge surge in the cost of bitcoin transactions that points to a growing existential threat to the cryptocurrency’s functioning.
Last Friday, the rewards bitcoin “miners” get for verifying transactions on the blockchain that underpins bitcoins halved, from 6.25 bitcoins to 3.125. The daily total of bitcoins available to the miners fell from 900 to 450.
The halving of the supply of new bitcoins and the consequential halving of revenue to the cryptocurrency’s miners raises big questions.Credit: Bloomberg
The halving is a quadrennial event, with the last one occurring in May 2020 and the next one scheduled for around this time in 2028. It is a design feature of the cryptocurrency, embedded in its code by its creator, Satoshi Nakamoto, to gradually squeeze the supply of new bitcoins and, in the process, provide an increasing incentive to the miners, who are paid in bitcoins, to participate in the network.
There is an eventual cap of 21 million bitcoins in circulation, which will be reached in 2140. To date, about 19.6 million bitcoins have been mined.
It is the throttling of supply relative to a demand that has been greatly expanded by the US Securities and Exchange’s reluctant decision in January (forced on by a court judgment) to allow exchange-traded funds to create bitcoin ETFs. The best part of $US10 billion ($15.5 billion) of new money has flowed into the bitcoin market via those funds.
The reason the bitcoin price movement has, by its volatile standards, been relatively small – it has risen from just under $US64,000 ($99,000) on Friday to just under $US67,000 (it has been trading locally around $103,000) – is that the halving was factored into the price ahead of the event. It hit a record price of just over $US73,000 last month, having traded below $US40,000 earlier this year.
It is logical that if an asset becomes relatively more scarce, particularly in a market for bitcoins which has limited liquidity because, for various reasons, there are large passive holdings that have never traded, its price should reflect that scarcity.
Bitcoins have no inherent value. They are not a payment system or a medium of exchange within the existing payment system. They are a mechanism for speculation and their limited supply has made them one of the purest of risk assets. Indeed, as their volatility suggests, they provided leveraged exposures to risk.
They rebounded this year from a two-year depression after a scandal-plagued 2022 ended with the jailing of FTX’s Sam Bankman-Fried, who was convicted of fraud, and the guilty plea of Binance’s chief executive, Changpeng Zhao, to money-laundering charges.
The catalyst for the surge in the price this year was the creation of 11 ETFs, including one by the world’s largest asset manager, Black Rock, which has brought a tide of new retail and institutional funds into the market for bitcoins.
That new and large-scale source of demand is now hitting a market with limited new supply and where the incentive for creating new supply has just been halved.
Bitcoin’s miners use massive amounts of processing power – and massive amounts of high-cost energy – in verifying the blocks of deals. The bitcoin system depends on those miners for its security and the trust that the blockchain is recording only legitimate transactions.
Those miners are processing more than half a million transactions a day within warehouses chock-full of computers. It’s a high-cost and capital-intensive process that’s now dominated by listed companies.
The halving will have a big impact on the revenue of smaller or more leveraged miners because their revenue per transaction has been halved.
If transaction costs go up significantly it will inevitably impact the demand for bitcoins and their price and make a relatively clunky system even less efficient.
That will be offset in the short term, at least, because of the increased value of bitcoins they might hold but, with a big cut in revenue, no compensating reduction in their operating costs and another halving due in four years, there is an ominous cloud over the miners’ futures.
That has major implications for the broader bitcoin market. While transaction fees are as volatile as the price of bitcoins, early this month they averaged less than $US3 per transaction.
On Friday, as the 210,000th block that triggered the halving was processed, bitcoins shot up to $US128. (One user, perhaps anxious to participate in the decisive block and become part of bitcoin history, paid a fee of eight bitcoins, or more than $US500,000). Over the weekend, the average transaction cost fell back below $US35.
If miners want to compensate for the losses of revenue generated by the halving, they will need to rely on increased transaction fees. Indeed, eventually, given that halvings are locked in every four years, transaction fees will be their only material source of revenue from their mining activity.
Given the global response to climate change, energy isn’t going to get any cheaper. The miners are now also in competition with artificial intelligence – also energy and computing power-intensive – which will put even more pressure on costs. Some miners are switching their attention and resources from bitcoin mining to AI.
If it is increasingly uneconomic to continue to mine, there will be a growing question mark over the capacity of the network to verify transactions.
Without the miners within the decentralised network, there would be no trust and therefore no network and no bitcoins. So there’s a question mark, which will grow with each halving, over the viability of bitcoin.
The obvious answer to the miners’ loss of billions of dollars of revenue from the halvings is more and larger transaction fees.
At present, those fees are, in practice, optional for users. That may have to change, with some form of fee schedule imposed by the miners or (this might be difficult to orchestrate within a decentralised network) the network itself.
If transaction costs go up significantly it will inevitably impact the demand for bitcoins and their price and make a relatively clunky system even less efficient.
If they don’t, the bitcoin ecosystem will confront a growing threat to its very existence.
Read more:
- Bitcoin’s ‘halving’: What is it and does it matter?
- Up to $150 million at risk as two Australian bitcoin schemes go bust
- What does US approval of bitcoin ETFs mean for Australia?
- ‘Speculate in bitcoin, hoard gold’: Precious metal’s value soars
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