Why Bitcoin Users Might not Need Top up Miner’s Revenue after Block Reward Halving

In late May 2016, the Swedish Bitcoin Mining firm KnCMiner filed for bankruptcy.

“Effectively our cost of coin – how much we produce the coins for – will be over the market price,” Sam Cole, the firm’s CEO explained.

As KnCMiner broke the sad news to the world, the price of Bitcoin was

[roughly] $480. Working with that figure, 12.5 bitcoins reward per block is apparently too small for mining operations to keep going. “With all of our overhead, after July, the cost will be over $480. All of the liabilities we’ll have after that time will be too high,” Sam had revealed.

Yes, according to Sam, after the halving of the block reward in July 2016, the company wouldn’t in whatever way meet its financial obligations.

As you know, mining is quite energy intensive. Thus, miners do receive real huge electricity bills. And with halved revenue, KnCMiner thought it was going to be tough paying them.

But KnCMiner exit was of concern to more than just its shareholders and members of staff. Indeed, the firm closing shop was an ominous signal to the entire Bitcoin community. It pointed to what could go wrong to the Bitcoin network with the reduced revenue from block rewards.

A worry in the community that more mining pools and companies (especially those outside of China, where electricity cost was very high) would follow suit, was far from misplaced.

But what would actually happen if more miners found no incentives and moved on to other things?

In a case of a bitcoin miners mass exit, then users are likely to experience slow confirmation of transactions, high risk of 51% attack or maybe a collapse of the entire network, with the value of over $10 billion in it going up in smoke.

Simply put; the beginning of the end (if not the end itself). Worrisome stuff indeed.

It was planned to happen

This fact should be clear, though; the halving of the block reward isn’t some kind of out-of-nowhere event. It is something that everyone in the Bitcoin community (especially those who are actively involved) has been aware of all along.  

Block reward has always been expected, it must happen and it is what makes bitcoin what it is (a currency with fixed supply).

According to the Bitcoin protocol (as laid down by Satoshi Nakamoto) the revenue for miners from block rewards will continue to shrink. That is because the reward is also the addition of new units into circulation, something that shouldn’t go on forever.

After every four years, it has to halve. And finally, when 21 million bitcoins have been mined, this source of revenue for miners will dry up (that will be sometime in the year 2140).

Nevertheless, miners are the bedrock of the bitcoin network, and somehow they must be encouraged to keep doing what they do. They must be there to confirm, secure and maintain the Bitcoin blockchain. They must provide the necessary infrastructure for the cryptocurrency.

Indeed, without them, there is no bitcoin.

But what happens when there is enough reward for them? Will they work for free after 2140?

No. There always has been a backup plan.  And the backup plan is transaction fees. With block reward fading out of the picture, send bitcoins will require you to attach higher and higher amount of fees for the miners. This is what will incentivize them to keep supporting the system.

Miners to stay and transaction fees needed

As a matter of fact, transaction fees are already a reality. But this far they have been voluntary. Users only attach them to hasten the confirmation of transactions.

A few months away from the halving the reward looming, mandatory transaction fees seemed inevitable.

And KnCMiner exit did put the transaction fees backup plan itself into doubt. It was an invitation for the bitcoin community to take a hard look at its viability as a source of revenue for miners.

However, just a few weeks before the reward halving things changed dramatically.

Almost suddenly, there was every reason to believe that there won’t be any mass exit of miners. Even more, there won’t be any reason to effect mandatory transaction fees to keep them profitable, at least not in this round of reward halving.

As a matter of fact, it wouldn’t be unexpected that KnCMiner was regretting filing for bankruptcy. And all that is because of one reason; the bitcoin price.

The bitcoin price really soared after May. It rose partly in anticipation for the reduced supply that the halving would occasion.

Other factors have also been cited. One of these being the increased demand for the cryptocurrency in China, which is driven by the need to go around the official restriction on asset movement.

Within a month, the price of Bitcoin had increased by over 30%.

Some like Trace Mayer, an Austrian economist, bitcoin expert and venture capitalist, have predicted an even bigger leap in the price will be witnessed after the halving.

“Whenever there is a big shock to the transaction demand and supply of bitcoin we see a two or three month period when the market has to readjust to the new equilibrium price,” he explained in an interview.  

He provided particular examples of how the price has behaved in the past when faced with similar situation. “And the first halving happened, we had a 30X increase in price. When the Silk Road coins got seized and everything, we had a 20X increase in price. This time around, 10X increase in price. We are looking at it going from $250 or $300 to $2500-$3000 per bitcoin.”

How does the rise in price play in the mining equation?

If in a few months the Bitcoin price doubles, then Bitcoin miners will have their revenue where it was in that month even with the Bitcoin reward halving.

If the price does better than doubling, then we are looking at miners making more from block reward than they did in the month of May. That means there won’t be any need to make transaction fees mandatory.

Indeed, everything points to a fattened paycheck for the miners with users having nothing to do with it.

 

Image by Fabian Figueredo

By | 2017-04-19T00:21:01+10:00 July 21st, 2016|Bitcoin|0 Comments