Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
How much does it cost to secure bitcoin and who should pay for it? Because that’s what this week’s much-discussed ‘halving’ event this week for the biggest cryptocurrency is really about.
For those fortunate enough to be unaware, at some point probably on Friday, the total of bitcoins that miners receive for securing the network and validating new transactions will be halved, from a share of 900 a day to just 450. This happens every four years and it’s an important foundational principle for bitcoin.
Its pseudonymous creator Satoshi Nakamoto envisaged bitcoin in part as a hedge against inflation and decreed there would be just 21mn coins in existence. To ensure its scarcity, Nakamoto also decided that the amount of coins distributed by the bitcoin protocol would halve every four years. Why 21mn and why every four years is a mystery. No matter — the fourth halving is upon us.
Just about everyone in cryptoland seems to agree that this ultimately is A Good Thing for Bitcoin’s price in the long run because it increases the coin’s scarcity (even though 19mn of the 21mn available have already been mined and availability of coins has never been a problem). Most bitcoin enthusiasts look back at patterns of the previous halvings, in 2012, 2016 and 2020, and it’s true that the price has gone up afterwards over time.
However, it’s Not A Good Thing for the crypto miners because their rewards go down. As Andrew O’Neill, managing director of S&P Global’s Digital Assets Research Lab noted yesterday:
Some operations will become non-profitable and will shut down as result, particularly those with higher energy costs. The most profitable BTC miners with lower energy costs will remain.
Between now and the next halving in 2028, the issues of reward and payment could become more of a serious problem for the bitcoin network too.
Satoshi’s bitcoin white paper offered an answer to something that had bedevilled internet cryptographic pioneers like David Chaum for years — in a digital world where things can be reprinted infinitely, how do you know that you’re only spending cash once?
There are many things to say about Satoshi’s 2008 white paper (as shown by 14 years and counting of FTAV coverage) but one is that it quite elegantly offers a real working solution to that problem. Central to it is the proof-of-work system, which depends on crypto miners to verify blocks of deals.
In a network designed to bypass a traditional centralised institution like a bank or a stock exchange, the miners are the ones supplying the trust that you’re not being defrauded. Miners being paid bitcoin is the main payoff for that effort. Up to now they have collectively taken on the cost of securing the bitcoin network.
But it’s also the part of the bitcoin system that has real-world bills to pay. Processing power takes up energy and space. Already many miners are only just recovering from an era of rapid overexpansion and leverage. But it’s getting more expensive, especially as AI is now competing for resources.
Already some miners have hit on the wheeze of being paid by local governments NOT to mine cryptocurrencies. The US is taking a closer look at exactly how much energy bitcoin mining in local areas in the US suck up, and trying to assess how it stacks up against directing to other uses, such as keeping people’s homes warm. Halving the reward is going to make things harder for miners to do what they do.
If they aren’t paid enough and drop out, that becomes a problem. There are issues around security of the network and centralisation of mining (such as the so-called 51 per cent attack) but the bottom line is no miners, no bitcoin.
So the debate is likely to turn to ways miners can keep going in sufficient numbers to both secure the network and decentralise it. S&P’s O’Neill expects miners will look at energy efficiency, especially the economics of renewable energy projects.
But that might not be enough. In its annual report at the end of February, Marathon Digital, one of the US’s largest miners and valued by the market as a likely survivor, laid out the two options:
This transition could be accomplished either by miners independently electing to record in the blocks they solve only those transactions that include payment of a transaction fee or by the digital asset network adopting software upgrades that require the payment of a minimum transaction fee for all transactions.
Neither will be appealing. Up to now miners haven’t really relied on transaction fees, paid by users every time they do a deal, to cover the computational cost. Fees are optional right now and are really just a way to ensure your deal is checked first, a bit like priority boarding on an airline.
On the other hand, not changing bitcoin’s software code is something of an article of faith for bitcoin followers, so at first the system may informally try to work out what the market will bear in fees.
How much could be the next friction point. As another miner, Riot Platforms, pointed out in its annual report:
High Bitcoin transaction fees may slow the adoption of Bitcoin as a means of payment, which may decrease demand for Bitcoin and future prices of Bitcoin may suffer as a result.
Widespread adoption of bitcoin as a means of payment couldn’t really get much slower but certainly, adding friction to a system only makes it less efficient.
The shift towards transaction fees has arguably already begun. Last year the crypto market saw the emergence of fungible tokens, which work as a way to bypass the limitations of the bitcoin protocol but at least generate some transaction fees. (No, of course there’s no broader use case for them yet.)
Last year Marathon earned 7.7 per cent of its full-year net income from transaction fees, up from 1.3 per cent in 2022. It’s almost inevitable that ratio will rise substantially in the coming years. It’s this, and not the endless bullish predictions, that is the biggest consequence of this week’s halving.
