Can Bitcoin continue to pay for its security?
Summary: The Bitcoin network relies on having multiple miners around the globe to validate the transactions to keep the network decentralized and secure. The reward for verifying transactions is halved every fourth year. If the Bitcoin price does not go up proportionally, the network will struggle to compensate for satisfactory security, potentially making the network vulnerable to attacks. There are several solutions to this, but none have so far gained traction.
Transactions on the Bitcoin blockchain are verified with the help of so-called miners. The transactions are collected into blocks, and these miners perform challenging mathematical computations with the help of massive computing power to ensure that all transactions in a block are valid. To compensate miners for verifying transactions and to incentivize as many to mine to keep the network decentralized, the Bitcoin network pays out what is known as security cost or mining reward to the lucky miner who get the right to verify the block. This occurs every 10th minute, and currently a miner is rewarded with 6.25 newly issued Bitcoin, presently equal to around $125,000.
Miners are selling Bitcoin to cover costs
To cover the miner’s cost of equipment and, miners must turn to the market to sell Bitcoins on an ongoing basis to raise fiat. The lower the Bitcoin price goes, the more miners will shut down, starting with the ones with the highest electricity prices and oldest equipment. Fewer miners do not by default affect Bitcoin’s transactional output – the same number of transactions will be processed; however, it reduces the network’s security and possibly the degree of decentralization, which can ultimately be fatal for a decentralized network.
It started with 50 Bitcoins
One should not only pay attention to the price of Bitcoin because the size of the reward is equally as important. When the Bitcoin network was launched in January 2009, the mining reward was 50 Bitcoins per block, significantly above the present reward of 6.25 Bitcoins. The substantial reduction in mining rewards comes as a result of the Bitcoin halving occurring every fourth year. As the name implies, the halving cuts the reward in half. A halving has taken place in 2012, 2016, and 2020, reducing the reward from 50 to the current 6.25 Bitcoins. The next halving will occur in 2024, after which the reward will be 3.125 Bitcoins. It is expected that every Bitcoin out of 21mn possible will have been mined at around the year 2140. Thus, the security cost will be equal to 0, at which point the transaction fees must alone compensate miners.
Limited demand for transactions is a problemFollowing the halving in 2020, the network issues 900 Bitcoins daily, presently worth around $18mn. Meantime, users are at the moment paying around $300,000 in total in transaction fees daily. In other words, the majority of miners’ income comes from newly issued Bitcoins rather than transaction fees. With the assumption that total transaction fees stay constant, the total mining reward gets cut in half nearly every fourth year. If the Bitcoin price does not double during this period, the reward essentially undergoes dilution and thus makes mining less profitable. It may reduce the number of miners since only the highly effective miners are left, at which point the network potentially becomes centralized. Alongside fewer miners, there will be less computational power utilized in verifying transactions called hash rate. The smaller the hash rate becomes, the more vulnerable the network will be to 51% attacks. If one controls more than 50% of the hash rate, you can to some extent break the network. Not only can it technically be fatal but the loss of trust in the network can likewise be destructive.
What does it cost to gain 51% of the hash rate?
At a given Bitcoin price, difficulty rate, and mining reward, it is challenging to estimate the cost of gaining 51% of the hash rate, since it depends on many factors. GoBitcoin.io estimates it currently costs at least $33mn in hardware and at least $23mn in electricity daily. However, these numbers assume that 1) you can acquire the necessary hardware at these prices, as it will without any doubt push prices up and 2) you have a location large enough accompanied with the required but cheap electricity. At present, these conditions are unlikely. There is also an option to rent the computational power through existing miners or cloud providers. Doing it through cloud providers would be much more costly, as they are not geared for mining Bitcoins. Renting the necessary computational power through existing miners is not realistic, as such an attack will dilute their future business. All in all, a 51% attack is quite unlikely based on the current Bitcoin price, difficulty rate, and mining reward.
All other things being equal, fast forward three halving’s the mining reward stands at around 0.78 Bitcoin in 2032. At the current Bitcoin price, this amounts to around $2,25mn daily plus $300,000 in transaction fees. If the hash rate decreases proportionally with the mining revenue, it might be durable to achieve 51% of the hash rate from 2032 and on, since the cost of doing so has decreased manyfold, while it is technically much more feasible. Yet, if the Bitcoin price has decreased, it will be even cheaper and easier by 2032.
It is important to notice that alongside the cost, there are significant uncertainties around to what degree such an attack will affect the network and the market’s reaction to it. However, what is clear, though, is that the cost of performing such an attack decreases following each halving, considering that neither the Bitcoin price nor total transaction fees appreciate significantly.
There are several solutions
With under 10 years until the halving in 2032, it is evident that the Bitcoin community must come together sooner or later to solve this issue if they do not want to put their trust in an ever-increasing Bitcoin price. There are various ways to solve it, however, none have so far gained sufficient traction.
The Bitcoin network is currently able to handle around 6 transactions per second. Altogether, these transactions shape the transaction fees paid to miners. To consistently raise total transaction fees, Bitcoin must raise its transactional output, thus massively improving its scalability, alongside advancing its ecosystem. The latter can be accomplished by supporting smart contracts and decentralized applications similar to Ethereum, Solana, and Avalanche. Compared to Bitcoin’s $300,000 paid lately in transaction fees daily, Ethereum averages around $5mn daily in transaction fees, mostly due to its superior on-chain ecosystem of decentralized applications. Developers have for years been trying to improve Bitcoin’s scalability and achieve smart contract compatibility through various solutions but with limited success other than Lightning Network, which hardly has any traction.
The Bitcoin network could adapt another consensus mechanism than proof-of-work to improve decentralization and security. If Bitcoin’s hash rate plunges significantly, it is easier to acquire or rent massive computational power for a short amount of time to gain 51% of the hash rate to attack the network. Prior to this, the attacker can go short Bitcoin for potentially a great return. By adopting proof-of-stake, the attacker needs to acquire at least 51% of all Bitcoins to attack the network. First, this will be severely expensive, as it will push the price much higher, if possible, at all. Next, following the attack, the Bitcoins will be worthless, so there is no idea of shorting Bitcoin on the side. Another aspect is that it is markedly cheaper to be a staker than a miner, so you can uphold higher security with a lower security cost. For instance, Ethereum’s security cost decreases to around 0.5mn from 5.4mn Ether yearly following the Ethereum merge. The Bitcoin community is not actively pursuing the path of proof-of-stake. Assuming it starts on this journey tomorrow, it will likely take years before it is ready to fully implement proof-of-stake. In the case of Ethereum, it has spent well over 4 years developing a proper proof-of-stake framework.
The final option is rather drastic, which is to remove the max supply of 21mn Bitcoins. In that way, the network does not have to undergo a halving every 4th year but can keep a constant mining reward. This is truly unlikely, as it will challenge the scarcity narrative that many Bitcoin advocates strongly adhere to e.g., MicroStrategy’s Michael Saylor. However, if the community does not act on the other two options, preferably both, it might be the final option to keep the network secure.
In conclusion, Bitcoin’s faith is deeply settled on a continuing price appreciation. If the latter is no longer true, Bitcoin can lose its decentralization and security, effectively worsening with each halving, one by one. Not only can it concentrate the hash rate on a few, highly efficient miners, but it can also make the network vulnerable to attacks for financial or political reasons.
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