Bitcoin Shifting From a Reward-Based Model to a Transaction Fee-Based Model: What It Means For Mining
A finite supply.
This is the defining characteristic that ultimately distinguishes Bitcoin from fiat currencies.
The logistics of ensuring Bitcoin had this finite supply meant that its supply would gradually contract as the coin got more popular. Every 210,000 blocks, Bitcoin mining rewards halve to ensure the end goal remains attainable in a sustainable way.
This latest halving milestone took place on May 11, 2020 on block 630,000, with the rewards from a set of Bitcoin transactions, called a block, reducing from 12.5 BTC to 6.25 BTC.
The reduction in block rewards plays an important role in managing Bitcoin inflation. There are only 21 million Bitcoins in existence and halving ensures that the remaining supply comes into circulation gradually as inflation drops, exceeding gold’s over time.
Figure 1: Bitcoin Inflation over Time
Miners earn less Bitcoin
A difference of 6.25 BTC may sound mundane, but it’s not.
With the price of Bitcoin close to $9,500, the reduction in rewards is a significant development. See, miners play their vital role for profit. The halving in Bitcoin supply has the most direct impact on Bitcoin miners.
Halving means loss of half their revenue from successfully mining a block of Bitcoin transactions. Given the current Bitcoin prices, 6.25 BTC less per block is the equivalent of over $50,000 worth of Bitcoins.
For a miner to get the same amount of Bitcoin rewards post-halving, they will have to run twice the number of computations, along with an increase in electrical costs. Needless to say, a lot of miners will lose their enthusiasm. This could actually lower the Bitcoin mining difficulty.
On the other hand, it can provide miners who wish to get started in mining with manageable power costs an opportunity to capitalize on the momentarily lower mining difficulty. And it has. Roughly 10 days after Bitcoin halving, mining difficulty dropped by six percent.
Meanwhile, the hash rate cratered from around 137 EH/s to less than the psychological 100 EH/s level.
Figure 2: Bitcoin Hash Rate
Therefore, halving can be seen as some sort of reset button for the mining community.
Mining revenue peaked on May 6, 2020. Perhaps a segment of miners turned their rigs on hoping to cash in one last time before the halving event kicked in. Since the halving of block rewards, revenue was significantly lower.
For many miners, this event spelled the death knell as their operating costs meant that mining was no longer profitable. To put it in perspective, worldwide Bitcoin mining consumes nearly as much electricity as the state of Israel as the Bitcoin Energy Consumption Index shows.
Figure 3: Bitcoin Network Energy Consumption
It is, therefore, an intensive activity that needs the rewards to justify the investment.
Transaction Fees Spike After the Halving Event
Every Bitcoin transaction has a transaction fee attached to it. These fees represent a few hundred dollars per block but could become exponentially more valuable should the price of Bitcoin rise as time goes by.
Even before the halving event, Bitcoin transaction fees were already skyrocketing.
By the end of April 2020, transaction fees had risen to an average of $2.94, a 10-month high. Data shows that on April 30, the average fee was at levels not seen since July 2019.
Mempool data indicated that there was a higher backlog of Bitcoin transactions awaiting confirmation by Bitcoin miners. When there is such a backlog, miners choose transactions with higher transaction fees first to add to their prospective blocks.
Individuals transacting Bitcoin have no choice but to increase transaction fees in the hope of outbidding others so that their transactions will be given priority.
Notably, the highest average transaction fee for Bitcoin was in December 2017 at the height of the historic Bitcoin Bull Run of late 2017. The fee spiked to an incredible $55 reflecting the high demand for Bitcoin transactions then.
After the halving on May 11, transaction fees continued to rise. By May 14, Bitcoin transaction fees had soared to an 11-month high of $5.16. The halving event was not the culmination for the transaction fee rise but instead a continuation. In total Bitcoin transaction fees went up more than 1,000 percent between the start of April to May 14.
Figure 4: Bitcoin Average Transaction Fees
The rise in transaction fees typically indicates heavier usage of the Bitcoin network. Competition for space in Bitcoin blocks is causing this race in transaction fees. At press time, the mempool size is over 80MB, which is pretty high.
The average Bitcoin transaction fee on May 20 was $6.48 meaning that transaction fees are likely to retain an upward trajectory despite halving by May 23 to around $3.3.
Users have to contend with higher fees if they want their transactions to get processed faster.
Transaction Fees to Become Increasingly Important In The Future
The future incentive structure for miners will increasingly rely on transaction fees. As the block rewards get smaller, transaction fees will become a bigger part of a miner’s subsidy from a successfully mined block. At some point, the transaction fees will become the majority of that subsidy. The block rewards will reduce gradually until the last Bitcoin is mined around the year 2140.
A higher average transaction fee is a good thing for miners, obviously. As block rewards continue to get smaller, miners will want high transaction fees to offset their mining costs. The 2017 Bull Run was a historically great time for miners because some users paid hundreds of dollars to get their transactions fast-tracked. It is unlikely that transaction fees will go up this high in the near term because the 2017 rally brought about an unprecedented spike in new users.
Bitcoin transaction fees seem to spike during periods where prices are high. Last year’s highs came around the time Bitcoin had rallied to an impressive $13,500. This was an impressive rebound after the devastating crypto winter of 2018.
Besides the halving event, Bitcoin prices have been on a rise after the Coronavirus fueled sell-off in March plunged prices to $4,000. Miners can have the reprieve of decent transaction fees if the price rally continues. A reduction in the supply of Bitcoin will hopefully translate to higher prices through the rest of 2020.
To wrap it up
Currently, close to 18.5 million Bitcoins have been mined. Bitcoin proponents laud the fact that this coin will be a check on the printing excesses of central banks, as a form of digital gold.
The halving in Bitcoin rewards, therefore, is a natural part of this process. High transaction fees may undercut Bitcoin’s role as a medium of exchange, especially micropayments. However, a surge in demand and higher prices is great for Bitcoin holders.
The average price of electricity worldwide is about 0.14 U.S. Dollars per kWh for household users and 0.12 U.S. Dollars per kWh for business users. With the halving event, mining Bitcoin with these electricity rates and older equipment is simply unprofitable.
VBit Technologies has cheap renewable power and state-of-the-art hosting equipment to cushion clients against such eventualities. As the mining landscape gets more sophisticated, they have both the resources and business structure to remain competitive. After the halving event, many miners have been forced out of business, a shift that has caused the Bitcoin network to readjust its mining difficulty lower as the hash rate fell.
VBit Technologies are in a prime position to take advantage of this shift. Purchase Bitcoin mining gear with VBit Technologies today and profitably mine Bitcoin, even during these tumultuous economic times.
Besides, VBit Technologies takes care of the hassle and logistics of Bitcoin mining including gear maintenance. All you have to do is purchase Bitcoin mining equipment from us and we will manage it for you.
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