As with so many others these days, I’ve been trying to get up to speed on Bitcoin. When I look at new financial products, I tend to try to poke holes in them as a way to better understand potential risks.
I will first pose the questions here, and then dive into my assumptions and thought process (sorry, it’s a long post):
**The questions are:** What level do BTC transaction fees need to be to support the physical infrastructure required to process and maintain the BTC blockchain once new BTC cannot be mined? And will that equilibrium transaction fee render BTC completely impractical and lead a breakdown to the entire blockchain?
I’ll start with some baseline assumption/stats, all taken from bitinfocharts (https://bitinfocharts.com/bitcoin/)
1. Miners are currently paid 6.25 BTC per block mined (US$375,000 @ 1BTC=$60,000)
2. Bitcoin mining rewards reduced by 50% roughly every four years at current rates (last time May 2020)
3. Transaction Fee rewards are around 1.49 BTC ($89,400 @ 1BTC=$60,000)
4. Fee as portion of total processing reward: 17.9%
5. Average transaction fee for a Bitcoin transaction is currently .00063 BTC ($37.80 @ 1BTC=$60,000)
Based on those facts, I calculated the following (pretty basic but bear with me):
1. Total Reward for processing a bitcoin block: roughly $464,400
2. Means there are on average 2,365 transactions/block (=total transaction fee / average transaction fee)
Assuming *current* transaction levels and BTC price remain the same, but miners no longer earn rewards for mining bitcoins and only get paid via transaction fees, then total transaction fees per block must equal $464,400 (=current value of mined BTC + value of transaction fees per block)
That equals $196 per bitcoin transaction (total transaction fee / average transactions per block). That’s based on current transaction levels and BTC price.
If I think about current Bitcoin trends, then I assume, going forward:
· The number of bitcoin transactions will increase over time as adoption grows.
· The value of BTC will increase over time as adoption grows.
· Increased BTC values results in increased processing time.
So, BTC blocks will become harder to process and there will be more transactions to process, requiring investment into new processing hardware to maintain blockchain performance. This hardware will need to be paid for.
The questions, again: What level do BTC transaction fees need to be to support the physical infrastructure required to process and maintain the BTC blockchain? And will that equilibrium transaction fee render BTC completely impractical and lead a breakdown to the entire blockchain?
I see a few potential scenarios here once mining new BTC stops:
Scenario 1: Transaction fee are not high enough to support most miners, thereby reducing the number of miners until you introduce the real risk of a 51% attack.
Scenario 2: Transaction fees inflate hugely as no miners will agree to process transactions unless the fee covers their operating costs and some profit. The increase in fees results in BTC becoming too costly to use.
Why am I wrong?
Thanks for reading this far. I may have rambled a bit toward the end. In any case I am interested in hearing answers to my questions and critics of my arguments.
One counterargument I have heard regarding high BTC transaction costs is the you can use Layer 2 solutions to reduce transaction fees. What I have seen is that the Layer 2 solutions DECREASE the number of actual BTC block transactions (there are lots of transactions on the Layer 2 level, but only one opening and one closing transaction on the blockchain). Also, as an aside, to me the Layer 2 solutions invalidate the basic purpose of bitcoin, namely anonymous transactions and no financial middlemen (since low transaction fees have already been proven to be false).
So instead of a large pool of miners competing over a large number of transactions, there will be fewer and fewer transactions to compete over, and less transactions to earn fees on, increasing the competition to process the remaining transactions and thereby driving down transaction costs.
However, if BTC can no longer be mined, and the only reward is the transaction fee, there could be a situation where transaction fees are not high enough or transactions not frequent enough for less efficient miners to cover the cost of processing the blockchain. This will result in those inefficient miners dropping out of the mining population.
So fewer transactions on the actual blockchain due to Layer 2 solutions, plus transaction fees being the only way to get paid results in a hypercompetitive “winner takes all” market where only the most efficient and most competitive miners will survive.