Disclaimer: The following is based on personal opinion and should not be considered any form of financial advice.
Within the next six months, Bitcoin Core (BTC), Bitcoin SV (BSV) and Bitcoin Cash (BCH) will all be undergoing a block reward halvening. On the 8th of October 2019, Bitstocks Relationship Manager, Antonio Shillingford, invited Bitstocks CTO David Arakelian into the studio to discuss the rub of the matter. The two broke down the role of Bitcoin miners, the purpose of block rewards, the impact of previous halvening events, and halvening 2020’s projected impact on the profitability and sustainability of mining.
We invite you to read the redacted transcript below or watch the video. If you’re short on time, the video index will allow you to jump straight to the topics that interest you most.
00:01:30 - The role of miners within the Bitcoin ecosystem
00:04:20 - Beyond ‘magic tokens’, Bitcoin as Timechain
00:05:06 - The incentives of mining bitcoin, then and now
00:08:53 - How block rewards incentivise growth of the Bitcoin network
00:09:53 - The deflationary design of Bitcoin
00:11:59 - Bitcoin’s economic model and token economics
00:13:51 - Why it’s illogical to bank on BTC price increase at halvening.
00:14:13 - What human nature (and history) predicts for the halvening’s impact on BTC
00:17:55 - The Bitcoin halvening’s impact on businesses
00:18:26 - A likely outcome of the 3 competing Bitcoin chains undergoing halvening
00:24:41 - Post halvening sustainability of mining profits
00:32:42 - Price action during previous halvenings and correlation with next halvening
00:36:47 - BSV gameplan to compensate for halvening with transaction fees
00:38:06 - Innovating income streams for miners
Today we’re talking about Bitcoin block reward halvening events, particularly the next halvening event coming up around May 2020. The last time a halvening occurred, it didn’t have a great impact on the bitcoin price or trading activity. The upcoming halvening event, on the other hand, will have a tremendous impact on Bitcoin miners, and as a result, the entire ecosystem.
Before we go into the details, let’s talk about the role of Bitcoin miners. The main role of a miner is to validate transactions and put them in a block, then to propagate those blocks across the network to other miners.
Although it sounds rather simple, there's a lot of things happening behind the scenes as Bitcoin miners are also competing with each other to be the first to find the block and get the reward. In order to remain competitive, miners have to do a ton of optimisation. They need to buy a lot of hardware to stay on top of their game.
“It didn’t always work this way. Early in Bitcoin, mining operators were just individuals practising a hobby. I still remember the first time I got into mining. All I had to do was to buy a graphics card, turn on my Windows machine, click on an application and I was set. You could set up your system and wake up the next morning to some Bitcoin rewards. That’s if, fingers crossed, your graphics card didn’t burn out.”
This was circa 2013. If you mined, you wouldn’t see it as a revenue stream. It was easy to do and didn’t require any significant investment, although people generally didn’t take into account the cost of electricity. Anyone with a home computer and an Internet connection could’ve joined the network. Those who mined bitcoin saw it as something cool to do as a side project. They often didn’t know exactly how it worked, but it was fun to collect these ‘magic little tokens’.
Around 2015 or 2016, a shift occurred. Bitcoin mining started evolving into a business-like operation, although hobbyists can still do solo mining and contribute their small miner to a bigger mining pool to try and earn some rewards. But mostly, big companies are buying loads of hardware so they can operate their own mining operation on the level of a massive data centre.
What has also changed is the level of understanding of Bitcoin’s technology. Although Bitcoin mining is about running a profitable business on a daily basis, there’s a growing understanding of Bitcoin’s real-world use cases.
Data transmission with Bitcoin’s trustless, peer-to-peer network is one of the exciting developments that holds great future promise. Bitcoin developers and businesses are growing in awareness of the need for the block size to expand to enable these applications. For Bitcoin miners, it means they need infrastructure and the energy to process these data transactions.
As miners are required to invest their hardware and time into securing the network and processing transactions, Bitcoin is built on a reward system that incentivises miners for their role.
When the Bitcoin network was launched, miners competed for a block reward subsidy of 50 bitcoins per block mined. Although the tokens weren’t worth much at first, it was also cheap and easy enough to run a mining operation.
Over time, at intervals of 210,000 blocks which occurs roughly every four years, the system is designedto halve the set block reward (excluding fees). BTC halvenings have already taken place on two occasions first reducing the block reward from 50 bitcoin to 25, and then to its current status of 12.5 bitcoins per block. The next halvening brings the block reward down to 6.25 bitcoins.
Another factor that changes over time is the ‘network difficulty’. Since the Bitcoin network is designed to pay out a certain total bitcoin reward over the period of a day, block propagation has to be maintained at approximately 1 block every ten minutes. As more miners join the network their combined computing power risks speeding up block propagation beyond the ideal. To respond to such scenarios and keep the block propagation rate stable, the difficulty of the algorithm that has to be solved for each block increases as more miners join. It could also decrease when the combined hashing power decreases. When the network operates as intended, 144 blocks are propagated per day, at an average of 6 per hour.
At the start of Bitcoin, however, the fee-based part of the reward wasn't really something to take into account because there weren’t enough transactions happening on the chain. So how do you incentivise miners to get involved in the first place?
“To entice people to sign up for Bitcoin mining in the early days, the network’s incentive scheme offered a huge number of bitcoins to jumpstart its heartbeat. I know the price point was low, but if you believed in Bitcoin and you understood how it changes financial markets and the financial system, then you’d be more than happy to be one of those people to give it that little jump start.”
The main focus was to collect the subsidy-based block reward, and nobody was really thinking about the small amount of fees added to the total block reward.
We have about six months to go until the next block reward halvening. And, this time, it will occur on all three Bitcoin networks - Bitcoin Core (BTC), Bitcoin Cash (BCH) and Bitcoin Satoshi Vision (BSV).
It will be the first time that there are three competing chains, each having accumulated a decent amount of hash power, experiencing a halvening.
With present-day mining operations running huge data centres that require a large monetary investment, it’s essential that Bitcoin’s block rewards compensate them for their expenses and offer them a good chance of being profitable.
When the block reward subsidy is halved this time round, it’s going to be essential for mining operations to receive value in another way.
Bitcoin’s token economics was designed to take halvenings into account and still function perfectly. Although the block reward subsidy is set to decrease over time, with network scaling the fee-based part of the reward is supposed to increase over time.
At the same time, the fee-based part of the reward can only increase if the number of transactions per block increases, and to make this happen, the block size needs to scale.
The other way to increase the fee-based reward is to keep the block size limited, which is the path that Bitcoin Core (BTC) has chosen, but this hampers the network and makes users suffer in several ways.
Firstly, the network becomes too expensive to use as peer-to-peer cash as described in the Bitcoin whitepaper. The other negative consequence of keeping the block size small is that users have to start competing with each other to have their transactions included in a block. We saw this happening at the peak of the 2017 price bubble. A crazy fee market emerged, and people had to compete to broadcast their transactions and get it approved by the network. Transaction waiting times can end up stretching to multiple days, as in December 2017.
But if we jump back a few steps to the creation of Bitcoin, we’ll see that the 1 MB block size limit was never meant to be there forever. If you read Satoshi Nakamoto’s early communications in emails and on forums, you’ll see that it was just a temporary limit. The reason Satoshi and Hal Finney agreed on imposing this limit, was because of the danger of someone blocking up the network with ‘spam’ transactions. At a stage, computer processing power was so limited and Bitcoin tokens worth so little, it would be relatively easy for someone to launch a ‘spam attack’ on the network. There was little monetary incentive to protect the network, so somebody could have just spent some money to destroy the network out of spite. These days the network is much more resilient, and that 1MB limit is stifling Bitcoin.
“Due to Bitcoin Core’s decision to inhibit scaling, the project has developed into a completely different model. BTC supporters are banking on a gradual and constant increase in price as well as fees. They believe that the halvening will create a scarcity mentality because of the reduction in supply. We don't think that’ll be the case.
It won’t take long for users to be impacted adversely. By nature, people will continue using a system even when there are obstacles, but only until they reach a certain threshold. The increase in price might spur on short term adoption, but it’ll only be temporary. As the obstacles increase, people will start looking for a replacement technology. They’ll start looking for another solution.”
Over the course of Bitcoin history, we’ve seen people looking for solutions that are willing to scale beyond the 1MB limit. We’ve seen this happen each time the BTC blockchain started backing up with transactions - people migrate to other blockchains. We’ve seen people trying to find Bitcoin dot 2 solutions, which didn’t turn out so well with projects like Bitcoin Diamond.
We think the same will happen during the next halvening. People will keep using BTC for a short period until the obstacles start outweighing the benefits. For users, transactions will become slow and expensive again. For miners, revenue will be slashed. Then the exodus will begin.
This time around, the majority of users are businesses who are more mindful of expenditure. A perfect example is what happened to us at Bitstocks at the end of 2017. The BTC price peaked and transaction volumes skyrocketed, but there was a considerable transaction backlog, and we were sitting there anxiously, waiting for our transactions to go through.
Because you had to out-compete the entire transaction backlog, it cost you anywhere between US$20 and US$50 to get an individual transaction processed. It doesn’t make for an enjoyable, or cost-effective experience. That’s what a 1MB block size limit does - it creates a huge bottleneck.
For us, as a company, we had to spend ridiculous amounts of money to make sure that our transactions were being processed during that period. It’s a situation we never want to see repeated, because it doesn’t make business sense.
Such experiences won’t entice companies into the space. And, mainstream adoption and business adoption work like a positive feedback loop: you need company support and business infrastructure to bring a technology to the mainstream.
This is why it’s imperative to build companies around Bitcoin, so they can provide services that people need. But if a business builds on Bitcoin Core (BTC) they would have to charge an astronomical amount in fees and nobody's going to use the service. It’s simply not viable in the long-term for businesses to build applications on BTC.
For the first time ever, block reward halvening 2020 will see three Bitcoin-based chains undergoing the event. We’ve been running the figures, and it looks like all three networks will be occurring within 6 months, but not at the same time.
The numbers could still change, but roughly speaking it looks like Bitcoin Cash will be the first to reach the 210,000 block milestone, followed shortly by Bitcoin SV, and Bitcoin Core (BTC) will follow only a bit later. As of 8 October, there’s roughly 187 days to go for Bitcoin Cash’s halvening, 190 days for Bitcoin SV, and 225 days until its Bitcoin Core’s turn.
With the gaps in time between these events, it will be interesting to see what happens. In terms of hash power, Bitcoin Core (BTC) currently holds the majority with more than 95% while Bitcoin Cash and Bitcoin SV are competing for the rest. What do you think will happen when they undergo block reward halvenings at different points in time?
Here’s the thing: all three of these networks run on SHA-256 which means that miners can jump between them. With a period of about 35 days between the halvening of Bitcoin Cash and Bitcoin SV on the one hand, and Bitcoin Core on the other, we could see some interesting dynamics develop.
The moment BCH and BSV undergo their halvenings, the set block reward will be halved to 6.25. If you’re a miner, you might choose to switch your hash power to mining Bitcoin Core for the month in between, while the BTC reward is still at 12.5. We’ll likely see this scenario unfolding, as most miners are in the game for monetary incentive instead of loyalty. Nonetheless, the situation will be short-lived.
Once Bitcoin Core has undergone its own halvening, miners will calculate the profitability of each chain anew. And it’s here where the rub lies. While all three of the networks will be offering a 6.25 block reward subsidy, Bitcoin SV has already made the move towards building up the fee-based portion of the reward to compensate for the loss.
Although BSV hasn’t built up the momentum to fully compensate for the halvening of the block reward subsidy yet, they’ve made big strides already. And so, it’s the long-term picture that’s most exciting.
As we’ve said before, miners invest a lot of money in their operations. They have to acquire hardware and data centres that are up for the task, they have to ensure their operating systems are optimised to put them in the best position to compete in the space. It’s not the type of industry where you can put all of your work in one month, and keep drawing the benefits. You have to keep performing every single day, every second of the day, or you get left behind.
With all these pressures you need deep pockets to get involved, but you also need to take a long-term view. When miners decide which projects to invest in, they look for longevity to ensure their own sustainability.
Since Bitcoin Core has decided to limit their block size to 1MB, they’ll have to increase transaction fees to such an extent that it discourages network use. What you end up with is very little transactions to process, which means that miners don’t really have much work to do.
While Bitcoin Core holds the majority of hash power right now, miners will reevaluate their choice when BTC’s shelf life comes to an end. Even though mining operations will always try and take advantage of changes in price and mining difficulty, they have to ensure the sustainability of their business over the long-run.
If you look at the situation right now, Bitcoin Core’s block reward is mostly subsidy and very little fees. Once the subsidy gets slashed by 50%, the picture changes drastically.
In the future, running a successful mining operation will require innovation. Miners will have to develop new revenue streams instead of just relying on block rewards.
We saw the beginning of this movement during the 2017 bull market when mining operations started offering services. This was when transaction fees went as high as US$20or US$50. Miners saw how desperate people were to get their transactions processed, so they introduced ‘transaction accelerators’ to guarantee that your transaction was included in a block. By charging an extra fee, these miners created their own legitimate business service. At first only a few pools offered the service, and then suddenly everyone was doing it.
We expect to see the creation of similar services as the next halvening draws near. But the most logical direction to head towards is offering services related to data. With Bitcoin SV’s capacity to transmit huge volumes of data, potential applications are endless.
Once we’ve moved beyond the myth that Bitcoin is only about transferring monetary value, we can see that you can really use it to transfer any data, property rights, or even IP. Miners could offer to archive data in a specific format, limiting access rights to specific parties.
David: At every previous halvening on the BTC network we’ve seen the token price rise. But we’ve also seen situations, like the last Litecoin halvening, miners stopped mining the Litecoin coin. As the hash rate dropped, the price also dropped.
I think the Litecoin scenario provides the best forecast for what’s about to happen on BTC, as Litecoin miners also primarily relied on the block reward subsidy.
On the whole, cryptocurrency prices are on a decline which means that holding a coin and waiting for the price to rise is no longer a good option. If you’re a miner with costs to cover, you’d probably want to liquidate the rewards you earn as quickly as you can, to cover your expenses. If the market was in an uptrend, you might still be tempted to hold the asset until you can make a bigger profit.
In summary, my bold prediction is that the coming halvening will have a similar impact on BTC than the previous Litecoin halvening. I think the hashing power will drop - I’m just not sure by how much. I don't think it will be an immediate drop in the scale of 50%, but it will be significant. I suspect that miners will wait until the price stabilises before they decide which network to hash on, choosing one that allows them to be profitable.
Antonio: I suspect we could see a dramatic drop in the BTC price for a time. It’s also likely for BCH and BSV prices to decline for the period after their halvening and before BTC undergoes its halvening, as it will temporarily be more profitable to mine BTC.
Months later, once things have stabilised, we’ll see miners returning. Over the next six months a clearer picture will start emerging, and I predict that we’ll see miners choosing to dedicate their hashing power to BSV. It’s about basic token economics. Bitcoin SV is building up towards a point where the fee-based part of the block reward is significant enough to keep mining profitable, even when the subsidy-based reward is diminished.
BSV has already increased the block size limit to 2GB and is planning to remove the limit altogether. Once application development reaches a certain point, transaction velocity will be high enough to sustain mining from fee-based rewards alone. BSV will have the best long-term position in the market, and it’s only logical that miners will choose to invest their hashing power in BSV.
The volume of innovation in the market right now makes it a very interesting and optimistic time to be part of it all. After many years of the monetary narrative dominating the market, people are finally starting to understand the broader applications of Bitcoin. We are seeing real-world business applications being built on BitcoinSV, instead of people simply speculating on price moves. Developers are building utilities that offer true value to society, and the community is incredibly passionate and dedicated to developing the Original Bitcoin to its true potential.