Bitcoin's 2024 Halving and the Miners' Dilemma

The 2024 Bitcoin Halving

As we approach the 2024 Bitcoin Halving, the cryptocurrency community is at the brink of a significant transformation. This event, which is likely to coincide with Tax Day 2024, is not just a routine occurrence in the crypto calendar. It marks a pivotal moment in the evolution of Bitcoin mining and the security of the network at large.

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Bitcoin's Deflationary Design and the Halving Mechanism

Image source: Investopedia

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Central to Bitcoin's design as a rare, deflationary asset is its halving mechanism. Every four years, the amount of Bitcoin rewarded to miners is slashed by half. This process will continue until the total supply reaches 21 million BTC, a milestone expected around the year 2140. This deliberate approach to reducing the issuance rate is what bolsters Bitcoin's resistance to inflation and underscores its value proposition as a digital asset.

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The Impact of Reduced Bitcoin Issuance on Network Security

With the upcoming halving, there will be a significant reduction in the new Bitcoin issuance for miners. This poses a substantial challenge, considering the vast market these miners protect. Despite the need for increased onchain transaction fees to balance the predictable decline in Bitcoin seigniorage, historical trends have not shown a significant rise in these fees. This situation raises concerns about the long-term financial sustainability for miners, who need to balance their revenue against expenses like energy and mining equipment.

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Five Possible Futures for Bitcoin Mining

Increased Transaction Fees Through Applications:

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Bitcoin may see the development of native applications, like Ordinals and Inscriptions, that could potentially generate higher transaction fees. The growing popularity of Ordinals and Inscriptions has led to increased network congestion and higher transaction fees. This is because these applications require significant block space, which becomes scarce as demand rises. Miners benefit from fuller blocks, as they receive more fees, maximizing their rewards for the same computational effort. The future trajectory of Ordinals and their impact on Bitcoin is still uncertain; however for now, it appears that their usage is on the rise. 

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Other applications such as the Liquid Network which is a Layer 2 sidechain built on top of the Bitcoin blockchain, developed by Blockstream, can also bring more revenue to the miners. The network enables the issuance of various types of tokens, such as securities, stablecoins, and others, on its sidechain. Bitcoin on the Liquid Network is referred to as L-BTC. Users can engage in peg-in transactions, where Bitcoin is locked up to receive an equivalent amount of L-BTC, which can be transacted on the network. It supports various applications like Raretoshi for digital art NFTs and Fuji Money for borrowing Bitcoin-backed synthetic assets and stablecoins.

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Soft Cap with Continued Proof-of-Work: 

Image source: The Economics of 21 Million

Another possibility is reaching a consensus on a minimal inflation rate for Bitcoin that is lower than that of the leading reserve currencies or the gold industry. This would help maintain Bitcoin's appeal as a payment method by keeping transaction fees competitively low. However, this means that the 21 Million Hard Cap is lost and might be equivalent to a blasphemy for many of Bitcoin's core believers.

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Transition to Proof-of-Stake: 

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The Bitcoin network could shift to a Proof-of-Stake system where holders stake BTC to earn transaction fees (just like Ethereum transitioned in 2023). Although this idea is controversial within the Bitcoin community, it might become necessary if fees don't increase sufficiently to replace diminishing seigniorage. Yet another blasphemy for many of Bitcoin's core believers.

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Reducing Operational Expenditure: 

In response to the reduced mining rewards, miners will need to cut operational costs. This could involve finding cheaper energy sources, using stranded energy from the grid, or repurposing the heat generated from mining for practical applications, thus creating new revenue streams. El Salvador is already using volcano (a.k.a. geothermal) energy to mine Bitcoin, issuing Volcano Bonds to investors supporting this mining operation. 

Image source: K33 Research 

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The Bitcoin mining industry, known for its high energy consumption, generates significant amounts of heat, which can be repurposed for heating or food production. In colder regions like Canada and Scandinavia, this repurposed heat is particularly valuable. For instance, the Canadian company Mintgreen is working with the city of North Vancouver to supply heat for buildings and apartments using heat generated by Bitcoin mining. 

Image Source: Compass Mining

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This involves using a heat exchanger to transfer heat from the mining process to the district heating system. Additionally, Bitcoin mining heat is being used to support food production processes, such as at Shelter Point Distillery for whiskey production and for heating greenhouses for growing fruits and vegetables

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The Path to Irrelevance: 

Image source: Bitcoin.com

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A less optimistic outcome is Bitcoin gradually becoming irrelevant, mainly due to internal conflicts and lack of innovation, as witnessed during the blocksize wars of 2015-2017. Although this is a very very low probability scenario, and it might take decades and decades for this scenario to play out, it is one that Senator Warren and her anti-crypto army would be salivating on. 

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Final Thoughts:

Bitcoin mining, despite its energy intensity, is fundamental to the network's security model. It represents a resilient, counter-mainstream approach, different from the Proof-of-Stake systems common in other cryptocurrencies. The energy requirements of mining serve as a bulwark against state-level interference and contribute to environmental objectives by promoting the development of renewable energy and grid stability.

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The upcoming Bitcoin halving transcends mere symbolism; it signals a period of significant challenges and decisions for the Bitcoin community. Whether it involves nurturing a thriving fee market, altering the protocol, or a drastic change in the consensus mechanism, the decisions made in the immediate future will critically shape Bitcoin's path. The direction taken will determine whether Bitcoin continues as a secure, decentralized and trusted digital store of value or yields to the evolving pressures of the lack of economic incentives.

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