Bitcoin
Miners need a Bitcoin use case to persist
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The security of the Bitcoin network is based on the addition of new blocks to the chain, which miners are financially incentivized to produce. In turn, miners’ revenues include transaction fees for all transactions included in a block they mine, as well as a block subsidy.
However, the block grant will not last forever: it is halved every four years (most recently on April 19, 2024) and will tend to zero. The goal is to support miners’ profitability until the fees generated by transaction activity on the Bitcoin network are sufficient to do so.
Miners can mitigate the reduction in revenue per block by increasing their market share of mined blocks. They can do this by upgrading existing equipment or acquiring new equipment, locations, or entities. Miners who have been most profitable to date, as well as those who have accumulated BTC reserves that have increased in value, are in the best position to make such investments.
On the other hand, some operations will no longer be profitable and will be closed, especially those with higher energy costs. Miners will continue to seek partnerships to provide load balancing to energy grids, improving the economics of renewable energy projects by stabilizing energy demand (by increasing mining rigs in times of oversupply and shutting them down in times of excess demand). How miners optimize their energy costs and manage their liquidity to cover fiat-denominated debt and operating costs will differentiate their credit risk.
After SEC-Approved Bitcoin Spot ETFs In the United States earlier this year, the price of Bitcoin rose sharply and transaction volumes increased as new institutional investors sought exposure to the asset. In a recent report, Chainalysis highlights that the Lightning Network (a scaling solution built on top of the Bitcoin blockchain) saw a threefold increase in its open channels throughout 2023, illustrating some growth in the network’s utility.
A recent IMF working paper also highlights Bitcoin’s significant role in cross-border flows. However, according to data from Coin Metrics, between the ETF’s approval in January and the halving in April, transaction fees represented, on average, just 6% of miners’ revenue. Therefore, miners remain highly dependent on the block subsidy.
Bitcoin’s limited scalability and functionality, relative to other blockchains, has contributed to its slow acceleration in transaction rates. Bitcoin was not designed to enable smart contracts; therefore, it does not benefit from trends like decentralized finance, tokenization, and stablecoin payments that are driving activity on other chains like Ethereum and Solana. Bitcoin’s main use cases to date have been peer-to-peer bitcoin payments and trading, and neither has proven to generate sufficient revenue on an ongoing basis.
The design of the Bitcoin blockchain will not change, so new functionality must come from technological developments in its ecosystem. The Runes protocol, which introduces features for fungible tokens, launched on the same date as the halving and immediately led to an increase in transaction fees.
Fees were also increased in 2023 by the launch of Ordinals subscriptions, which introduced non-fungible token features. So far, these innovations have led to increased fees for transaction activities focused on speculative trading of the tokens they allowed to be created. These new features could allow Bitcoin to reach other blockchains, supporting tokenization efforts in financial markets. Additionally, emerging layer 2 chains (which batch process multiple transactions before resolving them as one transaction on the main Bitcoin blockchain) could mitigate Bitcoin’s scalability limitations and overlay functionalities to develop defining or defining use cases. tokenization. Identifying a use case that “sticks” before the next halving is crucial for these nascent use cases to have a lasting impact.
In the long term, Bitcoin proponents hope that it will become a new global reserve asset and that it will one day serve as a credibly neutral medium of exchange within a global network of AI-powered economic agents. Meanwhile, higher and more stable transaction revenues for miners are crucial to sustaining the network, making progress on concrete technological developments critical.
Andrew O’Neill
Andrew O’Neill leads S&P Global research on digital assets and their potential impact on financial markets. He began focusing on risks related to crypto and defi in early 2022, with an emphasis on understanding their potential impact on ratings and financial markets more broadly. He also participated in the development of S&P Global Ratings’ stablecoin stability ratings, launched in November 2023. He joined S&P in 2009 as a covered bond ratings analyst before taking a role in developing rating methodologies, primarily for ratings of structured finance. . Prior to joining S&P Global Ratings, Andrew worked as an analyst in Investment Banking, Acquisition and Leveraged Finance at JP Morgan. Andrew holds a CFA certificate and a Masters in Aerospace Engineering from the University of Bath.