Bitcoin halving poses existential threat to cryptocurrency

They rebounded this year from a two-year depression after a scandal-plagued 2022 ended with the jailing of FTX’s Sam Bankman-Fried, who was convicted of fraud, and the guilty plea of Binance’s chief executive Changpeng Zhao to money-laundering charges.

The catalyst for the surge in the price this year was the creation of 11 ETFs, including one by the world’s largest asset manager, Black Rock, which has brought a tide of new retail and institutional funds into the market for bitcoins.

That new and large-scale source of demand is now hitting a market with limited new supply and where the incentive for creating new supply has just been halved.

Bitcoin’s “miners” use massive amounts of processing power – and massive amounts of high-cost energy – in verifying the blocks of deals. The bitcoin system depends on those miners for its security and the trust that the blockchain is recording only legitimate transactions.

Those miners are processing more than half a million transactions a day within warehouses chock-full of computers. It’s a high-cost and capital-intensive process that’s now dominated by listed companies.

If transaction costs go up significantly it will inevitably impact the demand for bitcoins and their price and make a relatively clunky system even less efficient.

The halving will have a big impact on the revenue of smaller or more leveraged miners because their revenue per transaction has been halved.

That will be offset in the short term, at least, because of the increased value of bitcoins they might hold but, with a big cut in revenue, no compensating reduction in their operating costs and another halving due in four years’ time, there is an ominous cloud over the miners’ futures.

That has major implications for the broader bitcoin market. While transaction fees are as volatile as the price of bitcoins, early this month they averaged less than $US3 per transaction.

On Friday, as the 210,000th block that triggered the halving was processed, they shot up to $US128. (One user, perhaps anxious to participate in the decisive block and become part of bitcoin history, paid a fee of 8 bitcoins, or more than $US500,000). Over the weekend, the average transaction cost fell back below $US35.

If they want to compensate for the losses of revenue generated by the halving, miners will need to rely on increased transaction fees. Indeed, eventually, given that halvings are locked in every four years, transaction fees will be their only material source of revenue from their mining activity.

Given the global response to climate change, energy isn’t going to get any cheaper. The miners are now also in competition with artificial intelligence – also energy and computing power-intensive – which will put even more pressure on costs. Some miners are switching their attention and resources from bitcoin mining to AI.

If it is increasingly uneconomic to continue to mine, there will be a growing question mark over the capacity of the network to verify transactions.

Without the miners within the decentralised network, there would be no trust and therefore no network and no bitcoins. So there’s a question mark, which will grow with each halving, over the viability of bitcoin.

The obvious answer to the miners’ loss of billions of dollars of revenue from the halvings is more and larger transaction fees.

At present, those fees are, in practice, optional for users. That may have to change, with some form of fee schedule imposed by the miners or (this might be difficult to orchestrate within a decentralised network) the network itself.

If transaction costs go up significantly it will inevitably impact the demand for bitcoins and their price and make a relatively clunky system even less efficient.

If they don’t, the bitcoin ecosystem will confront a growing threat to its very existence.

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