When Mining Sets on Bitcoin

Steven Gleiser - December 23, 2015

Bitcoin Mining

One day in the distant future, the sun will set on Bitcoin. The currency’s expiry date was set from its inception, at least in terms of mining rewards. With a fixed supply of 21 million coins, decreasing mining rewards, and increasing mining difficulty, mining for a reward becomes less and less profitable. Bitcoin mining however provides a key service for the network, which makes the ‘last coin’ scenario particularly abstract.

Miners Providing Financial Services

Many could mistakenly think that once mining rewards reach 0 Bitcoins, the miners will disappear, but the system will remain. In reality, the system is built to have the miners provide a transaction registration service and not only extract blocks for a reward. This means that miners are awarded a coin reward and can then profit from fees taken by recording transactions on the public ledger. Bitcoin mining actually only produces a block. The system is just wired to award a continuously decreasing reward for those who invest in ‘unearthing’ that block. This serves to encourage the wide distribution of transaction information and prevent 51% attacks, providing the security the network requires.

In theory, miners could be discouraged from mining if the Bitcoin rewards per block discovered diminish below the cost required to cover the energy and computing power invested in discovering the block. With less miners, a 51% attack is more likely. Less miners means more vulnerability in the system, but the system is supposed to balance itself out. At this point, transaction fees should kick in and help balance out the profitability of running the blocks, keeping the miners active.

Assuming that the transaction fees are not enough to make this proof of work operation profitable, then Bitcoin mining should definitely become extinct when the last coin is mined. This poses an existential threat to the Bitcoin economy as a whole. Miners will have to start looking for returns on their investment elsewhere within the system. This will only lead to increasing transactions fees. Even then keeping their transaction service online will turn into a price war: if fees are too low, it might not be profitable for most miners.

Dependence on Fiat

Current miners may record these transactions on the ledger, at a very small price or may even chose to do it for free. That is because discovering the block in itself is currently yielding a good enough reward from the system for them to concentrate less on charging transaction fees. Decreasing rewards will not only affect fee rates, it will also have an effect on the centralization of blocks, which in turn increases the vulnerability of the system to 51% attacks. This could lead to a more rapid decline of the Bitcoin system if it cannot rely on fiat to provide a safety net. Like any commodity or currency, Bitcoin has a fiat value. If fees are small enough in Bitcoin terms but the valuation of Bitcoin in terms of fiat rises enough, small fees could be profitable enough.

Valuation of Bitcoin in fiat terms depends on how intertwined it is with other fiat currencies. Demand for Bitcoin is a crucial factor to enable a fiat safety net for the mother of all cryptocurrencies. Economic logic suggests that if there is enough demand for Bitcoin – if demand is inelastic enough – then rising Bitcoin prices will progress in fiat terms. This means that decreasing coin rewards from mining, will not necessarily decrease profitability, preventing the doomsday scenario. Moreover, in an inelastic demand scenario, mining would make sense after the last Bitcoin reward is awarded – if there are any additional transactions left to be authenticated.

Transaction fees can potentially be worth enough in fiat to make it worthwhile for miners, but if they are not, small transactions are at risk. Bitcoin can turn into a network in which only large transactions are processed since small ones will not yield enough profit. This would be another reason to think about a substitute for Bitcoin. Basically the only attribute necessary to replace Bitcoin with a system that replicates its functional value, is enough acceptance – enough users who will trust it.

Demise by Substitution

Elasticity of Bitcoin demand will therefore be affected by the availability and acceptance of potential substitutes. Any cryptocurrency that works in a similar manner, can end up replacing Bitcoin. In light of the substitution possibility, the argument for inelastic Bitcoin demand seems weaker. It is even possible that Bitcoin substitution will commence before the last Bitcoin is mined. This means that Bitcoin potentially faces decreasing returns on mining not only from the halving of block discovery rewards, but also from devaluation in terms of fiat due to the rise of substitutes.

The Sun Will Set on the Bitcoin Empire

Since miners not only bring new coins into circulation but also serve as transaction enablers, record keepers and security providers, once the built in mechanism to reward them for their work is used up, users will have to start paying for these services more. This means the fee-less system touted by Bitcoin will disappear. Fees might not even yield enough profit for miners to keep on working once the last coin is mined. This will make demand for Bitcoin dependent on several other factors like its value in fiat terms perhaps. Ultimately Bitcoin cannot wane itself from dependence on the public’s trust, but the public can decide to invest its trust in other cryptocurrencies if the conditions that enabled cheap transactions and other advantages that stem from Bitcoin use, falter. If a reasonable enough substitute dawns on the horizon, Bitcoin will probably ride into the twilight leaving behind the fruit of blockchain for its successors to feed on.



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