Despite Bitcoin’s growing success, network transaction fees are historically low. If their level continues to decrease while the monetary emission decreases, the security of the protocol will be threatened sooner or later. Bitcoin is above all an economic system whose resilience is based on the greed of miners and not altruism. Without sufficient incentives, Bitcoin could disappear and fall back to zero.
Transaction fees, quesako?
Bitcoin is an economic system that encourages individuals who don’t trust each other to cooperate and without dictatorial authority. Miners validate transaction blocks, create a new page in Bitcoin history, and receive BTC in exchange.
This award consists of “block reward”i.e. new BTC created in an inflationary way, but also from the sum of transaction fees of the block paid by users. Transaction fees are simply the result of the confrontation between a rigid computing resource space with elastic demand.
On Bitcoin, however, money creation is not infinite : a mathematical formula has been present in the DNA of the protocol for more than a decade. A reduction in emission therefore takes place periodically every 210,000 blocks. It’s about halving.
If until now miners have mainly derived their income from “block rewards”, we expect to see a change in the future. Finally, we hope so. Bitcoin’s Security in Coming Decades Not Guaranteed and is based on the bet that transaction fees will be large enough to replace protocol inflation.
Satoshi Nakamoto already believed that transaction fees should compensate for the end of inflation:
“Once a predetermined number of coins have been released, the incentive can be funded entirely by transaction fees and no longer require inflation.”
Historically low fees on Bitcoin
The technological improvements implemented in Bitcoin in recent years have favored a structural decline transaction fees. The block space is indeed much better optimized. During the fall of 2021, for the first time in the history of Bitcoin, a record in the capitalization of BTC will not was not accompanied by complete blocks. When blocks are not full and demand is high, fees may increase further, but not substantially.
During a bull cycle, speculation intensifies and competition for block space creates pressure on transaction fees. But in recent months, technological gains have been so effective that them BTC fees are at an all-time low. The number of daily transactions has declined steadily since 2019.
What are the reasons for this downward trend in fees?
The contributions of SegWit
The SegWit upgrade adopted in August 2017 through a soft fork makes it possible to separate the data linked to the signature (cookies) by moving them at the end of the transaction and replaces the concept of bytes by virtual bytes (the weight). The fees are therefore no longer calculated according to the size of the transaction but to their weight. By recalculating the signature data weight so that each byte is only 25% of a weight unit, the protocol has gained in scalability.
Such an improvement therefore makes it possible to virtually double the block size if all transactions follow the SegWit standard. We see that more and more transactions use this evolution of the protocol, which mechanically reduces the pressure on the block space market.
Users have the opportunity to achieve efficiencies by combining multiple expenses into a single transaction. It is common that a exchange processes withdrawal requests from several customers a single transaction. Rather than sending a separate transaction for each user, the platform transfers funds by specifying multiple outputs in the same order. Naturally, individual withdrawal fees decrease, as they are shared by the sum of outflows included in the single transaction.
So, adding 4 outputs to a traditional BTC transaction with a single sender can save nearly 60% charge per outing.
The share of releases included in batches of 100 releases was 23% at the end of May 2021, a record. This use of ” batching » Significantly reduces the space required for each payment and reduces the cost pressure on the network.
The opcode OP_RETURN allows metadata to be stored with an anchor to a transaction. We see that solutions like Veriblock Where Tether have deserted the Bitcoin network, when they were the main users of this feature.
As a reminder, the USDT stablecoin was first launched on Bitcoin through Omni Network, before joining Ethereum. Nevertheless, it was only recently that the last vestiges of the stablecoin left the platform. Here too, the departure of Tether has favored the structural fall in transaction costs by reducing the use of the OP_RETURN opcode.
New sources of funding for miners
The report also mentions a drop in BTC sales by miners which are maintained at historically low levels. In fact, companies mining become professional and have the ability to finance their exploitation in the traditional way by raising debt and equity. They no longer have the need to sell their freshly mined bitcoins. Naturally there is fewer transactions and less competition for block space.
Lightning more popular than ever
The Lightning Network payment protocol allows two parties to lock BTC on the main chain and build off-chain payment channels. This routed network makes it possible to achieve a multitude of transactions for ridiculously low fees.
Although creating channels requires performing a multi-signature transaction on the core layer, the transactions carried out on LN are not registered in the blocks. This evolution of the Bitcoin proposal therefore seems to contribute to reduce costs.
An Existential Threat to Bitcoin
Bitcoin price has generally more than doubled after each halving so the miners haven’t really faced the problem yet. This is because if they receive less BTC, the dollar value remains higher. But this BTC price appreciation is obviously not unlimited and sooner or later the question of economic incentives.
Without economic incentives, miners would gradually abandon this economic activity unprofitable (under an unsubsidized free market). The budget needed to carry out a 51% attack would then decrease and Bitcoin would be much more fragile, less expensive to destroy. Difficult to accept for a payment system that has global ambitions…
When we look at the bitcoin emission curve, we see that inflation will be present until 2140. In fact from 2030/2040 the rewards will become really small. The protocol therefore has less than a century before addressing the issue of economic incentives and security.
Bitcoin is not an impregnable citadel
Just because BTC is the most capitalized crypto doesn’t mean it can’t go back to zero. It is not because she has managed to resist attacks for a decade that she is untouchable. Holding BTC is quite different from holding an Apple stock, as Bitcoin does not distribute any financial flows, which makes it extremely fragile. The collapse of UST and LUNA, with capitalizations in the tens of billions, shows that anything is possible.
Some bitcoiners consider it to be the greatest fragility of the protocol. Knowing that Bitcoin presents itself as an inflation-resistant currency, it seems unlikely that a modification of the code to establish perpetual inflation could occur. This would amount to socialize forever the cost of security by network users. A kind wealth tax levied on BTC holders. Changing the 21 million limit would likely kill bitcoin.
A Princeton University study already concluded that transaction fees alone will not be enough of an incentive, and that relying solely on transaction fees will have “troubling consequences” for the future security of bitcoin.
Of course, there will always be some altruistic, tech-savvy miners. But we can certainly not rely on these actions to secure the protocol. The security of Bitcoin does not rest neither on mathematics, nor on thermodynamics or on altruism, but on the self-serving action of greedy human actors.
Lightning to the rescue?
If Lightning were to see truly massive adoption, it’s possible that opening and closing channels would become so important that it is enough to ensure predictable income to minors. The predictability of income is indeed extremely important for a company and the block reward met this criterion, unlike transaction fees. However, this too is only a possibility.
It has never been cheaper to transact in BTC. Through the adoption of block space optimization technologies, the protocol can support the arrival of new users. But the low demand for block space is actually very worrying. If the transaction fees do not compensate for the drop in the “reward block”, then Bitcoin could lose interest. All the elegance of Bitcoin is based on this balance where each party has an economic interest in contributing to the security of the protocol.
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Bitcoin changes everything! Coming from a financial background, I am passionate about everything about this technology. Every day, I try to enrich my knowledge of this revolution which will allow humanity to advance in its conquest of freedom.