The Biggest Risk for Bitcoin

Bitcoin is an economic system that encourages people who are willing to work with it without trust, to cooperate without censorship. Miners confirm blocks of transactions, create a new page in the history of Bitcoin and receive BTC in return.

This price consists of the reward of the blockchain, i.e. new BTC created in an inflationary way, as well as the total cost of the transaction, from the mass paid by users. Transaction costs are simply the result of a confrontation between rigid computer resources and flexible demand.

In Bitcoin, however, the creation of funds is not unlimited: the mathematical formula is embedded in the DNA of the protocol already, we have been working for more than a decade. Thus, every 210,000 blocks there is a periodic decrease in remuneration. It exceeds half, and its name is halving.

Miners received their income mainly from the “block reward”, we expect changes in the future. Finally, we hope so. The security of Bitcoin in the coming decades is not guaranteed. It is based on the bet that the transaction cost will be high enough to replace protocol inflation.

Satoshi Nakamoto calculated that the transaction fee would have to compensate for the end of inflation:

“Once a predetermined number of coins are issued, the incentive can be fully funded by transaction costs, and inflation will no longer be needed.”

Historically low cost of Bitcoin

Many prefer the technological improvements made in Bitcoin in recent years to the structural deterioration of Transfer fees. The mass space is already much better. In the fall of 2021, for the first time in the history of Bitcoin, there was not a single case of BTC capitalization that was not accompanied by full blocks. When the blocks are not filled and demand is high, the fee may rise, but not by much.

During the growth cycle, speculation increases, and competition for a place in the block puts pressure on the value of the transaction. But in recent months, the technological advantages have proven to be very effective, and Bitcoin fees are at historically low levels. The number of its daily transactions has been steadily decreasing since 2019.

What are the reasons for this downward trend in rewards?

• SegWit Contributions

The SegWit update was approved in August 2017 by the file soft fork. It allows you to separate the signature-related data (cookies) by transferring them at the end of the transaction and replacing them. Byte concept, standard byte (weight). Thus, fees are now calculated not based on the volume of the transaction, but based on its weight. By recalculating the weight of the signature data so that each byte is only 25% of the unit weight, the protocol has gained scalability.

This optimization allows you to increase the block size almost twice if all transactions comply with the SegWit standard. We are seeing more and more transactions using this protocol evolution, which mechanically reduces the pressure on the blockchain space market.

• Aggregation of transactions

Users have the opportunity to achieve efficiency by combining several expenses into one transaction. Usually, the exchange processes withdrawal requests from several clients in one transaction. Instead of sending a separate transaction to each user, the platform transfers money by selecting multiple exits in the same order. Of course, individual withdrawal fees are reduced as they are divided by the total outflow of funds included in a single transaction.

Thus, adding 4 outputs to a traditional BTC transaction with one sender allows you to save about 60% of the margin per output.

The quota of issues included in batches of 100 pieces was 23% at the end of May 2021, which is a record. This use of “collection” significantly reduces the space required for each batch and reduces the pressure on the network.

The OP_RETURN game code allows you to store metadata along with the transaction anchor. You see that solutions like fireblock, where Rope left the Bitcoin network when they were the main users of this feature.

Recall that the stable cryptocurrency USDT was first launched in Bitcoin through the Omni Network, and then joined Ethereum. However, not so long ago, the last remnants of stablecoin left the platform. Again, Tether’s departure contributed to a structural reduction in transaction costs by limiting the use of OP_RETURN opcode.

New sources of financing for miners

The report also says: Bitcoin sales are falling due to the fact that miners are kept at a historically low level. In fact, mining companies become professionals, and have the opportunity to finance their operation in the traditional way, increasing debt and financial value. They no longer need to sell newly mined Bitcoins.

Of course, there are fewer transactions, and there is less competition for a place in the block.

Lightning Network is more popular than ever

The Lightning Network payment protocol allows two parties to block BTC on the main chain and create off-chain payment channels. This routable network allows for multiple transactions at a ridiculously low cost.

Although the creation of channels requires a transaction with multiple signatures at the basic level, changes made on LN are not recorded in blocks. This development in the BTC proposal seems to contribute to cost savings.

An existential threat to the BTC

The price of Bitcoin as a whole has more than doubled after each halving. So the miners have not yet encountered this problem. This is because when they receive less BTC, the value of the dollar remains higher. But this increase in the price of BTC is clearly not unlimited, and sooner or later the question will arise: economic incentives.

Without economic incentives, miners will gradually cease to engage in this type of activity, which will be unprofitable (with an unsupported free market). Then the budget required to carry out a 51% attack will decrease, and Bitcoin will become more vulnerable, and its destruction will be much cheaper. It is difficult to be accepted into payment systems with global ambitions….

Looking at the Bitcoin emission curve, we see that inflation will be present until 2140. In fact, the rewards will become very small from 2030/2040.

Bitcoin is Not an Impregnable Fortress

The fact that BTC is the most capitalized cryptocurrency does not mean that it cannot return to zero. Over the past ten years, he has not experienced attacks, which is why he is so untouchable. No one just encroached on him!

Owning BTC is completely different from owning Apple shares, where Bitcoin is not distributed as money, which makes it very vulnerable. The collapse of stablecoins and LUNA shows in “big bold font” in the tens of billions that anything bad is possible.

Some consider this to be the biggest vulnerability of the protocol. Since Bitcoin presents itself as an inflation-proof currency, it seems unlikely that changing the code will lead to permanent inflation. This would be equivalent to the fact that the users of the network would forever incur the costs of ensuring security. The type of welfare tax levied on BTC holders.

Changing the 21 million limit could probably kill Bitcoin.

A Princeton University study has already concluded that transaction fees alone will not be enough to incentivize, and that relying on transaction fees alone will have “alarming consequences” for the future security of Bitcoin.

Of course, there will always be miners interested in technology and altruism. But we certainly cannot rely on these measures to ensure the security of the protocol. The security of BTC does not give rest to mathematics, thermodynamics, or altruism, and even more so to greedy human subjects acting in their own interests.

Summing up

If Lightning really saw huge adoption, opening and closing channels would probably become so important that it would be enough to guarantee the expected manners revenue. The ability to predict revenue is actually very important for a business, and the reward block meets this criterion, unlike transaction costs. However, this is also only a possibility of the protocol.

BTC trading has never been so cheap. Using block space optimization methods, the protocol can support the emergence of new users. However, the low demand for blockchain is a concern. If transaction costs do not compensate for the decrease in the value of the “bonus block”, then Bitcoin may lose interest. The whole elegance of the BTC depends on this balance, where each party has an economic interest in promoting the security of the protocol.