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What happens if/when Bitcoin stabilizes in price

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I've been doing some analysis of the "HODL" movement (which attempts to use social pressure to convince people to hold on to Bitcoin and other holdings, rather than taking the normal profit-taking steps after such a large appreciation.) I believe that HODL goes against what a cryptocurrency is supposed to be about, since to be valuable it has to be useful, and to be useful, people need to be using it, not holding it. I will explore this in another article next week.

HODL is based on a faith that the price of a bitcoin will continue to rise and perhaps never fall. But to be useful it needs to stabilize, or at the least get to a period of fairly modest and predictable appreciation. You can't do smart contracts for more than a few days when the currency is highly volatile.

So what if Bitcoin did stabilize in price? What would it mean? I'm not sure it works.

If the price were stable, the mining capability would also have to stabilize at a level where mining is close to a break even proposition. If it's seriously profitable, then more people will bring up more mining gear until it's just modestly profitable. In addition, as people bring up newer generations of mining gear that are more profitable, the older gear becomes money-losing, and rational miners would shut it off. (This has not been happening for a couple of reasons I explored in other posts.)

Barely profitable mining just isn't a place to park your money. To help, miners sort transactions according to the transaction fees they offer. Right now, there is a serious limit on how many transactions can be included in every block. Only transactions with decent fees will get done right away, or perhaps at all. Lots of effort is underway to increase the number of transactions that can go in a block, possibly some day all the way up to "as many as desired." If this happens, transaction fees become quite low, which is what the world wants. Another option gaining in popularity is the idea of moving most transactions off the main blockchain, using tools like the Lightning Network. This also limits transaction fees.

In a world where mining is barely profitable, the slightly less efficient miners drop off. This pushes all the mining to only the most efficient gear, run in the one place with the cheapest electricity. Today, Bitcoin is too volatile, and the profitability too high because of appreciation. There is never "one place." In a stable coin, there is, after enough time. It could be the place with the cheapest offering of power and cooling. It could be the place with the cheapest price on mining gear. It could be the place with the strongest non-profit-oriented motivation for mining.

That place is China today. China makes the chips, they have the cheap electricity, and most of all they have currency controls which make it very attractive to pay for mining costs with RMB and reap rewards in bitcoins that can be turned directly to dollars. Today, the fast appreciation of bitcoin has made it worth mining in other, less profitable places. In a stable world, that might not be true. All the mining might go to one place, which has serious consequences.

Those consequences get even stronger when a halving arrives. Every 4 years the basic mining reward (today 12.5 bitcoins per block) gets cut in half, suddenly. In a world of stable prices, that will make every miner seriously unprofitable instantly unless there suddenly are large transaction fees. Any individual miner should immediately shut off, and only cooperation will keep the network operating at all. That cooperation would require the offer of fat transaction fees -- which people will offer to keep the network alive. They need to pay them, and pay them forever, or you get an unstable condition where unprofitable miners drop off, and the mining rate drops, which delays the next difficulty recalculation. Once the recalculation is done, more miners are profitable and they rejoin, and blocks come too fast, and so on.

The high fees would push more and more transactions off the blockchain, making it harder and harder for those needing to be on the blockchain to afford the fees. The few transactions still on the chain will end up costing a fortune. (At today's price of $10K, the mining reward is $18M per day. After the next halving, sustaining that would require transaction fees of $9M per day split among only the transactions that can't be moved to another, cheaper method.) If BTC reaches the $100,000 that HODLers dream of, it's $90M per day that must be coughed up to avoid the chaos of massive miner drop-off.

Unless it keeps going up. Massive appreciation hides all these flaws. But nothing can keep going up forever. Doubling every 4 years might not be impossible but it's difficult to imagine -- and if it became dependable, every investor in the world would do nothing but HODL, and nobody would actually do transactions. Something has to give.

Comments

These claims don't make any more sense than the last time you suggested difficulty adjustments could kill Bitcoin, and we now even have an existence proof in the form of the incredibly wacky and ill-thought-out difficulty adjustments of Bcash: despite being almost designed to cause your big freeze scenario with enormous swings in PoW difficulty level, Bcash continued ticking, just more slowly and unevenly.

Bitcoin is not going to "shut off" after a halving. All that happens is that if transaction fees are low, blocks will slow somewhat until PoW difficulty resets at the new lower rate and the cost of mining will drop accordingly, and equilibrium is restored - just as it always has despite enduring multiple halvings and many order of magnitude swings in price and hashpower over the past decade. The PoW cannot be much larger than tx fee + reward, and will adjust if one falls. When Bitcoin was worthless, PoW was much lower than it is now; when it becomes more valuable, PoW will be higher than it is now. It adjusts according to the necessary value. There is no such thing as a need to subsidize mining to 'avoid the chaos of massive miner drop-off'. This is just not a thing nor has it ever happened.

(Indeed, halvings will make Bitcoin cheaper & better by eliminating a highly-expensive arbitrary subsidy paid by Bitcoiners as a whole to miners which is buying *too much* PoW, much more than is necessary to secure each block against attacks - the optimal number of double-spends is not zero.)

I am looking at different factors here. In the past, I have considered what happens after a long term and large drop, which I still think is a risk, but things are kept alive because people are mining for other than simple mining profit. This article wants to consider a coin with a stable price but again, where people are mining for the mining profit (coinbase plus transaction fees.) Right now we don't have that.

If you have a mining rig that is returning you a profit (however you define it) of only 10%, then why, after a halving would you run it at a loss? If you want coins, you can go out and buy them for less. My point is that in a stable mining environment, nobody should be getting a 110% profit, and so everybody switches to a loss after a halving, unless trans fees jump up to match that which is lost to the halving. It isn't that some people drop out and others stay. In a stable environment, everybody has pretty much the same logic. They either all stay or all leave.

I don't think we've seen enough halvings to know what they mean, but I do agree that the recent one does not match the factors I describe here at all. However, that had nothing to do with transaction fees, which were at the time of the halving quite modest. My best conclusion is that most miners today are not mining purely for mining profit -- they are HODLers, willing to mine at a present-day loss to keep in the game, people paying a fixed price for electricity, or people trying to bypass currency controls. If you are mining at a 300% profit, a halving is very annoying, but doesn't shut you down. If you are mining at 15% profit, it shuts you down if all you care about is that profit. Bitcoin has been climbing so fast that mining profits are high.

I am arguing that if, 3 years from now when the next halving is due, bitcoin has been reasonably stable in price and most miners are in it for reasonable but not extreme mining profit, something will have to happen. That something is probably a lot of discussion in the community about how transaction fees will need to be added to the first block post-halving and all future blocks. Enough transaction fees to make up for the loss from the halving. Since nothing enforces this, that could be difficult. People making serious use of the blockchain at that time will be willing to add the fees, knowing their transactions will not clear if they don't. But some will be tempted to "let others pay the fees." However many transactions fit in a block in 2021, all you need to ensure is that your fees are in the group that fits. Miners have no reason to exclude a transaction paying any fee at all if it fits in their block. But if the total fees that do get into the blocks are not enough, big problems might ensue -- though the miners might give transactors time to get their act together.

"They either all stay or all leave."

No, they don't. There is value to getting transactions done; as time passes, transactions and fees build up. As transaction demand has proven rather inelastic (as we saw just recently with fees going as high as $50 before crashing to the $1 range), there will be demand for blocks. So it is not true that either everyone stays or leaves, it changes over time, even assuming everyone has exactly the same motivations, hardware, total costs, and beliefs (none of which are true or will ever be true even in a 'stable' environment). All that will happen is that blocks will slow until the difficulty resets at a lower cheaper value until transaction fees + smaller rewards match the difficulty. Transaction fees didn't matter before because of the excessive and arbitrary block rewards, but they will matter more with each halving.

'But some will be tempted to "let others pay the fees." However many transactions fit in a block in 2021, all you need to ensure is that your fees are in the group that fits.'

If you are in the block, you are paying the necessary fees by definition.

That is my point -- after a halving, fees have to rise or too many are unprofitable. Rise a lot, to match the lost reward if the old reward was stable and balanced to mining costs plus a modest but reasonable profit.

A miner will put in all the transactions that offer fees, even ones that offer lower than what is desired. Why leave them behind? However, if there are more off-chain transaction engines like Lightning, how many transactions need to be in the block? Will demand be inelastic? What if the various block expansion fights are won as well?

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