Original title: Upcoming Demand for Bitcoin Block Space and Its Impact on Mining Revenue, author: Matthew Kimmell
Translator’s note: Perhaps what is different from all previous halving cycles is the change in the income structure of miners, which is caused by factors such as the future price space of BTC and the current development status of the Bitcoin ecosystem.
Image source: Generated using DALL-E 3
Key Takeaways
The Bitcoin halving will reduce the main source of income for miners. This will cause miners to invest in more efficient machines and prepare for production losses.
Transaction fees are also expected to increase significantly due to the atypical use of Bitcoin block space. These fees are becoming a more important part of mining revenue and may even offset the reduction in revenue brought about by the block reward halving.
Trading demand has surged recently due to the resurgence of projects built on the Bitcoin network for non-monetary use cases, such as on-chain marketplaces, collectibles, and multi-layer platforms.
These projects also pave the way for other new revenue strategies, such as Miner Extractable Value (MEV) and Transaction Accelerators, which take advantage of major changes in the Bitcoin transaction market.
During the next halving period, transaction fees are likely to become the main source of miners’ income.
It is also very likely and plausible that the upcoming increase in trading demand could make up for nearly half (~43%) of the halving’s impact on fee revenue.
introduce
Everyone is waiting for the Bitcoin block reward halving to arrive. While many in the community are celebrating, miners are more worried as they face a significant reduction in mining revenue. So, as the story usually goes, miners have been actively preparing for the drop in output. Installing more efficient machines, reducing debt, and optimistically hoping (begging?) for the market price of Bitcoin to skyrocket.
But what if I told you that this time around, other factors in mining revenue could significantly or even completely offset the impact of the halving? There’s a good chance that transaction fees, which have always been negligible, will increase. And coincidentally, at the exact moment and exact block when the halving takes effect, it will start to increase.
My prediction of a significant fee increase is based on the motivations behind many of the changes to Bitcoin transactions. With new ways of using Bitcoin block space, a whole new universe of users, developers, and businesses are forming, and their non-monetary use cases are creating higher variance in the fee market. Simple peer-to-peer electronic cash systems as we know them are taking on more complex settlement forms. This isn’t the first time, but it’s happening at an unprecedented rate, to the point where these ancillary use cases are becoming real players in the fee market.
Users are choosing to use external software that allows them to see Bitcoin in different perspectives. One is like putting on kaleidoscope glasses that allow users to see the decentralized supply of Bitcoin in the form of unique fragments, rather than the liquid ocean of homogeneous units they actually are. Another example is reading data files that can be attached to transactions, letting users claim ownership of various media tied to the coins they received (think NFTs to understand this). And, some people interpret certain standardized messages in many transactions as issuance or expenditure of external assets, observe any such transactions on chain, and create ownership tracking for completely independent record systems (think sidechains or L2, L3 based on the main chain...).
This is unconventional. This is controversial. But that’s not what this post is about. We’re not going to argue what’s right or wrong, good or bad about Bitcoin. This post is going to focus on a less discussed part of mining revenue: transaction fees, and how the unusual demand vector for Bitcoin transactions might offset the revenue lost before and after the halving.
Unusual vectors of demand for Bitcoin transactions
Fungible Token Standards
Initial efforts to introduce new assets within Bitcoin were creative but crude. Early experiments actually laid the foundation for popular Ethereum applications (and Ethereum itself) while highlighting certain challenges that ultimately stifled Bitcoin adoption.
Projects such as Counterparty, Colored Coins, and Mastercoin (later renamed Omni) were significant innovations in the broader cryptocurrency space and pioneered the creation and popularity of Initial Coin Offerings (ICOs) and Decentralized Exchanges (DEXs), among several other pioneering technologies. However, they failed to gain widespread adoption and acceptance within the Bitcoin community. Unwelcome culture, scalability and other technical issues, and the competitive environment created by the rapid growth of these use cases outside of Bitcoin curbed their success. Adoption of these projects never really took off, and they even faded into obscurity.
However, the demand for external assets is rising again. New attempts have not solved the challenges that have hindered the development of projects in the past, but todays market timing makes things different. Today, peoples awareness of Bitcoin has greatly increased, venture capital is increasing, and, as silly as it sounds, the meme coin speculation boom is undoubtedly a significant contributor to this trend.
Regardless of the reason, or whether it is sustainable, we have seen some new Bitcoin token projects bring significant growth in transaction demand. For example, BRC-20 assets have spent more than $180 million (4.8k BTC) in fees on issuance and transfer since their launch in March 2023. These transactions account for nearly a third (30%) of all Bitcoin transactions, and the fees generated since launch account for 17% of the total Bitcoin network fees.
This is particularly relevant to the fee market around the halving, as a new standard called Runes is being launched with significant upfront demand and growing interest.
The demand for future Runes tokens has a market cap of over $1.2 billion, which is already half of all BRC-20 assets, and the market has only been open since around November. Note that the issuance of Runes tokens must be traded using Bitcoin, and when BRC-20 assets were first issued, fee levels soared to over $16 per transaction, over 300 BTC per day.
The potential impact is that when the Runes token is released, there will be a large amount of transaction demand on Bitcoin for issuing external assets, and they happen to be at the same block height as the halving. At the same time, other standards will not be abandoned with the launch of Runes, and updates to BRC-20, Taproot Assets, and RGB are still in progress.
If these transaction demands are similar to when BRC-20 was first released, then fees could easily reach 150 BTC per day, offsetting a full third of the reduction in mining revenue caused by the halving.
However, Runes won’t be the only catalyst to build demand for a trade.
Collection
The Ordinals protocol unveils a way for users to voluntarily agree to a tracking system for the smallest unit of Bitcoin, called a Satoshi (equal to 0.00000001 or 10^-8 BTC). Under the Ordinals protocol, each unit is assigned a sequential number. By adopting such a standard, each subdivision of Bitcoin is marked and identified along a continuous number line, from the first minted Satoshi all the way to the last minted Satoshi. In other words, when looking at Bitcoin units in this way, each Satoshi becomes a separate non-fungible unit.
By opting in, users can also choose to embed additional uniqueness to their identifiable satoshis by attaching arbitrary data files to any unit. These files are called inscriptions. Users can mix inscriptions with any satoshis they own, while retaining the ability to transfer and store such modified satoshis on the Bitcoin network, similar to regular BTC.
In this way, many tiny units of Bitcoin have now been designated as images, text, and even complete video game files, making them uniquely different from each other and giving investors a reason to value otherwise fungible units of Bitcoin differently.
The collectible value of some satoshis has been validated by the open market due to their numerical significance or associated inscriptions.
As far as we know, the highest price paid to date for a satoshi at auction is $240,000, with an inscription titled Genesis Cat hailed as a 1/1 artifact of cultural and political significance, part of a series of similar inscriptions meant to symbolize and support the restoration of previously removed features in the Bitcoin protocol. Another satoshi with no inscription attached sold for $165,100, advertised as a scarce supply unit due to its provenance dating back to Bitcoins first difficulty period.
Evidence of these sales is encouraging for those who are looking for expensive satoshis. The purpose of changing hands on Bitcoin units on the secondary market at a price far above their usual market price is to change the propensity of certain users to pay transaction fees. It is safe to say that the purchasing power of collecting one satoshi could be as high as hundreds of thousands of dollars, making fee bids much higher than most peer-to-peer transactions.
Given that the halving is a completely predictable and scarce event in Bitcoins history, there is bound to be competition in terms of collecting Satoshis and inscribing the first block. The demand for the first batch of minted Satoshis after the halving is expected to be so valuable that the Foundry USA mining pool even plans to share its revenue with miners if they are lucky enough to win a block. It may be short-lived, but this intense competition will almost certainly cause fees to spike.
Private Transactions
Another possibility for atypical demand is a transaction accelerator. Marathon launched a product called Slipstream in late February that opened a way to avoid Bitcoin’s memory pool (native transaction waiting room) by giving users the option to communicate and pay transactions directly with the MARA Pool. The product did not provide a sustainable advantage in earning fees compared to other mining pools, but there are still several successful examples.
While accelerators such as Slipstream are not widely popular, they have the potential to increase fees in an indirect way if there is enough demand. If a transaction is submitted directly to a mining pool, it is not known in advance to any other Bitcoin user. As a result, a user may find that their transaction, the next one to be processed, actually has to wait because those transactions submitted directly to the pool were secretly included. This can cause confusion for consumers about how much precise fee should be attached to encourage timely processing of transactions. With enough transactions flowing to these accelerators, a multi-sided market for fees emerges, one that is public as part of the Bitcoin protocol and another that is private.
In cases of extreme urgency, users may choose to pay far more than the open market would actually expect. This obfuscated fee market could lead to increased fees. We haven’t seen this actually happen at any meaningful scale, but it’s certainly worth keeping an eye on.
Miner Extractable Value (MEV)
MEV is another emerging dimension of Bitcoin’s block space requirements. MEV refers to situations where miners have the opportunity to earn additional profit by manipulating the order of transactions within a block. Previously, MEV was primarily a potential feature of Bitcoin, which was generally limited due to its more restrictive nature and simpler transaction model. However, due to changes in the Bitcoin software, and changes in the way some users conduct Bitcoin transactions, possible vectors for MEV will become more apparent, as we mention in this post. Here is a brief explanation:
Collectibles: The high value tags of certain inscriptions and satoshis, and inefficiencies in market technology, lead to additional fees being earned through buying or “sniping” and reselling mispriced market items, and sacrificing fees in pursuit of higher value satoshis
**Tokenized Assets (Runes, BRC-20, RBG, Taproot Assets, and potentially others)**: The above protocols provide fungible assets, opening the door for miners to participate in front-running and arbitrage transactions to earn additional rewards.
Bitcoin plug-in: As more external platforms, or so-called “Layer 2”, emerge and use Bitcoin to settle value, miners may be able to exploit loopholes in early designs and additional incentives to earn higher revenues.
Another halving means another reduction in block rewards and a relative increase in the importance of transaction fees to miners. This may provide additional incentives for miners to drive interests related to transaction selection and seek diversified income methods. As mercenaries in a highly competitive industry, we believe that the MEV strategy will at least be tried.
The transaction fee market is becoming more and more closely related to miners
The diversification of Bitcoin transaction demand could play a redemption role in the mining economy. As the halving event reduces the block reward, these new uses of Bitcoin block space could significantly increase transaction fees. This is critical for miners because these fees can offset the loss of block rewards and maintain their profitability.
As mentioned earlier, near-term fee increases will be driven by increased competition in new market segments, including issuing external assets and finding unique collectibles. Not only will these applications incur additional transaction fees, but they may also encourage a more strategic approach to transaction processing.
Ultimately, the shift to a more complex and transaction-fee-reliant economic model highlights the importance of understanding and leveraging new demand vectors to remain competitive.
Looking ahead, current transaction fee levels are expected to account for around 14% of mining revenue after the halving, a figure that is already several times higher than in previous years. However, I expect this percentage to become much higher, well over 50% in some blocks. Looking back at the two-month period at the end of 2023, which was mainly driven by high demand for inscriptions, the average fee level accounted for 30% of mining revenue after the halving. If this average value (193 BTC per day) is simply repeated, 43% of the impact of the halving will be covered.
Given the current trajectory, it makes perfect sense that transaction fees could become the primary source of revenue for miners during this halving period. However, the sustainability of these non-monetary demand drivers remains an open question, as to whether they are leading a long-term shift in the Bitcoin transaction market or are simply a transient symptom of a bull run? Only time will tell.
