Miners need a Bitcoin use case to stick

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The security of the Bitcoin network relies on the addition of new blocks to the chain, which miners are financially incentivized to produce. In turn, miners’ income consists of transaction fees and block subsidy for all transactions contained in a block they mine.

But the block subsidy won’t last forever: it is halved every four years (most recently on 19 April 2024) and will head towards zero. It aims to support the profitability of miners until the fees generated by transaction activity on the Bitcoin network are sufficient to do so.

Miners can reduce the decline in revenue per block by increasing their market share in the blocks they mine. They may do this by upgrading existing equipment or purchasing new equipment, locations, or assets. Miners who have been more profitable to date and those who have accumulated increasingly valuable BTC reserves are in the best position to make such investments.

Conversely, some operations, especially those with high energy costs, will become unprofitable and close down. Miners will continue to seek partnerships to provide load balancing on energy grids, improving the economics of renewable energy projects by stabilizing energy demand (speeding up mining rigs in times of excess supply and shutting them down in times of excess demand). How miners optimize their energy costs and manage their liquidity to cover fiat liabilities and operational costs will differentiate their credit risks.

After the SEC approved spot Bitcoin ETFs in the United States earlier this year, the Bitcoin price rose sharply and trading volumes increased as new institutional investors sought to invest in the asset. In a recent report, Chainalytic highlights that the Lightning Network (a scaling solution built on the Bitcoin blockchain) is seeing a threefold increase in its open channels through 2023, indicating some growth in the utility of the network.

A recent IMF working paper also highlights Bitcoin’s important role in cross-border flows. But between the ETF approval in January and the halving in April, transaction fees accounted for only 6% of miner revenues on average, according to data from Coin Metrics. Therefore, miners remain highly dependent on block subsidy.

Bitcoin’s limited scalability and functionality compared to other blockchains has contributed to the slow increase in transaction fees. Bitcoin is not designed to enable smart contracts; therefore, it cannot benefit from trends such as decentralized finance, tokenization, and stablecoin payments that are driving activity on other chains such as Ethereum and Solana. Bitcoin’s primary use cases to date have been peer-to-peer bitcoin payments and trading, neither of which have been proven to consistently increase revenues sufficiently.

The design of the Bitcoin blockchain will not change, so new functionality must come from technological advances in its ecosystem. The Runes protocol, which offers capabilities for fungible tokens, was launched to coincide with the halving, leading to an immediate increase in transaction fees.

In 2023, fees were also increased with the introduction of Ordinals inscriptions, which offer non-fungible token capabilities. These innovations have led to increased fees from transaction activities that have so far focused on speculative trading of the tokens they have allowed to be created. These new functions could support tokenization efforts in financial markets, allowing Bitcoin to catch up with other blockchains. Additionally, emerging layer-2 chains (which batch process multiple transactions before placing them as a single transaction on the main Bitcoin blockchain) can alleviate Bitcoin’s scalability limitations and reduce overlay functions to develop identification or tokenization use cases. Identifying a use case that will be permanent before the next halving is crucial for these new use cases to have a lasting impact.

In the long term, Bitcoin’s proponents expect it to become a new global reserve asset and one day serve as a reliably neutral medium of exchange within a global network of AI-powered economic actors. Meanwhile, higher and more stable transaction revenues for miners are vital to the sustainability of the network, making the progress of concrete technological developments critical.

Andrew O’Neill

Andrew O’Neill leads S&P Global’s research on digital assets and their potential impact on financial markets. It began focusing on crypto- and Defi-related risks in early 2022, focusing on understanding their potential impact on ratings and financial markets more broadly. He also participated in the development of S&P Global Ratings’ Stablecoin Stability Assessments, which launched in November 2023. He joined S&P in 2009 as an analyst on covered bond ratings, before taking on a role in the development of rating methodologies, primarily Structured Finance ratings. . Prior to joining S&P Global Ratings, Andrew worked as an analyst in Investment Banking, Buyout and Leveraged Finance at JP Morgan. Andrew holds a CFA license and an MSc in Aerospace Engineering from the University of Bath.