Opinion: Miners craving a compelling use case for Bitcoin to endure

Disclaimer: The author’s views and opinions expressed in this article are their own and do not reflect the views and opinions of crypto.news’ editorial team.

The security of the Bitcoin network relies on the addition of new blocks to the chain, a process that miners are financially motivated to carry out. Miners earn revenue from transaction fees associated with the blocks they mine, as well as a block subsidy.

However, the block subsidy is not a permanent solution and is halved every four years. The most recent halving occurred on April 19, 2024, and the subsidy will eventually reach zero. The intention is for transaction fees generated by activity on the Bitcoin network to become sufficient to support miners’ profitability.

The halving event has a negative impact on miners’ profitability and may lead to consolidation in the industry. Miners can mitigate the reduction in revenue per block by increasing their market share through equipment upgrades, acquisitions, or expanding their operations. Miners who have been more profitable in the past and have accumulated BTC reserves are in a better position to make these investments.

On the other hand, some miners with higher energy costs may become non-profitable and have to shut down their operations. Miners are actively seeking partnerships to balance the load on energy grids, which helps improve the economics of renewable energy projects. By ramping up mining rigs during times of excess energy supply and reducing them during times of excess demand, miners can optimize their energy costs and manage their liquidity to cover operational expenses and fiat-denominated debt. This will determine their credit risk.

In terms of transaction activity, the approval of spot Bitcoin ETFs by the SEC in the United States earlier this year led to a significant increase in the Bitcoin price and transaction volumes. New institutional investors sought exposure to Bitcoin, resulting in higher transaction volumes. The Lightning Network, a scaling solution built on the Bitcoin blockchain, experienced a three-fold increase in open channels in 2023, indicating some growth in the network’s utility, according to a report by Chainalysis.

A recent working paper by the IMF also highlighted Bitcoin’s significant role in cross-border flows. However, data from Coin Metrics shows that transaction fees accounted for only 6% of miner revenues on average between the ETF approval in January and the halving in April. This demonstrates that miners still heavily rely on the block subsidy.

Compared to other blockchains, Bitcoin has limited scalability and functionality, which has contributed to the slow growth in transaction fees. Bitcoin does not support smart contracts and does not benefit from trends such as decentralized finance, tokenization, and stablecoin payments that are driving activity on other chains like Ethereum and Solana. Bitcoin’s primary use cases have been peer-to-peer payments and trading, but these have not been sufficient to consistently generate revenues.

New use cases are emerging, but it is crucial for miners to find a sustainable solution. The design of the Bitcoin blockchain will not change, so new functionalities must come from technological developments within its ecosystem. The launch of the Runes protocol, which introduces fungible tokens, coincided with the halving and led to an increase in transaction fees. The introduction of Ordinals inscriptions, which enable non-fungible tokens, also boosted fees in 2023. These innovations have primarily driven transaction activity related to speculative trading of these tokens. They may allow Bitcoin to catch up with other blockchains by supporting tokenization efforts in financial markets. Additionally, layer-2 chains that process multiple transactions before settling them on the main Bitcoin blockchain could address Bitcoin’s scalability limitations and enable the development of decentralized finance or tokenization use cases. Finding a use case that gains traction before the next halving is essential for these emerging use cases to have a lasting impact.

In the long term, Bitcoin is expected to become a global reserve asset and a credible means of exchange within a network of AI-powered economic agents. However, to sustain the network in the meantime, it is crucial to have higher and more stable transaction revenues for miners. Therefore, the progress of concrete technological developments is critical.

Andrew O’Neill is the head of S&P Global’s research on digital assets and their potential impact on financial markets. He has been focusing on crypto and DeFi-related risks since early 2022 and has played a role in developing S&P Global Ratings’ Stablecoin Stability Assessments. He joined S&P in 2009 and has a background in covered bond ratings and rating methodologies for structured finance. Andrew holds the CFA charter and a Masters degree in Aerospace Engineering from the University of Bath.