Bitcoin’s ‘Halving’: Profit Surge or Miner Meltdown? And more

07/14/2023 0 Comments

1. Bitcoin’s ‘Halving’: Profit Surge or Miner Meltdown?

In a recent report by David Pan for Bloomberg News, the upcoming “Halving” event for Bitcoin, a significant occurrence that happens every four years, is causing concern among some Bitcoin miners. The event, which reduces the amount of Bitcoin miners can earn for validating transactions by half, has historically led to substantial increases in Bitcoin’s price. However, this time around, the event could potentially spell trouble for less efficient mining operations.

The Halving, predicted to occur on 26 April 2024, will decrease miners’ rewards to 3.125 Bitcoin per block, down from the current 6.25. According to a report by Bloomberg News published on 8 July 2023, while this scarcity is seen as a long-term value maintainer for Bitcoin, the upcoming Halving could prove challenging for miners with higher operating costs. Jaran Mellerud, a crypto-mining analyst at Hashrate Index, predicts that nearly half of the miners could suffer due to less efficient mining operations.

The break-even electricity price for the most common mining machine is expected to drop to six cents per kilowatt-hour from 12 cents/kWh after the Halving. Mellerud noted that around 40% of miners still have higher operating costs per kWh, and those with costs above 8 cents per kilowatt-hour could struggle to stay afloat.

Wolfie Zhao, head of research at TheMinerMag, told Bloomberg that the total cost for certain miners is well above Bitcoin’s current price, and net profits could turn negative for many miners with less efficient operations. This comes at a time when Bitcoin’s price is still less than half the record of almost $69,000 reached in late 2021, and miners’ production costs have risen in tandem with electricity prices.

The Bloomberg report also pointed out that the global mining industry has between $4.5 billion to $6 billion in debt, down from $8 billion in 2022. This debt, coupled with rising competition among Bitcoin miners and increasing electricity costs, is apparently creating a challenging environment for miners.

In preparation for the Halving, Bloomberg says that Bitcoin miners are taking measures such as locking in power prices, bolstering war chests, and cutting back on investments. For example, Hut 8 Mining Corp. entered into a $50 million credit facility last month with a unit of Coinbase Global Inc. to help preserve its Bitcoin treasury ahead of the Halving.

Despite these measures, the Halving is expected to double Bitcoin’s production cost to about $40,000, according to JPMorgan Chase & Co. strategists. This could potentially drive many miners out of the market, highlighting the high-risk nature of the Bitcoin mining industry.

2. Bitcoin Ordinals Are Transforming the Network For the Better

Bitcoin Ordinals are transforming the largest blockchain network at an astronomical rate, with miners earning a staggering $184 million in fees in just three months, from April to June.

Behind this impressive performance are BRC-20 tokens and Bitcoin Ordinals. A recent study conducted by research firm Coin Metrics indicates a surge in transaction fees garnered by miners on the Bitcoin network.

This uptick is attributed to the swelling number of BRC-20 tokens on the network. Consequently, miner profitability is witnessing a subsequent increase.

This article delves into the intricate world of Bitcoin Ordinals, aiming to elucidate what they are and their significance for Bitcoin’s trajectory. It will further examine their transformative potential for the network, and their broader implications, not only for Bitcoin but also for the whole cryptocurrency industry.

This discussion seeks to shed light on how these elements might shape the future of BRC-20 tokens.

What Are Bitcoin Ordinals?

Bitcoin now has a lot more to offer other than being the largest cryptocurrency and the symbol for digital currency. In addition to being known for its impeccable decentralization, security, and immutability, Bitcoin is also a platform for creating and trading digital art, collectables, and other forms of non-fungible tokens (NFTs).

Bitcoin Ordinals are the technology behind these disruptive elements taking the crypto sector by storm. Launched at the start of 2023, Bitcoin Ordinals are essentially satoshis (a 100 millionth of 1 bitcoin) inscribed with rich data, such as text artwork, video, or an image.

Much likе an NFT, Bitcoin Ordinals livе on thе blockchain, and thеir valuе is dеpеndеnt on thе information thеy includе rathеr than as tokеns thеmsеlvеs.

Bitcoin Ordinals wеrе dеvеlopеd by Casеy Rodarmor to lеvеragе thе smallеst divisiblе unit of bitcoin – Satoshi. Thеy еnsurе thе sеcurity and immutability of inscribеd contеnt, which rеmovеs thе nееd to havе a third-party validator.

How Do Bitcoin Ordinals Work?

Bitcoin Ordinals arе basеd on a simple but ingеnious idеa: using thе smallеst unit of bitcoin, callеd a satoshi or sat, as a carriеr of data. A satoshi is еqual to 0. 00000001 BTC, and each satoshi can be uniquely idеntifiеd by its transaction history on the blockchain.

Bitcoin Ordinals usе a protocol callеd Ordinal Inscriptions to writе or inscribе data onto thе satoshis, making thеm non-fungiblе and uniquе. Thе data is storеd in thе witnеss of thе Bitcoin transaction, which is a part of thе transaction that contains additional information such as signaturеs and scripts.

Thе witness was introduced in 2017 with thе Segregated Witnеss or SеgWit upgradе, which fixеd some bugs in Bitcoin and еnablеd morе transactions pеr block. SеgWit also laid thе groundwork for Layеr 2 solutions, such as thе Lightning Nеtwork, which allow fastеr and chеapеr transactions on top of Bitcoin.

Thе witnеss can storе up to 80 bytеs of data pеr satoshi, which mеans that a singlе Bitcoin transaction can inscribе up to 8000 bytеs of data using 100 satoshis. This is еnough to storе small imagеs, tеxt or codе snippеts. For largеr filеs, such as vidеos or gamеs, Ordinal Inscriptions usе a tеchniquе callеd chunking, which splits thе filе into smaller pieces and inscribеs thеm on multiplе transactions.

The process of crеating an Ordinal Inscription rеquirеs running a full node of Bitcoin Corе, which is thе software that implеmеnts thе rulеs of the Bitcoin network. A full nodе downloads and vеrifiеs all thе transactions and blocks on thе blockchain, ensuring sеcurity and dеcеntralization.

After syncing the node to thе nеtwork, thе user needs to create an Ordinal wallеt and sеnd somе satoshis to it. Thеn, they can usе a tool called Ordinal Studio to sеlеct a filе from their computеr and inscribе it on their satoshis.

Thе rеsult is an Ordinal Inscription that can be viewed on any Bitcoin еxplorеr that supports SеgWit transactions, such as blockstrеam.info. Thе usеr can also sharе thеir Ordinal Inscription with othеrs by sеnding thеm a link that contains thе transaction ID and thе indеx of thе output that contains thе data.

The Growing Popularity of BRC-20 Tokens

At the center of the sudden surge in network activity due to the growing popularity of Bitcoin Ordinals are BRC-20 tokens. With this new token standard, users can inscribe fungible tokens (like ERC-20 tokens) on the Bitcoin network.

The process of creating BRC-20 tokens on Bitcoin is similar to an Ordinal Inscription as it attaches data to a satoshi. This groundbreaking feature has grabbed the attention of the Bitcoin community, igniting a surge of enthusiasm and uptake.

Bitcoin miners have been reaping big with the introduction of Bitcoin Ordinals. Though the $184 million in transaction fees may appear minuscule when juxtaposed with the aggregate bitcoin mining revenue of roughly $2.4 billion, it surpasses the fees generated in the previous five quarters combined.

The BRC-20 token standard draws inspiration from the well-known Ethereum’s ERC-20 standard. The new crypto market segment has, within four months since its inception, amassed a market capitalization exceeding $143 million.

By submitting a transaction inclusive of a fee, users are able to mint BRC-20 tokens, thereby staking a claim on newly minted tokens from a BRC-20 crypto project. This advent of tokenization within the Bitcoin ecosystem has unveiled a plethora of opportunities for both market participants and miners.

3. What Is Maximal Extractable Value (MEV)? What Blockchain Miners Need To Know

One of the points of greatest interest for crypto miners and validators in recent months has been MEV, or “maximal extractable value” (the term can also stand for “miner extractable value”). Sometimes MEV is referred to as the “invisible tax” miners collect from participants in a crypto economy by reordering and manipulating transactions in the validation process. But what exactly is MEV, how does it work, and what are some of its potential impacts on crypto ecosystems?

Profit in Transaction Manipulation

In a cryptocurrency system, regardless of the type of consensus mechanism used to confirm transactions, pending transactions are held in what is known as the “mempool,” a waiting area that is visible to the public. Miners or validators in the system then select transactions, order them, and make a block, which is subsequently validated and added to the blockchain.

In 2014, an algorithmic trader using the handle Pmcgoohan predicted that miners might be able to manipulate the transactions in a mempool in order to derive a profit. They wrote that “miners can see all the contract code they run…and the order in which transactions run is up to individual miners…what is to stop front running by a miner in any marketplace implementation?”

Origin of the Term “MEV”

Phil Daian and a team of smart contract researchers wrote a 2019 paper, “Flash Boys 2.0,” which coined the term “miner extractable value.” For Daian’s team, MEV signified the “total amount of ETH miners can extract from manipulation of transactions within a given time frame.” MEV in this case was coined in the context of proof-of-work consensus mechanisms, in which miners govern the order of and whether or not to include transactions in a block. When Ethereum’s blockchain shifted to proof-of-stake during The Merge in 2022, the term shifted to “maximal extractable value” to reflect a wider group of methods miners and validators used.

How Does it Work to Extract MEV?

In theory, network miners or validators should receive the entirety of the MEV available for a given transaction. In actuality, though, independent network members known as “searchers” have increasingly used bots to detect MEV opportunities and automate the extraction process. This is not entirely a negative thing for miners, who tend to receive gas fees from searchers keen to have their transactions included in a block for validation.

Some of the techniques used to extract MEV include:

Liquidation: In a DeFi lending space, users must deposit crypto to be used as collateral. If a user isn’t able to repay their loans, the protocols often allow other participants the chance to liquidate the collateral and gain a liquidation fee from the borrower. Those searching for MEV opportunities may compete to find borrowers primed for liquidation so that they can gain the liquidation fee for themselves.

Front-running: A bot known as a “generalized front-runner” is able to search the mempool for transactions that could be profitable for a searcher. Upon discovering a candidate, the bot replicates the original transaction but with a higher gas price, prompting miners to choose that transaction over the first one.

While front-running may disrupt the overall flow of the transaction validation process, there are some participants in crypto systems that seek to find something positive in the goals of front-runners. A number of services now exist to allow miners and Ethereum users to communicate with one another about preferred transaction orders in a block. This helps to more fairly distribute MEV extraction and also minimizes the effectiveness of the front-running technique described above.

DEX arbitrage: Decentralized exchanges may list different prices for the same tokens as a result of different levels of demand. A wide price discrepancy may be an opportunity for MEV extraction. Bots can exploit these situations by buying tokens at a lower price at one exchange, turning around and selling them on a second exchange at a higher rate.

Arbitrage in this way is increasingly competitive, but it has the added benefit of helping to align token prices across exchanges and making the broader DeFi market more efficient.

Sandwich attack: A so-called “sandwich attack” is a technique used to manipulate the prices of crypto tokens. A searcher who finds a large trade that is pending on a DEX may attempt to “sandwich” that trade between his or her own. The searcher places a trade using the same token immediately before and another right after the large pending trade in an attempt to benefit from the temporary (and artificial) price discrepancy. The searcher thus pumps up the token price for the unwitting trader, who ends up paying a higher rate, and then sells tokens into the pool at that higher price to gain a profit on the difference.