The economics and incentives behind Bitcoin mining, and more

01/04/2024 0 Comments

1. The economics and incentives behind Bitcoin mining

Let’s take a new look at the economics and incentives that drive Bitcoin transaction processing, commonly called “mining.” The BSV Blockchain Association has published a new ebook on the topic authored by Bryan Daugherty, Gregory Ward, and Kurt Wuckert Jr., promising to be “your guide to understanding miner economics like never before.”

The book is titled “The Next Era in Miner Economics: Embracing Coopetition and Infrastructure” and is available for free digital download on the BSV Blockchain Association website.

Processor/mining economics is an “evolving landscape,” the book says. North America has returned to a forefront position in the industry; there are ongoing debates over optimal fee levels (and who, if anyone, should decide them), as well as intra-industry arguments over how blockchain networks should be used. In the wider world, blockchain itself must still make its case for why the technology is superior to non-blockchain data processing regarding cost-efficiency, security, and reliability.

“Responsible for validating and recording transactions, miners form the backbone of any blockchain. The economic motivations and actions of miners, commonly referred to as ‘miner economics,’ determine key aspects of a blockchain’s health and stability.”

Block subsidies vs transaction fees

“Miners are evolving beyond their traditional roles as mere extractors of block subsidies,” the book says.

“Block subsidy” refers to the set amount of bitcoins a miner receives upon discovering/solving a transaction block. This amount halves every four years according to Satoshi Nakamoto’s original design—from 50 bitcoins per block in 2009 to today’s 6.25, and this will halve again in 2H 2024 to 3.125.

Rather than worrying whether Bitcoin market prices will increase sufficiently to cover the lost income, miners should seek ways to grow the network and boost income from transaction fees. This should be in the form of more users, not higher fees.

The BSV blockchain network has removed caps on block sizes, though miners may set their own maximums. This shifts the focus away from income from block subsidies (and the hunger for ever-increasing Bitcoin prices, as in BTC) toward income from transaction fees. The latter promotes ecosystem building over price speculation by finding and encouraging new use cases and developing large-scale applications.

The authors frequently use the term “coopetition” to describe how players in the processing/mining space should interact with each other. It refers to the balance they must strike between investing to gain a computational advantage over other miners while recognizing their role in maintaining the network’s health and reputation overall and how these factors impact usage.

On a larger scale, miners’ true competition includes VISA (NASDAQ: V), Mastercard (NASDAQ: MA), AWS, and even legacy ISPs. These high-volume, big-data entities have scopes that range far beyond most blockchain discussions.

The true dangers of ‘centralization’

The book draws a distinction between “mining centralization” and “protocol control.” There’s a “widespread misunderstanding” that large amounts of hashing power in just a few hands will lead to bad outcomes. The protocol defines the rules, and miners must follow them or have their blocks rejected by the network. Thus, the real danger lies in the centralization of control over the protocol itself.

The necessity to process much larger blocks (as on BSV) is a technical challenge that advantages processing/mining operations with greater resources. However, the book argues this does not automatically lead to monopolization.

“Mining is not merely a game of computational prowess but a multi-faceted operation that rewards strategic and balanced growth in various aspects of the ecosystem.”

We’ve seen how protocol centralization became a problem for BTC, with a small cartel of protocol developers and their financial backers able to define new rules that support their own preferences or derail fixes that don’t. Under Bitcoin’s rules, miners can “vote” to follow rule changes. However, the only way to vote against the changes is to have blocks rejected and/or leave the network.

BSV’s “set in stone” protocol rule gives miners a similar choice (enforce or leave); however, developers do not have the power to change the base protocol rules. In neither case should miner decisions be called “voting.”

Maintaining a responsible blockchain network

Miners must act in the network’s best interest, investing their resources and energy in improving connectivity and integrity. The hypothetical “51% attack” threat has been a scenario since Bitcoin’s early days, suggesting that a miner that controls over 50% of total hashing power could perform “double spends” of the same coin/s. However, the authors point out that such action would leave an evidence trail, prompting other processors to reject/blacklist the bad actor.

Finally, the book presents a section on “environmental sustainability” to counter media claims that Bitcoin and superior proof-of-work (PoW) processing in any form are energy-wasters. A network with a few million users will consume the same energy as one with billions of users; therefore, a more useful and scalable network offsets energy-use concerns.

“The industry’s obsession with the token and/or its price often results in underestimating the inherent value of blockchain as a data utility protocol.”

Just as there are large incentives to invest in hashing supremacy over other processors/miners, there are equal incentives to maintain communication links between competing operations. This assists in block propagation, identification of possible rogue actors, and other threat warnings. Processing entities within BSV like TAAL, Quadlink, and GorillaPool should “ideally” have dedicated connectivity lines, and the book suggests “a more defined fiduciary relationship to the protocol” should become normalized.

The book is just 15 pages long, is easy to read even for newcomers, and does not get into heavy math or economic theory. Its intended audience is likely relative newcomers to BSV and Bitcoin protocol issues, though even those familiar with the concepts will benefit from the clear and concise arguments it makes. This makes it recommended reading for all interested in blockchain, Bitcoin, protocols, and infrastructure.

“Overall, the time is ripe for infrastructural innovation in the mining sector. By embracing coopetition and investing in network infrastructure, we can usher in a new age of mining, one that aligns more closely with the underlying ethos of Satoshi’s Vision.”

2. Bitcoin: Will ETF approval cause a ‘sell the news’ event?

The prospect of Bitcoin[BTC] Exchange-Traded Funds (ETFs) gaining approval has generated widespread anticipation, with many eagerly awaiting a decision. However, recent data suggested that the approval could trigger a sell-the-news event, potentially casting a shadow on the initial excitement.

Speculation on the rise

According to K33 Research, a decision on Bitcoin spot ETFs is expected between the 8th and the 10th of January, with the possibility of market-moving news emerging earlier. The research emphasized that the prevailing market dynamics point towards a sell-the-news scenario.

It was also noted that traders are heavily exposed ahead of the verdict, with derivatives showing significant premiums after Bitcoin’s recent months of continuous upside momentum. This exposure makes the event a prime target for profit-taking, potentially leading to a self-fulfilling prophecy of a sell-off.

A 75% probability to the sell-the-news scenario was assigned, contrasting it with a 20% chance of approval, followed by substantial inflows offsetting selling pressure and driving prices higher. Despite recent meetings and updated S-1 prospectuses suggesting imminent approval, there was a 5% chance of ETF denial according to the data.

Possible impacts

The potential sell-off following the ETF approval could impact Bitcoin’s price dynamics. Short-term traders eyeing profits may contribute to a temporary downturn, but the long-term implications remain uncertain, hinging on the balance between profit-taking and sustained institutional interest.

Mine on your crazy diamond

Amidst this uncertainty, optimism surrounded Bitcoin mining. Notably, Canadian miner Bitfarms ($BITF) witnessed a doubling of its stock price last month despite unchanged revenue. This development suggested a positive market sentiment towards Bitcoin-related stocks, emphasizing the broader bullish narrative.

Another positive indicator for Bitcoin lies in the surge in fees collected by miners. The king coin has claimed the top spot among blockchains by fees over the last 30 days. With fees annualized at over $4 billion for miners, this uptrend signals robust network activity and reinforces Bitcoin’s attractiveness to miners.

Despite these positive aspects, the immediate market sentiment reflected a decline in Bitcoin’s price. At the time of reporting, Bitcoin was priced at $42,544.09, marking a decline of -1.13% in the last 24 hours.

3. Decreasing Bitcoin Exchange Deposits Trigger Price Surge Anticipation

Cryptocurrency analysts Axel and Moreno from CryptoQuant recently provided insights into the latest trends shaping the Bitcoin market, revealing significant shifts in address activities and real-time equity analysis.

Since November 2022, a notable trend has emerged in the Bitcoin market, as highlighted by Axel, a CryptoQuant analyst. The number of addresses depositing BTC on exchanges has been consistently decreasing, reaching the lowest levels since 2015. This decline in exchange deposits points towards a shortage of sellers in the market.

The scarcity of sellers is a crucial factor that, according to Axel, sets the stage for a potential price surge. With fewer Bitcoin holders depositing their assets on exchanges, there is a decreased supply available for trading. This scenario can lead to increased demand and, in turn, drive the price of Bitcoin higher.

Axel further emphasizes that the timing is significant as the cryptocurrency market anticipates a significant influx of cash from Exchange-Traded Funds (ETFs). If the current trend of decreasing exchange deposits continues, the market could experience a shortage of available Bitcoin for trading, potentially causing prices to rise as demand outstrips supply.

Real-time Equity Analysis Unveils Bitfarms’ December 2023 Performance

Moreno, the Head of Research at CryptoQuant, sheds light on the evolving landscape of real-time equity analysis in the cryptocurrency space. Highlighting the recent report from Bitcoin miner Bitfarms ($BITF), Moreno emphasizes the importance of on-chain data for staying ahead of market developments.

In December 2023, Bitfarms reported mining a total of 446 Bitcoin. However, Moreno points out that this information could have been known days before the official report by tracking Bitfarms’ Bitcoin production in real-time using on-chain data. This highlights the increasing relevance of real-time analytics in gaining a competitive edge in the cryptocurrency market.

As the Bitcoin market continues to evolve, investors and enthusiasts are advised to pay close attention to these emerging trends. The decreasing number of addresses depositing BTC on exchanges suggests a potential shift in market dynamics, with scarcity becoming a key driver of price movements. Additionally, the emphasis on real-time equity analysis underscores the importance of leveraging on-chain data to gain timely insights into the performance of key players in the cryptocurrency space.

The combination of decreasing exchange deposits and the rise of real-time equity analysis paints a dynamic picture of the evolving Bitcoin landscape. Investors who stay informed about these trends may be better positioned to navigate the market and capitalize on potential opportunities.