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Home»BITCOIN NEWS»Anatomy of the Halving Part 2: Block Reward and Network Security: Navigating the New Economic Landscape
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Anatomy of the Halving Part 2: Block Reward and Network Security: Navigating the New Economic Landscape

By Crypto FlexsMarch 16, 202410 Mins Read
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Anatomy of the Halving Part 2: Block Reward and Network Security: Navigating the New Economic Landscape
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15 Mar Anatomy of the Halving Part 2: Block Reward and Network Security: Navigating the New Economic Landscape

Posted at 16:34h
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The upcoming Bitcoin halving will be the network’s most anticipated halving yet to take place. The halving, a programmed reduction in the block reward miners receive for validating transactions and adding them to the blockchain, is set to significantly impact the Bitcoin mining industry. The industry is known as extremely competitive, with miners sometimes operating on razor thin margins. Scheduled to occur next month, around April 19th, this halving will see the current reward of 6.25 bitcoins per block reduced to 3.125 bitcoins. What impact will this have on the mining industry?


Is the Mining Industry Well-Positioned for Reduced Block Rewards?

The halving, which occurs approximately every four years, reduces the rate at which new bitcoins are created, thus enforcing scarcity and potentially driving up the cryptocurrency’s value. However, for miners, this means an immediate halving of revenue from mined blocks, assuming the price of Bitcoin does not increase proportionately. This could lead to increased financial strain on less efficient mining operations, even forcing some out of business, which could cause a  temporary contraction in the network’s hashing power.

The reduced block reward also has implications for Bitcoin’s network security. The security of the Bitcoin network relies on a decentralised global network of miners competing to validate transactions and secure the blockchain. The mining process, which consumes substantial computational power, is incentivised by the block reward plus transaction fees. A reduction in the block reward means that, without a compensatory rise in Bitcoin’s price or transaction fees, miners could earn less for their efforts, which might reduce the incentive to mine. If a large number of miners leave the network, it could substantially weaken network security, potentially making the network more vulnerable to attacks, at least in the short term, until difficulty adjustments occur.

Historically, halvings have been followed by rallies in the price of Bitcoin, partly due to the reduced pace of new coin generation which exacerbates the supply scarcity. While we are the first to admit that past performance is not indicative of future results, in the past, halvings have been the catalyst for Bitcoin’s explosive price performance. If this trend continues, the increased value of Bitcoin could offset the reduced block reward, thereby sustaining miner incentives and preserving network security. This outcome depends on a variety of factors including market demand, investor sentiment, and macroeconomic conditions affecting liquidity and investment flows into cryptocurrencies.

On the regulatory front however, the Bitcoin mining industry faces increased scrutiny from governments worldwide, including the Biden administration in the United States and various governments in the European Union. Concerns over the environmental impact of Bitcoin mining, which requires a substantial amount of electricity, have led to proposals for stricter regulations on the industry. The Biden administration’s recent push for a Bitcoin mining energy tax, as outlined in the fiscal year 2025 budget proposal, represents a pivotal moment for the cryptocurrency mining sector  in the US. This proposal, aiming to introduce an excise tax on mining activities alongside a suite of regulatory measures for digital assets, including the application of wash-sale rules, is projected to generate substantial revenue, with nearly $10 billion in 2025 and over $42 billion across the next decade. 

This legislative effort not only demonstrates the US federal government’s intent to regulate the cryptocurrency space more closely, but also highlights the increasing recognition of the environmental impact associated with energy-intensive mining operations. If passed, this tax could significantly alter the economic landscape for Bitcoin mining in the United States, compelling the industry to innovate towards more energy-efficient technologies or relocate to jurisdictions with less stringent regulations. 

This move, reflecting a broader global trend towards the environmental accountability of digital asset operations, could catalyse a shift towards sustainability within the sector, albeit amidst challenges related to operational costs and international competitiveness. It could also be the first steps taken in a broader agenda to impose a regulatory regime which could lead miners to be regulated into complying with transaction censorship, an example being new rules which prohibit the mining of transactions of OFAC blacklisted wallets.

What Kind of Secondary Effects Will Miners Need to Overcome?

On or around April 19th, 2024, the fourth Bitcoin halving is set to occur, and we will see the current reward of 6.25 bitcoins per block reduced to 3.125 bitcoins. While this deflationary feature contributes to Bitcoin’s value proposition and scarcity, it also introduces challenges for miners and could have several serious implications for the network’s security.

The most immediate impact of the halving is a 50% drop in revenue for miners, as the reward for validating a new block is cut in half. Unless there’s a proportional increase in the price of Bitcoin or a decrease in operational costs (such as cheaper electricity or more efficient mining hardware), some miners may find it unprofitable to continue operations. This could lead to smaller or less efficient miners shutting down their operations.

If a significant number of miners turn off their machines due to reduced profitability, the total computational power securing the network, known as the hash rate, could decrease. A lower hash rate means the network is less secure and more vulnerable to certain types of attacks, such as the 51 percent attack, where a bad actor could potentially gain control over the majority of the hash rate and manipulate the blockchain. In a scenario where the hash rate drops significantly and miners prioritise high-fee transactions, the Bitcoin network could experience slower transaction processing times. This slowdown could impact the usability of Bitcoin, especially in cases where timely transaction settlement is critical.

As smaller miners exit the market, the remaining mining operations will likely be those with access to the cheapest electricity and the most efficient mining rigs, or publicly traded miners who can leverage financial relationships for liquidity on demand to keep their Application-Specific Integrated Circuit (ASIC) miners turned on. This concentration of mining power among fewer entities could lead to increased centralisation, which is contrary to Bitcoin’s ethos. Centralisation risks could mean the potential censorship of transactions and increased vulnerability to coordinated attacks or regulatory pressures.

One potential offset to the reduced block reward is an increase in transaction fees. As block rewards diminish, miners will increasingly rely on transaction fees as an income source. If the demand for transaction processing exceeds the space available in blocks, fees could rise. While higher fees could compensate miners, making mining profitable again, they could also lead to higher costs for users and potentially decrease the attractiveness of Bitcoin for small transactions. Currently, Bitcoin-based NFT projects like Stamps and Ordinals have been making headway in raising fee revenue for miners, although it remains to be seen whether or not these niche use cases are in fact sustainable.

A significant and prolonged decrease in the hash rate could also undermine trust in the Bitcoin network’s security, potentially impacting its price and adoption rate. While the Bitcoin protocol includes difficulty adjustments to ensure new blocks are produced approximately every ten minutes, a lower hash rate could still temporarily increase the network’s vulnerability to attacks. It’s worth noting that, historically, Bitcoin has shown resilience in the face of halving events, with the price often increasing in the months following a halving, which can alleviate some of the potential negative impacts on miners. However, the dynamics around each halving can vary based on broader market conditions and technological factors, and as we pointed out in part one of this series, this halving is very different from the prior three.

What Kinds of Beneficial Outcomes Can We Expect for the Mining Industry?

The best-case scenario for the mining industry following a Bitcoin halving centres around a series of positive outcomes that not only mitigate the challenges associated with reduced block rewards but also enhance the overall strength and resilience of the Bitcoin network. The most significant positive outcome would be a substantial increase in the price of Bitcoin. Historically, halvings have been followed by periods of price increases, driven by the reduced supply of new bitcoins entering the market and growing demand. If the price of Bitcoin rises sufficiently, it could offset the reduced block reward, maintaining or even increasing mining profitability. This price appreciation is critical for encouraging continued investment and participation in mining activities.

Continued innovation in mining technology, leading to more energy-efficient ASIC miners, could significantly reduce operational costs for miners. Lower energy consumption per hash computed would make mining operations more sustainable and profitable, especially in regions with higher electricity costs. This would also help in addressing the environmental concerns associated with Bitcoin mining. It could also lead to a dynamic where mining becomes more profitable for hobbyist home miners, which could actually increase the network’s resilience, censorship-resistance, and decentralisation if a large number of smaller miners join the network.

Expansion into new regions with abundant, cheaper, and cleaner energy sources would benefit the mining industry. Access to renewable energy sources, such as hydroelectric, solar, or wind power, could reduce operational costs and improve the environmental footprint of Bitcoin mining operations. Geographical diversification could also protect the industry against localised regulatory risks and grid reliability issues. In the same vein, if China were to lift its mining ban and allow miners to access its abundant and cheap renewable energy production, it could have a similar effect.

As block rewards diminish, transaction fees will become a more significant part of miners’ revenue. The best-case scenario would see a balanced increase in transaction fees that compensates for the reduced block reward without deterring users due to high costs. This could occur through a combination of increased Bitcoin adoption, more transactions per block through efficiency improvements (like Schnorr signatures and Taproot), Ordinals, Stamps, and Layer 2 solutions like the Lightning Network driving Bitcoin’s utility and demand for on-chain settlement.

Despite the reduced block reward, the hash rate remains stable or even increases due to higher Bitcoin prices and more efficient mining operations. Currently, Bitcoin’s hash rate has been reaching all time highs, which demonstrates that miners are not deterred by the upcoming block reward reduction. A stable or growing hash rate ensures the network’s security against attacks, maintaining trust in Bitcoin’s robustness as a decentralised financial system.

Increased recognition of Bitcoin as a valuable digital asset by institutional investors could drive demand and stabilise the market. Institutional investment would not only support higher Bitcoin prices but could also lead to more innovative financial products and services built around Bitcoin, further integrating it into the global financial system. The recent launch of the US Bitcoin ETFs are one such example of the impact of institutional adoption on the demand for Bitcoin.

The mining industry demonstrates resilience by adapting to the new reward structure, potentially through the formation of mining pools to share resources and rewards, thus spreading the impact of reward fluctuations. This adaptability ensures a more distributed and resilient mining ecosystem. Due to Bitcoin’s recent achievement of a new all time high, Bitcoin mining stocks have seen a correlated rise in valuation as well. The Bitcoin network continues to grow in terms of security, adoption, and technological innovation, reinforcing its position as the leading cryptocurrency. The mining industry, while preparing for the upcoming adjustment to the new economics post-halving, remains profitable and sustainable, driving further innovation and investment in the sector.

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