Economics of Bitcoin (3): What happens if the block reward disappears?

Writer: James K Lee

There are many criticisms to bitcoin. Few whales control the supply and demand, slow and limited TPS, insurmountable waste of electricity through PoW, etc. to name the few.

But still, bitcoin controls over 50% of the total market share of cryptocurrency, and it is still considered “the dollar” of cryptocurrency. Bitcoin itself represents the success of blockchain environment. It has the longest running and most stable network, and has limited inflation worries due to limited supply. Still bitcoin is perceived as the ‘gold’ of the cryptocurrency.

Bitcoin’s security and stability is built on PoW. By having miners constantly calculate one-way hash functions, bitcoin networks keep its security and provide block reward and transaction fees to the miners. If one were to attack bitcoin network, he/she would need 51% of the total computing power. But given this enormous mining network and infrastructure, getting that much computing power is near impossible.

Bitcoin system is designed that it the block reward will be halved every few years until it reaches its final stage with zero block reward. Right now, over 82% of potential mintable tokens (21 million) are already mined. Every halving event will result in smaller inflation and exponentially decreasing block rewards.

What happens to bitcoin network if the block reward finally disappears?

Bitcoin miners who keep the transactions safe will only receive transaction fees for keeping the network. As explained in previous articles, transaction fees will have limited upside. Even now, the transaction fees only make up less than 1/100 of the total miner rewards. Zero block reward would not make transaction fees increase to replace it automatically.

Bitcoin transaction fees will be determined by the demand for bitcoin transfer. Bitcoin transfer demands will grow organically with bitcoin adoption, therefore transaction fees will not likely to skyrocket suddenly with every halving period. Paradoxically, if there are more need for bitcoin transfer than the TPS bitcoin network can handle, then the transaction fees will indeed increase, while losing its utility as a currency due to expensive transaction cost.

Therefore, if the block reward disappears then most of miners will have to shut down its equipment due to limited profitability. And loss of miners will expose bitcoin network to 51% attack. Increasing bitcoin price with limited fees will only increase the attack incentive. Especially big miners with economies of scale will be able to pull this attack easily.

Right now, the largest holders of bitcoins are miners and exchanges. These ‘whales’ might continue unprofitable mining to keep the value and security of the bitcoin. But mining costs electricity and maintenance, and these whales will have to release their holdings to the market. This will cause a cascade of price drop.

Perhaps if bitcoin becomes the ‘digital gold’ and be considered as a reserve currency, then these problems could be overlooked. Gold also requires extra cost on keeping it safe and requires large transaction fees. Bitcoin might become this ‘safe asset’.

But right now, bitcoin is called ‘digital gold’ by enthusiasts because it is ‘limited in supply’, ‘transaction is ironclad secure’, and ‘its economy does not change’. These assumptions will not be held true simultaneously over longer period. Bitcoin might have to keep its block rewards constant or have to go through a hard fork. Current token economy of bitcoin cannot guarantee long-term security. This is the true dilemma for bitcoin going forward.

[1] Blockchain.info data

Disclaimer:

This report originates from and solely prepared by “Fair Square Lab”, and “Skytale investment”

The views and opinions expressed in this report may differ from the company’s opinion.