Is Bitcoin’s Security at Risk? Unveiling Three Crucial Issues
Joseph E. Ikhalia, Ph.D.
Introduction
In the realm of Bitcoin, transactions undergo verification through a combination of hash functions and digital signatures, which are integral components of the transaction metadata. To combat the double spending problem, all Bitcoin transactions must be broadcasted to every node on the network, with the majority of nodes reaching a consensus on the chronological order of their receipt. This consensus is facilitated by a proof-of-work system, where distributed hashed timestamps of all transactions are linked together in a chain.
At the heart of Bitcoin’s proof-of-work mechanism lies Adam Back’s Hashcash algorithm, employed to validate transactions. Within the context of Bitcoin mining, miners harness their computational power to discover a valid nonce (a number used once) through random computations. This nonce must meet specific criteria defined by the Bitcoin network, entailing a hash value with a predetermined number of leading zero bits.
From a technical perspective, the security of Bitcoin transactions rests on the cumulative hashrate of the network, denoting its computational power and capacity. Hashrate measures the speed at which mining hardware performs the required mathematical calculations for transaction validation and the addition of new blocks to the blockchain. This computational power is quantified in hashes per second (H/s), kilohashes per second (KH/s), megahashes per second (MH/s), gigahashes per second (GH/s), terahashes per second (TH/s), or even petahashes per second (PH/s), with higher values signifying greater processing capability.
Hashrate is influenced by various factors, encompassing the number of participating miners, the efficiency and type of mining hardware, electricity costs, and the mining algorithm’s difficulty. As technology advances and mining hardware becomes more powerful and energy-efficient, the overall hashrate tends to increase. When a miner successfully mines a new block, they are rewarded with a specified number of newly minted coins, currently 6.25 BTC. However, it is essential to note that mining primarily ensures the randomness necessary for validating a block of transactions rather than solely generating new bitcoins. The arduous process prevents any single node or entity from easily predicting the next block and sequentially claiming all mining rewards.
This article aims to delve into the potential security implications that the Bitcoin network may encounter following the 2024 halving cycle and the reduction in block rewards. Specifically, I explore the question of whether the post-2024 halving Bitcoin price can sufficiently compensate for the reduced block rewards to incentivize miners to secure the network, or if a significant reduction in mining activity could ensue, ultimately diminishing the cumulative hashrate and giving rise to unprecedented security risks.
By examining historical data, I shed light on the complex interplay between Bitcoin’s halving events, block rewards, and price to assess the potential consequences of a diminished mining activity and the subsequent impact on the network’s security.
Exploring the Impact of Bitcoin Halving on Block Rewards and Price
Bitcoin operates on a unique mechanism known as halving that profoundly influences its block rewards and price dynamics. This section explores the intricate relationships between Bitcoin halving events, block rewards, and price fluctuations.
The Bitcoin halving is a built-in event that occurs every 210,000 blocks, or approximately every 4 years. When a halving occurs, the block reward that miners receive for successfully mining a block is cut in half. This means that the amount of new Bitcoin that is created each day is also cut in half.
The table below shows the history and future of bitcoin halvings. There will only ever be 32 bitcoin halving events. Once all of these have occurred, there will be no more halvings and there will also be no more Bitcoin created as the maximum supply will have been reached. The maximum supply of Bitcoin is capped at 21 million coins.
Block rewards serve as a fundamental incentive for miners who contribute their computational power to secure the network and validate transactions. The reduction in block rewards, resulting from halving events, has a significant impact on the mining ecosystem. The block reward is currently 6.25 BTC. After the next halving, which is expected to occur in 2024, the block reward will be reduced to 3.125 BTC. The halving will continue every 4 years until the total supply of Bitcoin has been reached, which is estimated to be around 2140.
In the past, the Bitcoin halving has been followed by a significant increase in the price of Bitcoin. This is likely because the halving reduces the supply of Bitcoin, which can lead to increased demand and higher prices.
The following chart shows the relationship between the Bitcoin halving and Bitcoin price:
As you can see, the price of Bitcoin has increased significantly in the months and years following each halving.
Bitcoin halving matters because it affects the supply and demand dynamics of Bitcoin in the market. By decreasing the rate at which new bitcoins are created, halvings reduce the available amount of new supply and create scarcity for the cryptocurrency. This can have a positive effect on its price, as long as there is enough demand for it. However, this is not a guarantee, as other factors such as market sentiment, regulation, innovation and competition can also influence the price of Bitcoin.
Historically, Bitcoin has experienced significant price increases in the months leading up to and following a halving event. For example, in November 2012, when the first halving occurred, the price of Bitcoin was $12.31. A year later, it reached $1,037. In July 2016, when the second halving occurred, the price of Bitcoin was $650.63. A year later, it reached $2,526. In May 2020, when the third halving occurred, the price of Bitcoin was $8,566. A year later, it reached $57,354.
As we anticipate the next halving event, economic models can help us project potential scenarios for block rewards and price movements. By considering factors such as mining difficulty adjustments, hashrate distribution, investor sentiment, and market conditions, these models provide valuable insights into the future landscape of Bitcoin.
Relationship Between Hashrate and Block Rewards
The hashrate of a Blockchain network is a measure of the computational power that is being used to secure the network. The block reward is the amount of cryptocurrency that is awarded to miners who successfully add a block to the blockchain.
The relationship between hashrate and block rewards is a complex one. Intuitively, one might expect that there would be a positive correlation between the two, i.e., that an increase in hashrate would lead to an increase in block rewards. However, the relationship is not always so simple.
There are a number of factors that can affect the relationship between hashrate and block rewards. One factor is the difficulty of the mining algorithm. The difficulty of the mining algorithm is adjusted automatically by the network to ensure that a new block is added every 8 — 10 minutes on average. This means that if the hashrate increases, the difficulty of the mining algorithm will also increase, which will offset some of the increase in block rewards.
Another factor that can affect the relationship between hashrate and block rewards is the price of the cryptocurrency. The price of the cryptocurrency is determined by supply and demand. If the price of the cryptocurrency increases, then the block rewards will also increase in value, even if the number of block rewards does not change. Furthermore, the relationship between hashrate and block rewards can also be affected by the economics of mining. The cost of mining includes the cost of hardware, electricity, and maintenance. If the cost of mining becomes too high, then some miners may be forced to stop mining, which would reduce the hashrate.
Overall, Hashrate plays a vital role in the security of blockchain networks. A higher hashrate enhances the network’s resistance to attacks, as it becomes increasingly challenging for malicious actors to amass sufficient computational power to compromise the system. The cumulative hashrate of the network acts as a safeguard against potential attacks and ensures the overall security and integrity of the blockchain.
Bitcoin’s Security and the Role of Mining Post-2024 Halving
The next halving is expected to occur circa May 4, 2024, when Bitcoin reaches 840,000 blocks. At that point, the block reward will drop from 6.25 BTC to 3.125 BTC. This will reduce the annual inflation rate of Bitcoin from about 1.8% to 0.9%, and the total supply of bitcoins will approach its maximum limit of 21 million.
The halving has significant implications for Bitcoin’s security and price. In this section, we will critically assess the potential implications of this compensation on miners’ incentives to secure the network and examine the potential consequences of a significant reduction in mining activity, leading to a cumulative hashrate decline and unprecedented security risks.
How does the halving affect miners?
Miners are essential for Bitcoin’s security, as they provide the computational power (or hashrate) that secures the network against attacks. Miners also play a role in determining the consensus rules of the network, as they can choose which version of the software to run and which transactions to include in blocks.
However, mining is not a charitable activity, but a competitive and costly one. Miners incur expenses such as electricity, hardware, maintenance, and rent, and they need to cover these costs with their revenues. The main source of revenue for miners is the block reward, which consists of newly created bitcoins and transaction fees paid by users.
The halving reduces the block reward by half, which means that miners will receive less bitcoins for their work. This creates a downward pressure on their profitability and may force some miners to exit the market or reduce their hashrate. The remaining miners will have to compete for a smaller share of rewards, which may increase their operational risks and lower their margins.
In the event that the price of Bitcoin fails to compensate adequately for the reduction in block rewards, a significant reduction in mining activity may ensue. This decline can arise from several factors, including lower mining profitability, increased operational costs, and reduced economic incentives for miners. A decrease in mining activity directly impacts the cumulative hashrate of the network, potentially compromising its security.
However, the halving could create an upward pressure on Bitcoin’s price, which may offset or even exceed the loss of revenue from the reduced block reward. This is because the halving reduces the supply of new bitcoins entering the market, while the demand for bitcoins may remain steady or increase. According to the economic theory of supply and demand, a lower supply and a higher demand lead to a higher price.
Bitcoin’s price has historically increased after each halving event, as shown in the table below:
The table shows that Bitcoin’s price increased by an average of 323% in the 150 days following each halving. If this trend continues, we can expect Bitcoin’s price to rise significantly after the next halving in 2024.
A higher price means that miners will receive more value for their bitcoins, which may compensate for the reduction in quantity. For example, if Bitcoin’s price doubles after the halving, miners will receive the same amount of revenue as before the halving (in dollar terms), even though they receive half as many bitcoins.
Therefore, the halving affects miners in two opposite ways: it reduces their revenue from the block reward, but it also increases their revenue from the price appreciation. The net effect depends on how these two factors balance out in relation to their costs.
How does mining affect Bitcoin’s security?
Bitcoin’s security depends on its hashrate, or the total amount of computational power dedicated to mining. A higher hashrate means that it is more difficult and expensive for an attacker to disrupt or manipulate the network by performing a double-spend attack or a 51% attack.
A double-spend attack occurs when an attacker spends some bitcoins and then reverses the transaction by creating a longer chain of blocks that excludes the original transaction. A 51% attack occurs when an attacker controls more than half of the network’s hashrate and can create a longer chain of blocks that overrides the valid chain. Both attacks require a large amount of computational power and resources, which makes them impractical and unprofitable for most attackers. However, if the network’s hashrate drops significantly, the network becomes more vulnerable to such attacks.
The halving may affect the network’s hashrate in two ways: directly and indirectly. The direct effect is that some miners may stop mining or reduce their hashrate due to lower profitability, which lowers the network’s hashrate. The indirect effect is that some miners may switch to mining other cryptocurrencies that offer higher rewards or lower difficulty, which also lowers the network’s hashrate.
The difficulty adjustment ensures that the network’s hashrate and security are not permanently affected by the halving, as it creates a feedback loop that stabilizes the system. If some miners exit the market or switch to other cryptocurrencies, the difficulty level will drop, making mining easier and more profitable for the remaining miners. This will attract new miners or bring back old miners, increasing the network’s hashrate and security. Conversely, if more miners join the market or switch to Bitcoin, the difficulty level will rise, making mining harder and less profitable for all miners. This will deter some miners from mining or make them switch to other cryptocurrencies, decreasing the network’s hashrate and security.
How does Bitcoin’s security affect its price?
Bitcoin’s security is what gives it value and credibility as a digital currency and a store of value. Without security, Bitcoin would lose its trustworthiness and usefulness as a medium of exchange and a unit of account. Security is also what distinguishes Bitcoin from other cryptocurrencies that may offer faster transactions, lower fees, or more features, but lack the same level of security and decentralization.
Therefore, Bitcoin’s price is positively correlated with its security. A higher security means that Bitcoin is more reliable and resilient against attacks, which increases its demand and value. A lower security means that Bitcoin is more vulnerable and risky, which decreases its demand and value. The halving may affect Bitcoin’s price through its impact on its security. As discussed above, the halving may cause temporary fluctuations in the network’s hashrate and security, which may affect the market’s perception and confidence in Bitcoin. If the network’s hashrate drops significantly after the halving, some investors may lose faith in Bitcoin’s security and sell their bitcoins, driving down its price. If the network’s hashrate recovers quickly after the halving, some investors may gain confidence in Bitcoin’s security and buy more bitcoins, driving up its price.
However, these effects are likely to be short-lived and overshadowed by other factors that influence Bitcoin’s price in the long term. The halving is not a surprise event, but a predictable and transparent one that is already priced in by the market. Moreover, Bitcoin’s security is not solely determined by its hashrate or block reward, but also by its network effects, innovation, adoption, regulation, and reputation. Overall, the halving may have a minor and temporary impact on Bitcoin’s price through its effect on its security, but not a major or lasting one.
In conclusion, the forthcoming 2024 halving in Bitcoin presents a crucial turning point for the network’s security and the role of mining. As the landscape evolves, it is imperative for stakeholders to closely monitor the potential compensation between reduced block rewards and the price of Bitcoin. A significant reduction in mining activity could lead to a decline in the cumulative hashrate, posing unprecedented security risks. It is our collective responsibility to explore innovative solutions, foster dialogue, and develop sustainable incentivization mechanisms to ensure the long-term security and stability of the Bitcoin network. Join the conversation and contribute to shaping the future of Bitcoin’s security by sharing your insights and ideas. Together, we can navigate this critical juncture and pave the way for a robust and resilient decentralized ecosystem.
