How to ensure the security of the Bitcoin network when there is no mine to be mined in the future?

The Bitcoin experiment has been going on for 10 years, and despite the harsh environment it has experienced in the past, all the data shows that we have every reason to believe that it will continue to prosper.

By Dan Held

Compiled by | Jhonny

As we all know, the Bitcoin security model is based on block subsidies and transaction fees (Note: block subsidies are also commonly referred to as mining rewards. The current Bitcoin mining reward is that miners will receive 12.5 BTC for each block they mine; transaction fees are the transaction fees that users are willing to pay to miners when sending transactions, which are used to reward miners for confirming the transaction).

Summary of the main points of this article:

• The larger the Bitcoin network, the more secure it is.

• In the long run, there will be a natural evolving security trade-off between block subsidies and transaction fees. As the Bitcoin network effect grows, miners’ demand for block space will increase, reducing the need for block subsidies. This is happening now, and the future trend is optimistic.

• Bitcoin block space is a scarce and unique commodity. The demand for block space will continue to increase.

• Bitcoin transactors are highly price elastic. Even in the event of a significant increase in transaction fees, the demand for Bitcoin block space will increase.

Block Rewards

We know that a new Bitcoin block is created approximately every 10 minutes, which contains newly minted Bitcoins (i.e., "block subsidies") and transactions that are confirmed and packaged by miners (transactions contain transaction fees paid by the entity that sent the transaction). The newly minted Bitcoins (block subsidies) plus transaction fees are what we usually call "block rewards."

According to Bitcoin's hard-coded monetary policy, the number of newly minted Bitcoins in each block will decrease over time, eventually reaching 0% in 2140 (this policy is also called anti-inflation mode). At the time of publishing this article, more than 83% of Bitcoins have been mined, and the current annual Bitcoin inflation rate (i.e., issuance rate) is only 3.8%. By 2040, more than 99% of Bitcoins will have been mined. Let's take a look at Satoshi Nakamoto's explanation:

“In reality, there is no central bank or Fed that will adjust the money supply as the number of users grows. Because I don’t know how the software can know the real world prices, there will need to be a trusted party to determine the value of Bitcoin. If there is a clever way, or if you want to trust someone to actively manage the money supply and keep it tied to something, you can program the rules to do that.

In this sense, Bitcoin is more like a typical precious metal. Rather than changing the supply to keep the value constant, the supply is predetermined and the value changes. As the number of users grows, the value of each Bitcoin increases. It has the potential to enter a positive feedback loop; as the number of users increases, the value of Bitcoin increases, which attracts more users to enjoy the benefits of the increased value.”

——Satoshi Nakamoto

Satoshi believed that setting a "proper" inflation rate for Bitcoin was impossible (due to the "Local Knowledge" problem) and that this would also introduce a political attack vector, so Satoshi decided to remove human decision-making from the process. Whenever monetary policy changes or is modified, human governance will re-enter the system to invalidate the current money supply, which will ultimately lead to reduced social scalability of the network and increased risk of network splits and disagreements. Therefore, Satoshi believed that a predictable monetary policy was crucial: Bitcoin focuses on long-term stability and transparency, which gives confidence to investors and developers.

In other words, Bitcoin's fixed monetary policy effectively and directly solves a property rights problem: without a fixed supply cap, there is no way to determine how much of the currency any particular holder owns; as a result, a changeable supply policy will almost always weaken an individual's ownership of a share of the currency over time. Because Bitcoin's supply cap solves this property rights problem, these currencies tend to appreciate in value.

This article will not go into an in-depth analysis of Bitcoin’s monetary policy, as the author believes that this would require a very long article.

So why is this fixed monetary policy important? Block rewards incentivize miners to secure the network. As Bitcoin's inflation rate (i.e., the rate at which new coins are issued) approaches 0, miners will only be able to continue to earn income through transaction fees. Some people worry that transaction fees alone will not provide enough compensation for miners, and when storing large amounts of wealth, security and trust are both critical.

Bitcoin inflation rate (orange line) vs. the number of mined Bitcoins (blue line)

Bitcoin's security model

“After a few decades, when mining rewards are too low, transaction fees will become the main compensation for miners.”

——Satoshi Nakamoto

The current Bitcoin UTXO set (i.e., the set of unspent transaction outputs) model and new blocks are secured using game theory and physics. Bitcoin uses a PoW mechanism to ensure that it is difficult to modify the ledger, which eliminates the need for trust while creating external costs for any potential attackers. Miners purchase hardware (capital expenditures) and electricity (operating expenses) and hope to receive corresponding block rewards by consuming work (hashing). From an economic perspective, block rewards incentivize miners to behave properly (i.e., not to do things that harm the entire network).

As the price of BTC increases, the value of the block reward also increases, which incentivizes miners to introduce more computing power (hashrate) into the mining process. The higher the total computing power of a cryptocurrency network, the more expensive a 51% attack becomes. This attack budget protects the Bitcoin network from 51% attacks.

In the early stages of the Bitcoin network, the block subsidy of Bitcoin miners was much higher than the transaction fee. Due to Bitcoin's anti-inflationary monetary policy, Bitcoin's block subsidy will drop by 50% approximately every four years (that is, what we call the mining reward halving: the initial mining reward was 50 BTC, and the first mining reward halving occurred in November 2012, falling to 25 BTC, and the second mining reward halving occurred in July 2016, falling to 12.5 BTC. It is expected that Bitcoin will have its third mining reward halving in May 2020, falling to 6.25 BTC).

A drop in the block subsidy tends to create volatility and higher prices: if demand for Bitcoin remains constant (or increases), then a drop in Bitcoin supply means that the market is undersupplied, leading to higher prices. This effect can bring in new speculators, which is one of the beauties of Bitcoin’s design , as supply shocks increase awareness of Bitcoin. As Satoshi Nakamoto said:

“As the number of users grows, the value of each bitcoin also increases. It has the potential to enter a positive feedback loop; as the number of users increases, the value of bitcoin increases, which attracts more users to enjoy the benefits of the increased value.”

——Satoshi Nakamoto

Bitcoin mining rewards have already undergone two halvings, with the third expected to occur in May 2020.

While the block subsidy (mining reward) and transaction fees represent the same security budget, they are very different. In the case of the block subsidy, its declining trend is valuable both as a reasonable way to issue new BTC and as a way to spread the FOMO (fear of missing out) cycle built into the Bitcoin protocol, increasing the number of Bitcoin believers and network effects. At the same time, the block subsidy further expands the need for miners to earn transaction fees by simply providing network security, which is why it is called a "subsidy."

In the long run, there will be a natural trade-off between the two parties: as the network effect becomes larger, miners' demand for block space will increase, thereby reducing the need for block subsidies. Although we don't know why Satoshi Nakamoto specified the issuance plan of Bitcoin so clearly, we can speculate that the mining reward is halved every four years, which leaves enough time for related planning and construction work. You know, in the same long period of time, the entire United States also gives each president four years to promote the development of the entire country.

From the modeling provided by Awe & Wonder in the figure below, we can see that around 2030, Bitcoin transaction fees will begin to take up a significant portion of the block reward (see the yellow dotted line in the figure below). When transaction fees account for more than 50% of the block reward for a long time (on an annual basis), Bitcoin will develop to rely more on transaction fees (rather than block subsidies) to continue to operate.

Charts and forecasts provided by Awe and Wonder

Critics of Bitcoin often argue that transaction fees alone cannot provide adequate security for Bitcoin. But how is an appropriate level of security defined? This is highly subjective, as the number of confirmations one waits for a transaction depends on the size of the transaction and the health of the network. However, despite this subjectivity, we should try to calculate Bitcoin's security level. At the MIT Bitcoin conference, Nic Carter proposed several ways to quantify an adequate security budget:

• Threshold: At a certain level of security expenditure, Bitcoin is considered safe;

• Stock: Security spending should be tied to the value of Bitcoin itself;

• Flow: Transaction fees must be large relative to the volume of transactions;

The author believes that the best measure of security is the percentage of stock, which will eventually reach a threshold level. Stock is more meaningful than flow because as the efficiency of ASICs (dedicated mining chips) decreases, miners will increasingly focus on long-term operations. Eventually, Bitcoin's security will reach a certain threshold level that even the richest countries will find difficult to break.

Hundreds of billions of dollars at the current value of the dollar would be a sufficient security budget, as it would be very difficult for a government to spend such a huge amount of money to launch a 51% attack on Bitcoin, and the government would also have to respond publicly to such an attack because its citizens (taxpayers), businesses, and banks would all be invested in Bitcoin.

It is worth noting that a 51% attack cannot "kill" Bitcoin because you still cannot easily reverse historical transactions.

Finally, if in the worst case scenario of a sustained 51% attack, the UTXO set (i.e., the set of unspent transaction outputs) must be preserved. If the SHA256 algorithm must be abandoned, then so be it. In this case, Bitcoin may switch to another mining algorithm that already has a mature market - which will render all countries' mining equipment ineffective. The author wants to make it clear that this will be a last-ditch effort, and while there is no guarantee that it will succeed, the consequences of this situation may prevent a country from attempting such an attack.

It is worth noting that the PoW mechanism not only minimizes 51% attacks, but also achieves other goals (see the figure below) and improves network effects, while ensuring that the cost of creating BTC is very high.

Bitcoin hashrate not only minimizes 51% attacks, but also:

• Allows nodes to reach consensus on a single global state;

• Ensure that counterfeiting BTC is very difficult;

• Define the cost of each BTC and use that cost as a proxy for Bitcoin’s value.

Blockspace is a scarce and unique commodity

We can think of "mining" as buying a portion of a block. For example, a fixed amount of land is created every 10 minutes on average, and those who want to trade bid for a portion of this land. Selling this land is the incentive for miners to continue mining and maintain the security of the Bitcoin network, even when Bitcoin's inflation rate is zero (that is, all Bitcoins are mined).

The price of this land is determined by the demand for transactions, as the supply of land is fixed and known. The basic premise is that if the Bitcoin network is used (i.e. there is demand for transactions), then miners who validate/secure the network will be rewarded.

Some people argue that altcoin blockspace is a viable alternative to Bitcoin blockspace. However, there are many ways to disprove this argument. Bitcoin real estate is prime real estate (e.g., no matter how cheap land is in Midland, Texas, it will never have the same views or social networks as San Francisco, so it will be in less demand). The unique value of Bitcoin blockspace is its security, exchange, volatility, and coordination costs.

01. Security costs: Bitcoin is the most secure cryptocurrency network (thanks to its accumulated total computing power). This will create a market for safe high-value Bitcoin transactions , such as central banks, governments, enterprises, and other high-value payment users, who will be happy to pay very high transaction fees. This is why other blockchains (such as Verblock) use Bitcoin's strong security to conduct on-chain transactions.

02. Exchange costs: When both the sender and receiver of a transaction want to store Bitcoin as value but need to transfer it, if the sender converts BTC into some altcoin, then sends the altcoin to the receiver (the handling fee will be lower), and then the receiver converts the altcoin into BTC, friction will be generated in the process. There is an indifference point between the exchange fee (between 0.1-4%), the spread (altcoins have lower liquidity and therefore lower prices), and the two BTC and altcoin transaction fees involved. If this point is exceeded, it is better to send BTC directly and pay a certain amount of BTC handling fees. If Bitcoin is a very good means of storing value, it will also increase transactions within BTC for this reason.

03. Volatility costs: People tend to ignore volatility costs. Volatility costs depend on your holding period. Altcoins usually have higher price volatility than BTC, which makes their volatility cause users to bear higher transaction costs as the transaction scale increases. See the example below:

• LTC: $10 transaction value + 10% volatility + 0.01 fee = $1.01

• BTC: $10 transaction value + 1% volatility + 0.20 fee = $0.30

• LTC: $100 transaction value + 10% volatility + 0.05 fee = $10.05

• BTC: $100 transaction value + 1% volatility + $1.00 fee = $2.00

As can be seen from the example above, higher price volatility tends to result in higher transaction costs.

04. Coordination costs: Not all cryptocurrencies will survive. There will be a limited competitive market for block space. This is because our minds are limited, and we will not want to keep 250+ cryptocurrency names, 250+ transaction fees, and 250+ different prices in our heads, and choose the cheapest price every time we want to transfer value. Our brains can only support understanding the value of 2-3 cryptocurrencies at most, and to a certain extent, we can easily use them interchangeably. In addition, since Bitcoin HODLers have a strong preference for trading BTC, multicoiners will be forced to use Bitcoin for trading. For example, Square, Bakkt, and Fedility currently only support Bitcoin trading.

Finally, the Bitcoin Core software is competing with the traditional mature ecosystem. This increases the value of Bitcoin’s unique block space as more developers and businesses study and rely on Bitcoin’s code.

Given all of the above, there will be a limited number of cryptocurrencies in the future, as will block space and transaction volume. This means that the cost of transferring value will be distributed among the surviving blockchains in proportion to the value and security demand. In other words, the higher the demand for a certain value and its security, the higher the transaction transfer cost (i.e. transaction fee) allocated on that chain. But ultimately, each altcoin offers a lower security model and a higher risk.

However, I believe that a large portion of cryptocurrency payments are generated out of curiosity, although I have little data to support this statement (and it is quite subjective). It should be noted that compared with traditional payment methods, using cryptocurrency payments is more difficult, more expensive, and slower. Nevertheless, Bitcoin's base layer is the strongest foundation for building a new global monetary system, rather than creating another payment platform like Venmo.

In the above chart, the current “spend bitcoin” (blue line) is barely visible.

Above: Users do not expect to use any cryptocurrency to purchase goods, otherwise we would see an upward trend in “spend bitcoin” even if its price fluctuates, when in reality it is not.

Trading requirements

“I’m sure in 20 years, Bitcoin will either have a lot of volume or no volume.”

——Satoshi Nakamoto

Another concern is that as Bitcoin transaction fees get higher, users will avoid making transactions to avoid paying transaction fees. In practice, however, we see that this is not the case (see the figure below): as transactions/transaction volume increase, transaction fees also increase.

Price elasticity

“Think of transaction fees as insurance premiums. You’re paying for security.”

——Ari Paul

The fees that Bitcoin transactors need to pay are largely determined by the nature of the type of payment being sent, namely Bitcoin being an immutable store of value (SoV). During the height of the Bitcoin network congestion in 2017, the average transaction fee was $38. During this time, we have seen transaction fees exceed the block subsidy. Below we compare the cost of transacting SoV:

01. Wire transfer of legal currency

For US banks, the average domestic wire transfer fee is $30-40, and the average international wire transfer fee is $65-80 (regardless of whether the transfer is inbound or outbound).

02. Offshore Banking (7 Trillion USD Market)

"Monthly offshore bank account maintenance fees range from $20 to $100. Wire transfer fees typically range from $25 to $75." Data source:

https://www.offshorecompany.com/banking/costs/

03. Real estate (250 trillion market)

"From April 2017 to March 2018, Chinese buyers purchased 40,400 apartments for a total of US$30.4 billion. They spent an average of US$439,100 per purchase." Data source:

https://www.gbreb.com/GBREBDocs/GBAR/News/Informer/2018/2018-profile-of-international-transactions-in-us-residential-real-estate-07-26-2018.pdf

04. Physical gold delivery (7.5 trillion market)

Donald McIntyre, a member of the ETC (Ethereum Classic) development team, once asked the German central bank to provide information about the Federal Reserve Bank of New York's transfer of 300 tons of gold (worth $12 billion at the time) from New York to Frankfurt. The response he received was that the delivery took three years and cost $4.8 million.

For smaller quantities of gold delivered, insurance, freight, or physical protection costs during the pickup/delivery process may need to be paid, and the estimated cost is at least between US$10-100.

Increase transaction density

Nic Carter, co-founder of cryptocurrency analysis company Coinmetrics, once emphasized two ways to increase transaction demand in a speech at MIT: increasing the economic or semantic density of transactions. Semantic density refers to allowing other blockchains to embed data into the Bitcoin blockchain, such as Veriblock. Economic density is about increasing the types of transactions in Layer 1, as follows:

01. Privacy Protection

“Schnorr signatures can create new transaction types, break heuristics widely used in blockchain analysis, and make it nearly impossible to locate a specific entity by viewing the blockchain, while allowing for a greater density of transactions per block by aggregating signatures.”

——Lucas Nuzzi

02. Layer 2 (such as Lightning Network)

As Bitcoin makes progress in scalability (Schnorr signature algorithm for Layer 1, Lightning Network for Layer 2, etc.), the Bitcoin network will become more and more efficient, driving increased usage on the chain. The Jevon paradox intuitively predicts this - as cars become more fuel efficient, the number of miles driven by cars will increase each year. Layer 2 will support a large number of low-cost small transactions, while Layer 1 represents a higher-cost settlement layer for large transactions.

As businesses and Lapps (Lightning apps) are built on the Lightning Network, a large part of the operating costs of these businesses and Lapps will be managing payment channels. This will ensure that there is a continuous demand for Layer 1 settlement when these operators adjust the balances of funds between the transacting parties in the payment channel (rebalance) and optimize the transaction volume & connectivity of the channel. On-chain, block space is an additional fee, so transactions need to pay a fee to register the transaction in block space; off-chain, liquidity is an additional fee, so transactions will be charged a fee based on the amount transferred through the channel (because it involves rebalancing the balances of the transacting parties). In other words, on-chain transactions and off-chain transactions have different fee models, and they complement each other. On-chain, transaction fees are fixed regardless of the transaction value; off-chain, transaction fees are priced as a percentage of the transaction value. There is a crossover point between on-chain and off-chain transaction fees, at which high-value transactions will require higher costs to be conducted on the Lightning Network than on Layer 1 transactions.

We’ve seen reports that Lightning is increasing Layer 1 usage, even in a highly experimental phase. In February 2019, a block was created where 25% of transactions were done through Lightning channels. This was detectable because Lightning used Segregated Witness (SegWit) for its scalability fix, and all open Lightning channels were SegWit transactions.*

03. Quantum-resistant computing

“The adoption of quantum-resistant computing technologies will also result in larger (and more expensive) transactions. Post-quantum cryptographic algorithms require larger key sizes, which in turn increases the size of non-witness data in transactions.”

——Lucas Nuzzi

04. Overall

Experience shows that total transaction fee revenue will slowly rise to match the block subsidy over the next few decades. Based on this data, concerns that transaction fees will not replace the block subsidy are undoubtedly overblown.

The figure below shows the trend of transaction fees (yellow line) as a percentage of block subsidies (it will tend to 100% in the future, that is, transaction fees completely replace block subsidies).

Graphics courtesy of Awe & Wonder

As Alex Sunnarborg points out, only Bitcoin and Ethereum have enough transaction fees to compensate miners for their losses without inflation. It is unlikely that any other network will be competitive.

Daily transaction fee changes of mainstream blockchain platforms (BTC vs ETH), source | CoinMertrics

Safe stability

“Volatility in transaction fees may result in correspondingly large fluctuations in hashrate.”

——Nick Szaboq

A legitimate concern is that in a future security model that is purely supported by transaction fees, cash flows will be volatile. Transaction fees are market-centric, meaning they will fluctuate as supply and demand change. The underlying assumption is that cash flows from transaction fees will be volatile, making the network less secure. Dan Mcardle sums this up well:

What miners like is a steady cash flow, which is why they join mining pools. Instead of playing short-term games to win a block, they socialize mining rewards.

The worst case scenario is that the transaction fees obtained from mining are unstable, but this will not actually destroy the entire system. It is just that before the transaction fees grow to a certain level, transaction confirmation will take longer. Due to the need to take time priority, entities (companies or individuals, etc.) will increase the handling fee to respond to the problem of long confirmation time.

Furthermore, the block subsidy has been very volatile in real terms over the past few years, but mining has remained strong and stable - even with an 80% drop in the value of the block subsidy. This "instability" has not yet affected the entire Bitcoin network, and as the market continues to mature, the mining industry will continue to become more resilient to large fluctuations in transaction fees.

In the future, miners may be able to auction off "land" in future blocks in advance, which could have a stabilizing effect on their income (much like farmers selling agricultural futures). The basic premise is that if Bitcoin usage continues to increase, the free market for future block space will correctly price block space.

Finally, if this is a major problem that the market cannot naturally correct, we could make some minor changes in the Bitcoin protocol to smooth out the transaction fee revenue for miners. However, this would make the base protocol more complex, and the game theory behind the Bitcoin protocol is not well-studied.

Conclusion

We have discussed what a sufficient level of security means, Bitcoin's primary (non-copyable) block space, transaction demand, what happens when the block subsidy does not exist, and the stability of security. As Bitcoin's inflation rate approaches 0, miners will only be able to continue to earn revenue through transaction fees. As the network effect becomes larger, miners' demand for block space will increase, reducing the need for block subsidies. Of course, if Bitcoin has no economic (transaction) volume in the next 10 years, it may also fail.

The Bitcoin experiment has been going on for 10 years, and despite the harsh environment it has experienced in the past, all the data shows that we have every reason to believe that it will continue to prosper.