Bitcoin's security ticking time bomb
Bitcoin price enthusiasts are often happy to tell you that the number of Bitcoins minted every year is declining exponentially, which they hope leads to a supply crunch. What they don't tell you is that this schedule also will choke the miners who provide security out of existence. This could lead to a catastrophic collapse, making any sort of Bitcoin Strategic Reserve and embarrassingly asinine risk.
How Bitcoin Security Works
Bitcoin is a ledger of ordered transaction. While the payments are often described as "peer-to-peer," this description misses the fact that every payment needs to be checked by miners for consistency with the current blockchain and then added to the ledger in an order chosen by the miners, and then the tens of thousands of node around the world need to communicate this to each other. Miners are engaged in a constant digital needle-in-a-haystack search, churning out trillions of hashing computations per second. If they find the needle they get the right to add the next set of a few thousand transactions to the chain, and they also get the right to mint themselves new bitcoin, called the block subsidy. Right now this block subsidy is 3.125 bitcoin. A mechanism called the difficulty adjustment calibrates the difficulty of finding the needle-in-the-haystack so that on average the blocks will only be found once every ten minutes.
Now in order for the number of bitcoins in existence to converge to a fixed number, the block subsidy programmatically cuts itself in half every four years. Initially it was 50 bitcoins per block. The first halving in 2012 halved the block subsidy from 50 to 25 - earlier this year it was cut from 6.25 to 3.125. A little bit of math tells you where this is going; every 20 years, this cuts down by a factor of 32. The block subsidy will be less than 0.1 in 2044. By 2140 this number will fall below the precision tracked in Bitcoin transactions, and all bitcoin will be have been mined. Another way to describe this: Between 2009 and some date in 2012, 50% of all bitcoins that will ever exist where minted. In 2016 we crossed the 75% threshold. As of now in 2024, about 94% of bitcoins have been created, and there are only about 6% left to be given to miners in all of Bitcoin's future.
Now fortunately for the miners, they also receive fees that come out of the transactions themselves. When you send a bitcoin transaction, you typically designate some small amount for the miner. The miner then chooses the transactions with the highest fees and includes these in the block, which has limited space.
Recently (as of December 17, 2024) the block subsidy in real dollars is about $330,000 while the fee revenue is around $10,000. The fee revenue tends to jump all over the place, surging during bull markets and when fads like ordinals are being pumped, but spending most of the time in somewhat depressed territory. As recently as 2022 there were frequently blocks with fees only in the hundreds of dollars range.
This fee revenue is, in theory, what will keep miners afloat once the block subsidy dwindles away; at least that's the hope. But there's some major problems with this right off the bat:
1) There has never been a sustained period where fees have gone anywhere near the block subsidy. Bitcoin's future security model is based on hopes of a development that hasn't been observed yet.
2)Even if a robust fee market does develop (and people are willing to pay hundreds of dollars per transaction) this an entirely new game theoretic regime. Without the block reward being worth significantly larger than fees, game theory suggests that miners will begin to steal each other's fees by rewriting blocks that already have been written, causing the ledger to be unstable and unpredictable.
3)The future is closer than Bitcoiners would like to tell you: "We don't have to worry about that until 2140" is a common defense, but the fact of the matter is that this transition to fees should happen within the next 20-25 years.
Bitcoiners (the real ones at least) have always been fully aware of this
This problem is not something that some haters made up recently. Much of the early discussion among Bitcoiners was about this topic. In 2015-2017, Bitcoin fought sort of a civil war, now called the "Block Size Wars." One of the disputes was how to avoid the "fee market death spiral": The small block model (few transactions, higher fees) versus the large block model (many transactions, lower fees.)
This conflict was largely fought when Bitcoin was under $1000. Then as billions of dollars began to pour in small blockers won this war as the narrative coalesced into a "container ship" aspiration for future Bitcoin security: In the future, transactions will be high value because we will have innovated some way to aggregate transaction fees in a way to pass the fees on to miners.
At the time, the hopes were pinned on the Lightning Network. Lightning is a clever cryptographic innovation allowing two users who create a joint transaction to send payments back and forth to each other at the speed of the internet, and then build a network out of such channels. While this was a incredibly cool idea, in practice, it doesn't work like Bitcoiners hoped. Many within the Bitcoin community have declared it a failure.
Old school Bitcoiners, in particular those around before the Block Size War have always been tuned into the problem. Peter Todd, (recently accused by HBO of being Satoshi) has argued in favor of tail emissions, a proposal that would break the finite supply promise of Bitcoin in favor of more payments to miners. Paul Sztorc has been actively working on the problem for a decade, promoting Drivechains, built around the idea that allowing sidechains to plug in to the small blocks will allow enough fee revenue to save the network from disaster. Paul has written extensively on how Bitcoin is doomed without any new ideas.
But after the price first breached $20K in 2017, the money manager class saw the potential and jumped in the money grab. The narrative began to shift away from tough questions like "how do we ensure this payment network is robustly secured against government and corporate interests?" and to much more exciting and numerable questions like "if everybody in the world puts 2% of their portfolio into Bitcoin, how rich will we all be?" It then became a sort of a cutting of teeth ritual among Bitcoin influencer to "debunk" the "security budget FUD." Many prominent Bitcoiners have made attempts to do this. Most debunking are not assurances of security, they are usually arguments that it is at least feasible that Bitcoin doesn't succumb to the fee market death spiral.
Some examples :
Nic Carter, founding partner at Castle Island Ventures,
Lyn Alden, investment strategist and the founder of Lyn Alden Investment Strategy
Jameson Lopp, Co-founder and Chief Technology Officer (CTO) of Casa,
Hasu, well-known pseudonymous researcher and writer in the cryptocurrency space. (with James Prestwich, and Brandon Curtis.)
If you do take the time to read these assessments (there are many others) you'll notice a trend: Concern about Bitcoin security "FUD" seems to be higher among those with actual experience in research or writing code, and becomes lower the closer one is to huge piles of money. People who know the most seem to know one thing: They have no idea how this will play out.
Jameson Lopp condensed his thoughts into a tweet:
The future of Bitcoin's security budget is a Schrödinger's cat.
Anyone who claims to know what will happen is relying upon unprovable assumptions.
One thing is clear: the best way to fend off a security budget crisis is to continue furthering adoption on all fronts.
One thing that anyone who has looked at this seems to agree upon: In order for Bitcoin to stay viable; adoption (that is people actually using Bitcoin) has to increase orders of magnitude beyond what it is now.
And that's exactly the problem, there is little evidence that adoption is surging. The hope with a Bitcoin Strategic Reserve is that it will kickstart the adoption, but this hope isn't based on any sort of observed reality, or theory. People do not use a skyrocketing speculation asset that costs many dollars to send as money, they use it as a a skyrocketing speculation asset. What's left is the hope that enough high net worth individual and institutions will be happy to pay, say $1000 to send themselves $10 million in bitcoin, because, as a percentage this is a tiny fee. This is the view of Michael Saylor, who has been obnoxiously hoarding Bitcoin for the last few years via MicroStrategy. It's not that it's impossible that hundreds of centi-millionaires in 2045 are sending themselves huge Bitcoins transactions every minute, it's just a bit of any iffy proposition to bet a treasury on.
What does the fee market death spiral look like?
There's many paths this can take, they don't really take a ton of creativity, but this is one possibility. Suppose that in 2048, Bitcoin is worth $1 million. The halving occurs in early 2048, and the block subsidy will drop to from 0.09765625 to 0.04882812 or from about $98k per block to $49k block. Suppose there are around $10k per block are in fees. Now due to the market mechanism involving mining, by now the market will have matured, and we can expect that miner are making almost $108k in expenditures, at least well over the $59k they get after the halving. If they keep mining, they're collectively going to lose almost $300k an hour. Some miners will be forced to drop out, go bankrupt, or sell saved up bitcoins to pay bills. Let's say also that the FOMO geist is gone, Bitcoin is like gold, boring. Suppose a miner goes bankrupt; their coins and equipment are auctioned off. The coins sold into a lackluster market causes a further drop. Now the equipment is held by some private equity LLC who bought them all for a cheap. The private equity company places $500 Billion in Bitcoin shorts, and then turns their machines back on. Now they are losing money mining, say $1 million per day, but this forces other miners to also lose money. After a few months they've lost $100 million in wasted electricity, but they've forced other miners out into bankruptcy court. As other miners sell coins and equipment, people start to smell what's happening. Everybody starts to short Bitcoin, there is no floor, just something that started at $20T and headed quickly to zero. Finally, the private equity who bought all the ASICs turns their machines off. Due to the difficulty adjustment, Bitcoin blocks will stop being found: Because the subsidy is so small miners will be reluctant to turn on their machines to find the next block. The crisis of confidence continue; everybody is racing for the exits.
The thing about this scenario is that it's more final than say the usually post-FOMO crash of recent cycles. The mining business will have been completely wrecked, and this the moment the scheme is exposed. In previous cycles miners have mined through this with no problems.
(If you think Bitcoin will be worth $2 million in 2048, just replace 2048 by 2052 and repeat the exercise.)
OK but why hasn't this happened before?
It's reasonable to ask why the security budget death spiral hasn't hit yet. The simple answer is that we are outrunning it while on the way up.
Bitcoin has been more than doubling every four years against the dollar, so the dollar amount paid to miners has still been rising upwards overall. More miners are still joining the fray to chase the increasing reward.
Many of the miners are enthusiasts and holders themselves, so have been making money on the appreciation of the asset itself, still coasting on being early movers in a profitable industry. Many miners have been profitable in US dollar terms, but not necessarily Bitcoin terms, because they held onto rewards they were acquiring along the way. So even if they weren't the most competitive miner in the pack, they still can stay in business as long as they're enjoying profits from the bull market.
Because miners are still making money, they don't have to be incredibly cutthroat. The real game theory hasn't kicked in yet. Miners have made investment in technology that will only pay off if they can continue to mine. But once margins compress enough, all bets will be off. We don't know what happens then.
It's not a guarantee that Bitcoin will collapse in 30 years, very much like it's not a guarantee that if you leave a backpack in your car in San Francisco, your car's window will be smashed. It might not happen exactly like the pessimists predict. But to pretend that there is no problem is dishonest.
