On May 11, 2023, the Bitcoin network underwent its fourth halving event, a pivotal moment that slashed the block reward from 6.25 to 3.125 BTC. This quadrennial occurrence, hardcoded into Bitcoin’s protocol, has once again reshaped the economic landscape for miners and sparked discussions about the network’s future. Let’s delve into the technical intricacies and economic repercussions of this event.

Article originally prepared in Italian for my personal podcast Disruptive Talks (read it here).
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The immediate aftermath: fee dynamics and network resilience

In the wake of the halving, the Bitcoin network experienced a notable shift in its fee structure. Transaction fees, which had traditionally played a secondary role to block rewards, suddenly became a crucial component of miners’ revenue streams. At its peak, fees constituted up to 30% of total miner income, a significant increase from pre-halving levels.

This surge in fees was not merely a knee-jerk reaction but a complex interplay of several factors. The introduction of Ordinals and Inscriptions—essentially NFTs and tokens on the Bitcoin network—contributed substantially to network congestion and, consequently, higher fees. These innovations, while controversial, demonstrate Bitcoin’s evolving capabilities beyond simple value transfer.

From a technical standpoint, the fee spike can be attributed to the sudden reduction in block space supply (as measured in satoshis per byte) relative to demand. The halving effectively doubled the “cost” of including transactions in a block for miners, leading to a natural upward pressure on fees. This phenomenon can be expressed mathematically as:

Fee_pressure = (Block_reward_reduction / Block_space) * Transaction_demand

Where Block_reward_reduction is 50% in this case, Block_space remains constant at 1MB (or 4MB weight units with SegWit), and Transaction_demand is a variable influenced by market conditions and network usage.

Hash Rate resilience: a testament to network health

Contrary to some predictions, the network’s hash rate—a measure of the total computational power securing the Bitcoin network—showed remarkable resilience. After a brief dip immediately following the halving, it quickly stabilized and even grew. This resilience can be attributed to several factors:

1. Technological advancements: the latest generation of ASIC miners, such as the Antminer S19 XP Hyd. and the WhatsMiner M50S++, boast efficiency ratings of up to 20.8 J/TH (joules per terahash). This represents a significant improvement over previous generations, allowing miners to maintain profitability even with reduced block rewards.
2. Difficulty adjustment algorithm: Bitcoin’s difficulty adjustment mechanism, which recalibrates every 2016 blocks (approximately two weeks), played a crucial role in maintaining network stability. The algorithm can be expressed as:

   New_Difficulty = Current_Difficulty * (2016 * 10 minutes) / (Time to mine last 2016 blocks)

This adaptive system ensures that block times remain consistent regardless of fluctuations in hash rate.

3. Strategic relocation: many mining operations have strategically relocated to regions with lower electricity costs, such as Texas in the United States or certain provinces in China that offer abundant hydroelectric power. This geographical arbitrage has helped offset the impact of reduced block rewards.

The rise of “Ordinals” and “Inscriptions”: a new era for Bitcoin?

The post-halving period coincided with the explosive growth of Ordinals and Inscriptions, introducing new functionalities to the Bitcoin network. These innovations leverage the OP_RETURN opcode and witness data to store arbitrary data on the blockchain, effectively creating Bitcoin-native NFTs and tokens.

From a technical perspective, Ordinals work by assigning a unique identifier to each satoshi (the smallest unit of Bitcoin), allowing for the creation of “rare” satoshis. Inscriptions, on the other hand, embed data directly into transaction witnesses, bypassing the traditional 80-byte OP_RETURN limit.

While these developments have been controversial due to their impact on fees and block space utilization, they represent a significant evolution in Bitcoin’s capabilities. The ability to create and transfer unique digital assets directly on the Bitcoin blockchain opens up new use cases and potentially increases the network’s value proposition beyond mere monetary transactions. But this open’s up a debate on Bitcoin ETOS as a store of value that we will not evoke here.

Economic projections and long-term implications

The post-halving economy of Bitcoin mining is characterized by a delicate balance between operational costs, hash rate, and market price. To understand this relationship, we can use a simplified version of the miner’s profit function:

Profit = (Block_reward + Fees) * Bitcoin_price - (Operational_costs + Capital_expenditure)

As block rewards decrease, the importance of fees and Bitcoin price in maintaining profitability increases. This shift could lead to a more volatile mining ecosystem, where profitability is more closely tied to market conditions and network usage.

Looking ahead, the industry faces several challenges and opportunities:

1. Energy efficiency imperative: with each halving, the pressure to improve energy efficiency intensifies. We can expect to see continued innovation in chip design and cooling technologies, pushing the boundaries of what’s possible with current semiconductor technology.
2. Layer 2 solutions and scalability: as on-chain fees potentially rise, the development and adoption of Layer 2 solutions like the Lightning Network become increasingly crucial. These technologies promise to alleviate congestion on the main chain while preserving its security properties.
3. Regulatory landscape: the growing prominence of Bitcoin mining as an industry has attracted regulatory attention. Future halvings will likely occur in a more regulated environment, potentially impacting everything from energy consumption to financial reporting for mining operations.

A network adapting and evolving

The 2023 Bitcoin halving has once again demonstrated the network’s resilience and adaptability. The interplay between miners, developers, and users continues to shape the ecosystem in unexpected ways. As we look towards future halvings, it’s clear that Bitcoin’s journey is far from over. The network’s ability to maintain security, innovate functionally, and adapt economically will be key to its long-term success.

While challenges remain, particularly in terms of scalability and energy efficiency, the post-halving landscape suggests a maturing ecosystem capable of weathering significant changes. As always in the world of Bitcoin, the only constant is change, driven by the relentless march of technological progress and the ingenuity of its global community.

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Notes

For those interested in exploring the technical and economic aspects of Bitcoin’s halving and its aftermath in more depth, here are some valuable resources:

Technical analysis and data

1. Blockchain.com Explorer: real-time Bitcoin blockchain statistics and visualizations.
2. Glassnode Studio: advanced on-chain analytics for Bitcoin and other cryptocurrencies.
3. BitInfoCharts: comprehensive charts and comparisons of various Bitcoin metrics.

Mining and hash rate

4. Bitcoin Mining Council: information on sustainable Bitcoin mining practices and industry trends.
5. Braiins Insights: technical articles on Bitcoin mining from a leading mining software provider.
6. Cambridge Bitcoin Electricity Consumption Index: detailed estimates of Bitcoin’s energy consumption and carbon footprint.

Ordinals and Inscriptions

7. Ordinals Protocol Documentation: official documentation for understanding and working with Ordinals.
8. Hiro Systems – Ordinals Explorer: an explorer specifically designed for Ordinals and Inscriptions on Bitcoin.

Economic analysis

9. CoinMetrics State of the Network: weekly reports on crypto asset fundamentals, including post-halving analysis.
10. Kraken Intelligence Research: in-depth market research, including analysis of Bitcoin halving effects.

Technical developments and scaling solutions

11. Bitcoin Core: the primary software implementation of the Bitcoin protocol.
12. Lightning Network – Lightning Labs: resources and tools for the Lightning Network, a Layer 2 scaling solution for Bitcoin.

Academic and research papers

13. Coindesk Research Reports: comprehensive reports on various aspects of the cryptocurrency ecosystem.
14. arXiv Cryptography and Security: academic papers on cryptography and security, including Bitcoin-related research.

Community and discussion

15. Bitcoin Talk Forum: one of the oldest and most active forums for Bitcoin discussion.
16. r/Bitcoin: the main Bitcoin subreddit, featuring discussions, news, and analysis.

Books for in-depth understanding

17. “Mastering Bitcoin” by Andreas M. Antonopoulos: a comprehensive technical guide to Bitcoin.
18. “The Bitcoin Standard” by Saifedean Ammous: an economic analysis of Bitcoin’s role in monetary history.