Fees, Prices, and Irrational Markets
Key Takeaways:
- The next block reward halving is scheduled to take place in May 2020
- Miners may be concerned that the biggest source of their revenue will be cut in half
- Fees and rising bitcoin price are two ways that miners may be compensated for the loss they incur from the block reward halving
The block reward halving is an interesting phenomenon coded into the bitcoin protocol which has been central to much speculation. The halving results in the block reward miners receive for appending blocks to the blockchain being cut in half approximately every four years.
Both prior halving events in 2012 and 2016 resulted in significant price increases and many believe that this will be a regular occurrence. However, the implications of the halving on a number of variables such as the network fees and the price remains far from certain.
With the next halving estimated to take place in May 2020, this event is likely a key concern for miners. We analyse the impact the halving may have on the network fees and the price to assess whether miners are likely to be compensated for the reduced block reward they will receive.
Miner Implications
Miners earn their revenue from two sources – the block reward and transaction fees. With the block reward scheduled to halve, will fees rise to compensate for the lost income?
Not necessarily.
Fees are decided at the discretion of the network user, typically someone sending bitcoin. Higher fees incentivise miners to include a transaction in the block being appended to the blockchain but the transaction will still sit unconfirmed in what is known as the mempool until then.
This means that fees are more closely associated with the demand to use the network than they are with the block reward. Historically, mining fees have only represented a fraction of what miners earn from block rewards.
However, this fraction has been generally increasing.
Despite there being no direct relationship between mining fees increasing upon block rewards halving, transaction fees have been on average increasing over time.
While miners are not guaranteed to be compensated for their loss in block rewards with compensation in fees, the fees will likely continue to provide some relief to miners at least between the 2020 halving and the 2024 halving.
However, there is one metric which holds the power to completely compensate miners for the reduced bitcoin they will be receiving in the block reward. That is the value of bitcoin.
The Impact of Halving on Price
It’s a common belief among analysts and enthusiasts that the block reward halving is an event that serves to push prices significantly higher. There are a number of assumed reasons for this:
- Price increases after the previous halvings
- Bitcoin becoming a scarcer resource due to the rate of issuance halving, and new coins being released into a larger circulating supply
- Less selling pressure from miners who sell their block rewards on the market
Let’s break down the reasons to assess if they hold weight.
The prior price increases are not a strong reason. Firstly, the past is not the best indicator of the future. Secondly, only two prior halvings are not enough to make any strong statistical claims. Thirdly, there has been plenty of times in which the price of bitcoin has increased without the block reward halving.
Less bitcoin being issued into an ever larger supply is a valid reason why value should go up at face value. It is a mechanism coded into the protocol that serves to make bitcoin an artificially scarce resource.
However, with the halving event being publicly known among all in the market, rational market participants should be able to price this in leading up to the halving. This would result in no significant spikes around the halving. Given that market participants are not always rational, this reason still holds weight.
What about less selling pressure from miners who sell their block rewards to meet costs? A simple comparison of volume sizes can debunk this theory.
Miners currently receive roughly 18,000 bitcoin in block rewards per day. Assuming that all of this is dumped on to the market, it would equate to roughly $90 million at prices at the time of writing.
This is a minuscule amount when compared with the average daily trading volume of bitcoin conducted on exchanges. There is no reason to believe it would have any significant impact when compared with the trading that takes place on exchanges.
Theoretically, there is no solid reason as to why the price should be driven up around the halving. However, the markets tend to not follow theories. There is only one strong reason that the price could see a significant increase around the next halving: expectation.
Market prices are based on the cumulative expectations of market participants. Halving events result in increased media attention, speculation from analysts, and likely a degree of FOMO among the talks of less bitcoin being issued into existence.
With the market having a significantly greater capital pool than the last block reward halving in 2016, a change in a few factors such as media coverage and general market sentiment could manifest itself in a significantly greater price.
Conclusion
Theory and data give us conflicting signals regarding what miners can expect in the upcoming block reward halving. Theoretically, there are no strong reasons that miners will be compensated in other means to match the reduced block rewards.
However, markets often do not behave according to theory and miners may be compensated for their reduced block reward either partially or fully by increases in price and/or increases in transaction fees.
