What Happens When Bitcoin's Transaction Fees Disappear?
Discover how Bitcoin's declining transaction fees threaten its security model. Learn about potential solutions like Layer-2 rollups and Bitfinity's EVM-compatible sidechain
As mentioned several times on our Bitfinity blog, Bitcoin has THE strongest consensus mechanism, with the most diverse nodes verifying the blockchain and the most secure blockchain in the world.
However, the Bitcoin community has long been aware of the potential risks associated with the proof-of-work (PoW) consensus mechanism that underpins the 'safest' network.
A growing body of evidence suggests that the security model is facing a ticking time bomb, one that could have far-reaching consequences for the entire cryptocurrency ecosystem. Is this true, and what is at the heart of this issue? Let's take a look...
The Decline of Transaction Fees
It all comes down to transaction fees, which are a crucial component of the Bitcoin security model, as they provide a source of revenue for miners to secure the network.
By coming down, we also mean that transaction fees are declining, which is not a good thing. The data suggests that fees are at a 9-year low, constituting just 1% of miner revenue. ⛏️😭
The 30-day moving average of daily transaction fee volume is now at 6.5 BTC/day, a level that is lower than at any point in the past 13 years. This decline in fees is not a new phenomenon for the miners; it has been a persistent trend over the past decade, with fees decreasing faster than the block reward issuance.
To understand the significance of this trend, it's essential to examine the historical context. The Bitcoin network has undergone several halving events, which have reduced the block reward issuance by half.
Hans
However, the fees have not increased correspondingly, resulting in a decline in the overall security budget. For instance, in March 2016, the block reward was 25 BTC, and fees constituted 1% of the security budget. In March 2020, the block reward was 12.5 BTC, and fees still constituted 1% of the security budget. This trend has continued, with the block reward now at 6.25 BTC and fees remaining at 1% of the security budget. What this trend could mean...
The Consequences of Low Fees
The implications of low transaction fees are dire. If fees were the only source of miner revenue today, the revenue would drop by a factor of 100, leading to a corresponding decrease in hashing infrastructure.
Possibility of a 51% attack
Could it be that when this happens, the possibility of a brute force 51% attack is there? Well, the community is divided on this subject.
While a 51% attack by a single entity becomes more feasible with falling hashrate, the sheer scale required is still enormous. Producing the millions of ASICs and generating 25 gigawatts of power (double NYC's consumption) would be a massive undertaking for any actor, even a nation-state. It would also be very difficult to hide such an operation.
See all articles by Lucas Nuzzi
Some argue that the true risk is censorship by mining pools, not raw hashrate attacks. But Bitcoin's game theory around transaction fees creates strong incentives for miners to resist censorship. 🧐
We've already seen some concerning incidents, like F2Pool admitting to censoring transactions based on OFAC compliance.
Hans
Interesting to know is that block producers can censor transactions by excluding them from blocks and rewrite chain history with majority collusion (51% attack). However, they cannot arbitrarily change protocol rules, like the max supply, or steal user funds by forging signatures.
When Prices Rise Who Pays the Price?
But what if the price goes parabolic and it becomes harder to sustain high BTC-denominated fees?
For example, if the price of Bitcoin were to rise to $1 million (in a hypothetical scenario), the current 6.5 BTC/day in fees would translate to $6.5 million/day. Depending on the timeframe, this would still be only 10% of the current security budget and could leave the network under-secured.
Assuming a $10 million price target for Bitcoin, the network would be securing a $200 trillion asset. However, the cost of a 51% attack would be relatively trivial at just $20 billion, or 0.01% of the network's market capitalization.
In other words, even a significant increase in the price of Bitcoin would, for some, not be enough to offset the decline in transaction fees.
Proposed Solutions
So, what are the potential solutions to this problem? Some have suggested that fees could magically grow by orders of magnitude, but this seems unlikely given the historical failure of various attempts to drive sustained fee volume. Think of Runes, Ordinals, and all new experimentations on Bitcoin that provided spikes but no sustainability... yet.
Hans
One potential solution is to implement a hybrid model that combines the benefits of PoW and PoS. This could involve using PoW for block creation and PoS for finality, or vice versa. Another potential solution is to implement a fee-based mechanism that incentivizes miners to secure the network, even in the absence of a block reward.
While others have proposed more radical solutions, such as effectively removing the 21 million coin limit or switching to a proof-of-stake (PoS) consensus mechanism such as Ethereum, there are many possibilities to explore. However, given the 'stubbornness' of Bitcoin maximalists and even extreme fanaticism, we need to look for a solution that is perhaps built on the existing infrastructure.
Fred
The Bitfinity L2
One possible solution to Bitcoin's fees problem is to leverage Layer-2 rollups, which can scale throughput by orders of magnitude without compromising the base layer's security model. By using the main blockchain as a "light client," rollups can verify transactions without re-executing them on-chain, reducing the load on the network.
Fred
However, Bitcoin's limited 4MB block size presents a significant obstacle for rollups aiming to use it for data availability. To overcome this challenge, solutions like Bitfinity's EVM-compatible Bitcoin sidechain can be employed.
Bitfinity utilizes Chain-Key Cryptography, a threshold cryptographic scheme that enables secure cross-chain communication and decentralized signing and verification. It directly integrates with Bitcoin, making it perfect for rollups to build upon.
Fred
Conclusion
The decline in transaction fees has resulted in a decrease in the overall security budget, making the network more vulnerable to potential attacks. While some might argue that a rising Bitcoin price will mitigate the effects of low transaction fees, this is not necessarily the case. The cost of a 51% attack could become relatively trivial.
The problem with the current security model is that it is not as antifragile as it seems. Today, yes, it is very secure and the most reliable. Tomorrow, when prices rise? Maybe not that much. But Bitcoin isn't as experimental as it used to be when new solutions were being searched for and tried.
To address this issue, the Bitcoin community needs to consider alternative solutions. While these solutions may be cultural non-starters for some, they are worth exploring in the face of the growing security risk.
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