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The Bitcoin network’s security is based on the addition of new blocks to the chain, which miners are financially incentivized to produce. In turn, miners’ revenues comprise the transaction fees for all transactions included in a block that they mine as well as a block subsidy.

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However, the block subsidy will not last forever: it is halved every four years (most recently on April 19, 2024) and will trend to zero. It aims to support miners’ profitability until such time as fees generated by transaction activity on the Bitcoin network are sufficient to do so.

Halving hits miners’ profitability and may drive consolidation

Miners can mitigate the reduction in revenue per block by increasing their market share of blocks mined. They can do so by upgrading existing equipment or acquiring new equipment, locations, or entities. Miners who have been more profitable to date, as well as those who have accumulated BTC reserves that have increased in value, are best positioned to make such investments.

Conversely, some operations will become non-profitable and will shutter, particularly those with higher energy costs. Miners will continue seeking partnerships to provide load-balancing to energy grids, improving the economics of renewable energy projects by stabilizing energy demand (ramping up mining rigs at times of excess supply and switching them off at times of excess demand). How miners optimize their energy costs and manage their liquidity to cover fiat-denominated debt and operational costs will differentiate their credit risk.

How is transaction activity developing?

After the SEC approved spot Bitcoin ETFs in the United States earlier this year, the Bitcoin price rose sharply, and transaction volumes increased as new institutional investors sought exposure to the asset. In a recent report, Chainalysis highlights that the Lightning Network (a scaling solution built on top of the Bitcoin blockchain) saw a three-times increase in its open channels over the course of 2023, illustrating some growth in the network’s utility.

A recent IMF working paper also highlights Bitcoin’s significant role in cross-border flows. Yet, according to data from Coin Metrics, between January’s ETF approval and April’s halving, transaction fees were, on average, only 6% of miner revenues. Therefore, miners remain highly dependent on the block subsidy.

Bitcoin’s limited scalability and functionality, relative to other blockchains, have contributed to its slow acceleration in transaction fees. Bitcoin is not designed to enable smart contracts; therefore, it does not benefit from trends such as decentralized finance, tokenization, and stablecoin payments that are boosting activity on other chains, such as Ethereum and Solana. Bitcoin’s primary use cases to date have been peer-to-peer bitcoin payments and trading, and neither of these has proved to sufficiently drive revenues on a continuous basis.

New use cases are emerging, but miners need something to stick

The Bitcoin blockchain’s design is not going to change, so new functionality must come from technological developments in its ecosystem. The Runes protocol, which introduces capabilities for fungible tokens, was launched on the same date as the halving and immediately led to a spike in transaction fees.

Fees were also boosted in 2023 by the launch of Ordinals inscriptions, which introduced non-fungible token capabilities. These innovations have so far led to increased fees from transaction activity focused on speculative trading of the tokens they allowed to create. These new functionalities may allow Bitcoin to catch up with other blockchains by supporting tokenization efforts in financial markets. Furthermore, emerging layer-2 chains (that process multiple transactions as a batch before settling them as one transaction on the main Bitcoin blockchain) could mitigate Bitcoin’s scalability limitations and overlay functionalities to develop defi or tokenization use cases. Identifying a use case that “sticks” before the next halving is crucial for these nascent use cases to have a lasting impact.

In the long term, Bitcoin’s proponents expect it to become a new global reserve asset and one day serve as a credibly neutral means of exchange within a global network of AI-powered economic agents. In the meantime, higher and more stable transaction revenues for miners are crucial to sustain the network, making the progress of concrete technological developments critical.

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Andrew O’Neill leads S&P Global’s research on digital assets and their potential impact on financial markets. He began focusing on crypto and defi-related risks in early 2022, with an emphasis on understanding their potential impact on ratings and on financial markets more broadly. He also participated in the development of S&P Global Ratings’ Stablecoin Stability Assessments, which launched in November 2023. He joined S&P in 2009 as an analyst in covered bond ratings before taking on a role in the development of rating methodologies, primarily for Structured Finance ratings. Before joining S&P Global Ratings, Andrew worked as an analyst in Investment Banking, Acquisition, and Leveraged Finance at J.P. Morgan. Andrew holds the CFA charter and a Masters degree in Aerospace Engineering from the University of Bath.

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