Welcome to Hvbris, a crypto-focused newsletter.
In today’s edition, I share my thoughts about BTC the asset and whether it needs Bitcoin the network to be successful
… and also some quality bits and bytes worth your time. Don’t miss those.
DISCLAIMER: This content is not financial advice and only represents my personal opinions.
Crypto is high risk. Always do your own research.
Let’s dive in!
Does BTC need Bitcoin?
I’ve come to the (late!) realization that BTC the asset might not need Bitcoin the network to be successful.
But that’s okay.
BTC could do fine living on other networks just like gold is fine living outside gold mines.
Bitcoin the network is a fantastic (and fair!) distribution mechanism for BTC the asset thanks to POW. Once it’s done minting its last fraction of a BTC, the network can happily wind down and let the supply roam free across chains and be digital gold/pristine collateral anywhere.
BTC without Bitcoin? Sounds a bit nuts.
Why does the question matter at all?
Well, Bitcoin’s sustainability beyond the expiration of the block rewards is still very much an open question at this point.
A question the Bitcoin community puzzlingly considers a non-issue for the most part.
Prominent Bitcoiner Dan Held believes for example that Bitcoin’s security is fine. Held sees “empirical evidence that there will be proper security budget financing will equilibrate through fees.“
That’s cool.
This sentiment is nuanced by Lyn Alden who believes that “security through fees is economically workable based on achieving sufficient long-term adoption”.
Alden proposes a neat mental framework to evaluate the robustness of the fee market.
The question is whether fees can reach a point where they reliably are 0.5%-1.5% of market capitalization, but fortunately the protocol has another full halving cycle or two to get there.
The problem is that we’re nowhere near that level of fee density nor seeing an encouraging trend towards it.
On a monthly average basis, Bitcoin’s total market cap is 1.05 trillion USD and the daily contribution from fees to Bitcoin’s security budget is 5.2 million USD.
In other terms, fees represent a meager 0.0005% of Bitcoin’s total market cap, three orders of magnitude below the lower range of what Alden’s consider an adequate fee-financed security budget for Bitcoin.
Worse, according to The Block/CoinMetrics’ data, fees are actually going down as a percentage of total miner revenue compared to the previous bull market.
True, the latter is not completely unexpected.
After all the block reward is becoming more valuable relative to transaction fees because the price of BTC is rising.
Yet, this shows that the Bitcoin network’s dependence on block rewards becomes particularly salient during bull markets and times of intense economic activity.
If the block reward were to disappear tomorrow, fees alone wouldn’t come close to provide adequate security for the level of economic activity we’re seeing today.
Okay but the block reward is still a thing and we have quite a few halvings to go before it dries out.
No doubt that BTC’s increasing price will keep miners around for the foreseeable future but can a robust fee market develop before the block reward expires?
The game theory going forward looks, ahem, complicated.
The development of blockchain alternatives and of L2 solutions on top of Bitcoin (Lightning Network, Liquid sidechain, etc.) is fee-bearish because it pushes economic activity away from Bitcoin miners.
The fee-bullish argument on the other hand is that fees on L1 Bitcoin just need to be expensive (or blocks “economically dense” as Nic Carter likes to put it) to keep the miner around to secure the network after the last BTC has been mined.
This is basically a bet that the network will stay congested and the block size small.
What would that look like:
expensive L1 Bitcoin transactions (think container ship instead of UPS) which only large BTC holders can afford
as a consequence, retail economic activity is pushed to the edges of the Bitcoin network onto L2 solutions and/or other blockchains like Ethereum
L2 to L1 settlement transactions and justice transactions happen. These generate fees for Bitcoin miners but their volume is difficult to project
on L1, the Bitcoin fee market is volatile because demand for blockspace is not consistent and in competition with cheaper alternatives for transacting value on other blockchains and on Bitcoin L2s
corollary to an inconsistent fee market, the hash-rate becomes volatile with SHA-256 miners dropping in and out of the Bitcoin network to mine other SHA-256 coins (hopefully Bcash will still be around to make that hash-rate stick)
BTC holders are still free-riding Bitcoin’s security budget because they use BTC like gold and seldom move it.
As I said, it’s complicated.
I am not saying it is impossible that a solid fee market emerges, I just think it’s not unreasonable to predict that the game theory which keeps miners around could break down after the block reward dries up.
In a mono-chain world, there could be a solid case to be made for the world’s entire economic activity to exist entirely on Bitcoin with enough fee generated for miners to be incentivized to stick around.
However, we seem to be headed for a poly-chain future.
I doubt transactions on the Bitcoin network will remain competitive once large users get comfortable with transacting BTC on competing blockchains that can provide an acceptable/equivalent level of security at a fraction of the cost.
This phenomenon already exists on Ethereum.
Solutions like WBTC (fully custodial), renBTC (pseudo-decentralized), and tBTC (very decentralized but also very capital intensive ) make trading BTC on DeFi a thing with WBTC currently leading the pack with a total supply of 137,904 BTC as of today compared to 14k BTC locked as renBTC and tBTC.
I expect fees as a fraction of Bitcoin's total market cap to keep dwindling and BTC the asset to keep cross-pollinating on other blockchains as a direct consequence.
To sum up.
Bitcoin the network is a great distribution mechanism for BTC the asset
Bitcoin’s premium blocksize (ie why people want to use Bitcoin rather than another blockchain) is primarily a function of the security of the network.
Security is a function of total hashing power (ie how many miners mine BTC on Bitcoin)
Hashing power is currently incentivized by BTC’s price and miners’ total reward (block reward + transaction fees)
It is not clear whether a robust fee market can emerge before or after the last BTC is mined on Bitcoin
I expect the (fee/total market cap) ratio to continue dropping alongside the block reward and to not reach enough density to secure BTC transactions in the future (I am not sure when but I think this trend will be confirmed in the next couple of halving cycles)
This doesn’t spell the end of BTC, BTC can migrate to other chains where security is continuously subsidized (like Ethereum).
Finally, I am not a fortune teller so I could be completely wrong here.
Bits and Bytes.
Jump Capital Peter Johnson breaks down why interest rates in crypto are so high.
Lyn Alden analyses Bitcoin’s network effect.
Nic Carter explains Bitcoin on Lex Fridman’s podcast, Carter is a great ambassador for Bitcoin and on point with everything Bitcoin-related. I disagree with his take on Ethereum though. Pointing to the DAO as the reason why Ethereum is not decentralized is a bit of a lazy take at this point.
Ray Dalio dunks on bonds.
Brian DeChesare explains hedge fund strategies.
MetaKovan on why they’ve spent 69 million USD on the Beeple NFT. Honestly, the dude didn’t come across as very confident in his investment in a “what have I done“ sort of way, but what do I know.
A very entertaining debate on NFTs. Motion: NFTs are Dumb.
CoinMetrics issued a cool report on Ethereum Gas.
Hasu was on Bankless to discuss the upcoming Ethereum EIP-1559 upgrade.
Balaji was on Tim Ferris’ podcast to talk about his vision of the future. Balaji is one of my favorite VC/crypto people. Smart and genuinely humble. These are rare traits.
Get rid of bull-market anxiety with this hilarious Bitcoin relaxation app.
Microsoft’s decentralized ID project ION is live on Bitcoin.
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See you soon for more insights.
Until then,
Hvbris.