https://zemgao.com/the-economics-of-bitcoin-mining/

This post originally appeared on ZeMing M. Gao’s website, and TAAL has republished it with permission from the author.”



This is the most significant bitcoin chart to look at, because it is signaling the future.

BSV’s transaction fee to total block reward ratio has surpassed that of BTC on July 16 for the first time, and seems to be opening up a runaway gap, standing at 4x over BTC as of August 1. (Source: coin.dance. The chart shows daily ratios, but the ratios computed block to block averages would essentially be the same.)

Why is this important? Because this is where the dynamics of competitive mining economics lies. And if the trend continues, BSV miners will enjoy exponential growth of revenue from network fees, while BTC miners will face growing avalanche pressure to migrate to BSV for superior profitability, and this despise the fact that fee per transaction on BSV is many thousands of times lower than that on BTC and is likely to continue to drop further lower by many times in the future.

At the most basic level, the economics of bitcoin mining is not complicated, and is the same with BTC as with BSV.

Miner’s block reward = block subsidy + network transaction fees

The block reward is a miner’s revenue for successfully creating a valid block on the chain.

As will be shown in this article, in terms of comparative mining profitability, the block subsidy parts essentially cancel out on each other among BTC, BSV and BCH, and therefore the only competitive action is found in the network transaction fees.

And as will be shown in this article, the trend of the network transaction fees, along with the inherent designs of BTC and BSV, has bad news for BTC.

Please do not quickly jump into the following superficial conclusions:

Because presently there is a huge price difference between BTC and BSV coins, the block subsidies are not comparable and cannot possibly cancel out on each other.

Because historically the BTC’s fee percentage reached levels that were much higher than even the BSV’s recent highest fee percentage, the current trend must be a temporary fluke.

Your intuition is wrong if you think the above. Read on. But first a hint:

The actual prices of BTC and BSV are irrelevant in this analysis, as the dynamics is determined by the relative ratios, and the fundamental profitability metrics is the profitability per-unit hash power (rather than that of the total hash power).

For example, currently, BSV price is 1/300th that of BTC. But as far as the mining subsidy only is concerned, mining on BSV is equally profitable to that on BTC, because mining BSV requires 300 times less hash power. Therefore, the subsidy part of the economics evens out between BTC and BSV, and the only thing that is competitive comes from the network transaction fees, which is a focus of this article. This is not a theory. If you’re a miner, whether you understand this intellectually or not, you will actually feel it in your mining operations. Anyone who has done multi-chain BTC/BCH/BSV mining simultaneously would know this as a fact.

The background & status quo

As said above, the block reward is a miner’s revenue for successfully creating a valid block on the chain.

And creating a valid block involves two major types of work performed by the miner, namely:

(1) building a block, and

(2) proving the block.

Building a block including adding and processing transactions in the block. It can be very simple when the miner includes only those transactions that have simple straight scripts, but may become very complex when the miner includes transactions that have complex smart contracts. For BTC, there is no smart contract. All transactions on BTC have simple standard scripts and a miner needs no special software nor technological know-how to process these transactions. With BSV, however, a new field is opened up because more and more transactions are created to take advantage of the smart contract capability on BSV. A BSV miner has a choice to make when building a block, namely deciding what transactions it wants to include in the block it is building.

This is where the BSV mining business becomes sophisticated and competitive beyond the mere hash power competition. A BSV miner cannot just blindly include every transaction into its block. Transactions having smart contracts can be highly complex, and they can come from all kinds of customers in various businesses, from art, esports to enterprise software. To include such a transaction in a block requires a good understanding of the customer’s business logic, building a good business relationship with the customer, and developing software capabilities to compile the smart contracts to straight OP_codes. Advanced miners may even go beyond and start to build tools for new businesses in BSV blockchain ecosystem. There is no limit.

Proving a block is a different matter. Broadly speaking, it involves two different kinds of block proving activities:

(i) solving a hashing puzzle, which is a hashing competition among miners for the next block (as every miner builds its own block and wants its block to be accepted in the chain), and

(ii) validating and accepting the block created by another miner who has won the hashing competition (miners are required to do this is matter of the consensus).

Note that the miner who has won the next block does not need to do extra work in validating and accepting the block, because all that should have been done already in building the block, see the above (1). But to be accepted to the chain, the block has to be validated and accepted by other miners.

It is important to also note that, after a block has already been built, validating and accepting the block by another miner becomes easy and can be done by any miner, because all have been compiled into straight scripts (OP_codes). In other words, although not every miner may be sophisticated enough to build a block to include transactions that have complex smart contracts, every miner that runs standard mining software is capable of validating and accepting such a block created by another miner.

Bitcoin protocol uses Proof-of-Work (PoW) to build a consensus among the miners.

The concept of PoW itself has been a source of confusion, because by “work” in Proof-of-Work, most people refer to “hashing” only. But that’s a misunderstanding, because there are at least two different types of work involved as indicated above.

The term “mining” is also confusing, because to many people, it suggests working for newly “minted” coins as a block subsidy only. But that is not accurate, because in reality:

(1) there is no ongoing “minting” (in a real sense of the term) of bitcoin, as all 21 million bitcoins were minted all at once when the Genesis block was created; and

(2) the only difference between block subsidy and network transaction fees is that the former receives new coins from the preprogrammed coinbase (an initial market) while the latter receives coins from customers (a secondary market).

Therefore, even if the block subsidy has stopped, miners’ work will continue and may still be considered as being “mining” in a sense that the process yields coins for a miner.

It is therefore misleading to focus on the block subsidy only. Block subsidy is supposed to be a temporary bootstrapping strategy for establishing the blockchain, but the real dynamics of the mining economy is supposed to be in the network fees.

The block subsidy is mostly static (except for halvings roughly every four years). And more importantly, as will be shown in this article, block subsidies are non-differential between different chains (that is, they are essentially the same for BTC, BSV or BCH, on unit-hash power basis).

Currently, BTC and BSV prices track almost precisely in proportion to the network hashing powers. In other words, the ratio between BTC price and BSV price is almost exactly the same as the ratio between BTC hash power and BSV hash power (which both stand close to 300:1 presently). Both ratios fluctuate with time, in the range of 200:1 to 300:1 in the recent year, but they are almost synchronized.

It means the market is completely writing off the network transaction economics.

This reflects a temporary fact that the fee percentages of both networks are still very low and almost negligible (i.e., the network transaction fee is still a small portion on these networks and have a negligible impact on miners’ decisions on operations).

However, this ignores what is already happening behind the scenes and will likely happen at an even faster pace in the future.

To read the rest of this article, find it on author ZeMing M. Gao’s website.