The Future of Bitcoin and its Transaction Fees

It is yesterday once more in the bitcoin ecosystem.

The recent spike in bitcoin transaction fees has surfaced memories of similar occurrences in the past. Those fee hikes were also instigated by spurious activity on bitcoin’s network and set off a debate in its community about the size of blocks on bitcoin’s network.

The Importance of Blocks

Blocks determine the cost of a transaction on bitcoin’s network. Large blocks with more transactions lead to lower fees. But they have the potential to centralize bitcoin’s workings because profits in such a system depends on transaction volumes, and not bitcoin rewards handed out to miners.

Therefore, big miners that process more transactions are can extract greater fees as compared to smaller ones. They will dominate its ecosystem and compromise the network’s decentralization ethos and security.

At the opposite end of the spectrum are small blocks. Bitcoin’s original design called for block sizes of 1 MB. That size is inefficient to process high transaction numbers. The flip side to this drawback is diversification in the mining ecosystem. Small blocks promote decentralization and security because they enable small miners to participate in the cryptocurrency’s network.

Resolving An Identity

While the block size wars may seem like much ado about a trifling matter, their resolution can help answer an important question about bitcoin’s identity.

Is it a store of value or a payment network?

A malleable block size, one that accommodates large and small blocks, with low transaction fees is well suited to become a payment network. But it will translate to centralized mining operations as a prerequisite to network efficiency. This is because bitcoin mining rewards scale. More machines equal more transaction blocks and more transaction fees.

Another danger to large blocks is that the currency that underpins this network will not have much, if any at all, value because transaction volumes will replace bitcoin rewards as the primary motivation for miner profits.

On the other hand, the inefficiencies of having small blocks in its network will keep bitcoin’s transaction fees volatile and unpredictable. In such a scenario, bitcoin rewards, and consequently the cryptocurrency’s price, will continue to be an important source of revenue for miners, at least until its issuance limit is reached.

Bitcoin As a Payment Network

As is evident, the dilemma facing bitcoin involves tradeoffs.

For what it is worth, Bitcoin inventor Satoshi Nakamoto was in favor of the first path. He designed the network to evolve a mechanism for daily payments in his whitepaper. Regardless of what its proponents shout, bitcoin’s value is not determined by the markets or demand from investors or users.

In fact, liquidity in its ecosystem has dried out even as it is yet to gain traction as a medium for daily transactions. The current frenzy in its network is a result of trading worthless tokens and meme coins.   A speculative coin grafted onto an unstable network is liable to crash and burn its way to extinction.

But a reliable network able to handle varying use cases and block sizes can help fund the cost of maintaining operations for the network’s miners with predictable transaction fees. That is why recent developments, whether it is the Taproot upgrade or Lightning Network, have focused on enhancing the network’s capabilities.

Of course, the handicap to opting for this course of action is a consolidation in mining networks. But that choice was already made, albeit in an unwritten fashion, in bitcoin’s whitepaper.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.