Bitcoin Economics

In April 2024 the fourth Bitcoin halving occurred - the block reward dropped from 6.25 to 3.125 BTC. A few days later fees for a single transaction soared to $128 due to the Runes Protocol frenzy. Miners earned more from fees than from the block reward itself. For the first time in Bitcoin's history the fee market eclipsed the subsidy. This is not an anomaly - it's a rehearsal for the future in which 21 million coins will have been mined and billions of dollars in network security will rest entirely on users' market willingness to pay fees.

• **Halving 2024** - Foundry USA and Antpool miners adapted strategies: switching to fee-optimized block construction, integration with Ordinals infrastructure
• **Grayscale GBTC and Bitcoin ETFs** - institutional investors evaluate Bitcoin through Stock-to-Flow, comparing it to gold (S2F ~62) and treasury bonds
• **Blockstream/Lightning Network** - companies build L2 solutions partly because high mainnet fees are economically inevitable with limited block space

Предварительные знания

• Mining: from CPU to ASIC

Supply Schedule

Bitcoin is the first asset in history with an **absolutely predictable monetary policy**. No central bank, no government can change the issuance rules. Everything is hardcoded.

The maximum number of Bitcoin that will ever exist is **21,000,000 BTC**. This number is hard-coded in the protocol. Why exactly 21 million? Satoshi Nakamoto didn't explain the choice, but the math is clean: initial reward 50 BTC, halving every 210,000 blocks, the geometric series converges to 21M.

**Stock-to-Flow (S2F)** - a model for measuring asset scarcity. The ratio of current stock to annual new production (flow).

**Deflationary model:** unlike fiat currencies where central banks increase the money supply (inflation), Bitcoin moves toward zero issuance. Lost coins (forgotten keys, sends to burn addresses) **permanently** reduce supply. Chainalysis estimates ~3.7M BTC are already lost forever.

Mining game theory

Bitcoin works not because miners are 'good people'. It works because **honest mining is economically more profitable than cheating**. This is the fundamental principle of incentive compatibility - the system is designed so that rational selfish behavior aligns with what is beneficial to the network.

Nash Equilibrium in mining

Imagine two miners. Each has a choice: mine honestly or attempt an attack (double spend, transaction censorship, selfish mining). Nash Equilibrium is the state from which neither player benefits from deviating alone.

**Why is an attack unprofitable?** The attacker spends electricity and equipment. If the attack is detected (and in a public blockchain everyone can see it), the BTC price drops - and the attacker devalues their own assets. This is called the **miner's dilemma**: a miner with 51% hashrate can attack, but the economic incentive to not do so is stronger because they would lose the most from a collapse in network trust.

Selfish Mining

In 2013 Eyal and Sirer described **selfish mining** - a strategy where a miner finds a block but doesn't publish it immediately. Instead they continue building a private chain and publish it when the rest of the network 'catches up'. This allows spending less hashrate to earn a disproportionately larger share of rewards.

MEV in Bitcoin: Ordinals and BRC-20

**MEV (Miner/Maximal Extractable Value)** - a concept from Ethereum, now relevant for Bitcoin too. With the advent of Ordinals (NFTs on Bitcoin) and BRC-20 tokens, transactions began to contain valuable data. Miners can extract additional profit by reordering transactions within a block.

• **Inscription sniping** - a miner sees a popular mint in the mempool and inserts their own transaction first
• **Fee bumping wars** - users compete via RBF to get into a block during a collection mint
• **BRC-20 front-running** - a miner sees a large token purchase and buys ahead, selling at a higher price

Unlike Ethereum where MEV is extracted through smart contracts, Bitcoin MEV is simpler and more direct: a miner controls transaction order in a block directly. But the scale of MEV in Bitcoin is still much smaller due to limited programmability.

Fee market

Every Bitcoin block has **limited capacity**. After SegWit the maximum block size is 4 MB (in weight units). When there are more transactions than a block can hold, an **auction** occurs: users compete by offering higher fees so the miner includes their transaction.

Transaction Fee Auction

Bitcoin uses a **first-price auction** - the miner selects transactions with the highest fee rate (sat/vB). Unlike Ethereum (EIP-1559 with base fee + tip), Bitcoin is fully market-driven: there is no algorithmic burning, all fees go to the miner.

Replace-by-Fee (RBF)

**RBF** allows a sender to replace an unconfirmed transaction with a new one at a higher fee. It's an adaptation mechanism for a changing market: if you set a fee too low, you can 'boost' it via RBF.

• **Full RBF (Bitcoin Core 24.0+)** - any unconfirmed transaction can be replaced, even without an opt-in flag
• **Opt-in RBF (BIP 125)** - a transaction is marked as replaceable via nSequence < 0xFFFFFFFE
• **CPFP (Child Pays for Parent)** - the recipient creates a child transaction with a high fee, incentivizing the miner to include both

SegWit Weight Units

SegWit (2017) changed how block size is measured. Instead of a simple byte count, **weight units (WU)** are used. Witness data (signatures) weighs less than the core transaction data.

**Mempool dynamics**: on weekends and at night (UTC) the mempool clears, fees drop. During hyped events (Ordinals mint, halving) fees can reach 500+ sat/vB. A savvy user monitors the mempool and sends transactions during off-peak hours.

Security Budget

The **security budget** is the total amount miners receive for securing the network. It consists of two parts: **block subsidy** (new coins) and **transaction fees**. Currently the subsidy dominates, but with each halving its share decreases.

The subsidy → fees transition problem

When the subsidy approaches zero, network security must be fully funded by fees. But fees are **volatile**: during periods of low activity they fall nearly to zero, while at peak moments they spike. This creates an unstable security budget - a potentially dangerous situation.

**Dan Robinson (Paradigm)** in his analysis 'The Security of Bitcoin' showed that with a falling subsidy the problem of **fee sniping** emerges - it may be more profitable for miners to re-mine the previous block with high fees than to build a new block with low fees. This undermines finality and creates chaos in the chain.

Tail Emission Debate

Some cryptographers (Peter Todd, among others) have proposed **tail emission** - a minimal permanent issuance forever (e.g., 0.1 BTC/block) to ensure a stable security budget. Monero has already implemented this: after reaching its main issuance, the network emits 0.6 XMR/block indefinitely.

• **For tail emission:** guarantees a minimum security budget, makes hashrate predictable, compensates for lost coins
• **Against tail emission:** violates the 21M social contract, introduces permanent inflation, the change is a hard fork with unpredictable consequences for the ecosystem

Ethereum vs Bitcoin approach

Ethereum solved the security budget problem differently. The transition to Proof of Stake (The Merge, 2022) reduced security costs by ~99.95%. Staking requires no electricity or ASICs - validators risk their own ETH (slashing). Plus EIP-1559 burns part of the fees, potentially making ETH deflationary.

**Open question:** nobody knows whether Bitcoin's fee market will generate a sufficient security budget in 2040 and beyond. This is the biggest unresolved economic question in Bitcoin's design. Optimists point to growing adoption and Ordinals. Pessimists point to fee volatility and game-theoretic instability.

Summary

• **21M hard cap** and halving every 210,000 blocks create a predictable deflationary model with a Stock-to-Flow higher than gold
• **Game theory** makes honest mining the dominant strategy: an attack devalues the attacker's own assets (Nash Equilibrium)
• **Fee market** is a first-price auction for limited block space; RBF and CPFP provide flexibility, SegWit optimizes weight
• **Security budget** - the main open question: as the block subsidy approaches zero, will fees be enough to secure a network worth tens of billions of dollars? The 2024 halving showed for the first time that fees can exceed the subsidy - exactly the rehearsal of the future discussed at the start of this lesson

Related topics

Bitcoin economics connects mining, consensus, scaling, and game theory into a unified economic system:

• Mining: from CPU to ASIC — The supply schedule and block reward directly determine mining profitability and equipment choices
• Proof of Work — PoW creates thermodynamic cost that shapes the security budget and makes attacks expensive
• Lightning Network — An L2 scaling solution that reduces mainnet fee market pressure and enables micro-transactions
• Game theory in blockchain — Formal analysis of Nash equilibrium, mechanism design, and incentive compatibility in crypto protocols

Вопросы для размышления

• If you were Satoshi Nakamoto, would you have chosen tail emission instead of the 21M hard cap? What trade-offs do you see between predictable scarcity and a guaranteed security budget?
• Ordinals and BRC-20 sharply increased fee revenue for miners. Is this a positive signal for the security budget, or a side effect of speculation that won't be sustainable?
• Bitcoin uses PoW for security at ~$15-20B/year. Ethereum switched to PoS and spends ~$2-3B/year. Does this mean PoW is economically inefficient, or does the higher cost of attack justify the expense?

Связанные уроки

• stat-09-regression