The Economics Behind Big-Block Bitcoin: An In-depth Analysis

Not too long ago, I made an article called The economics of a high volume, low-fee Bitcoin market. In that article, I went over a hypothetical scenario in which fees are extremely low, and Bitcoin Cash is the only peer-to-peer electronic cash that is being used for payments (this is quite an unrealistic assumption). Considering the fact that there are only 7-8 billion people on Earth, I find it extremely unlikely that a third of the global population will ONLY use Bitcoin Cash. There are plenty of alternative cryptocurrencies that are also viable alternatives including, but not limited to: Ethereum (2.0), XRP, Binance Coin, Litecoin, Bitcoin SV, Cardano, EOS, Monero, Digibyte, Dash, ZCash, Dogecoin, and many more. I believe that if we want decentralization, we shouldn't encourage only one coin as peer-to-peer cash, but several coins so the idea of decentralized peer-to-peer electronic cash is harder to stop/set back.

For this article, I wanted to take a closer look into "big-block economics", and take a more realistic approach of Bitcoin Cash's fee market with bigger blocks. One of the issues with Bitcoin Cash currently is that it is barely getting any revenue from fees. While it technically is cheap to use (<$0.01 per transaction), there aren't many transactions on the network, which results in fees being a very low percentage of the block reward. Currently, the percentage of fees making up the block reward is <0.02%. Right now it isn't much of an issue since the block reward subsidy is enough for miners to rely on, but later down the road it is something that makes or breaks the underlying security of the system, and as such, is extremely important.

I think the fees being very low right now is fine (as explained above), but as Bitcoin Cash acheives more adoption, especially on a global scale, a fee-market will develop regardless of how big the effective blocksize limit is. This is partially because of the fact that tech has and always will have limitations, incentivizing miners not to create blocks too big (as they need to propagate over the network quick enough) and fit their blocks with the transactions paying the highest fees, and the fact that those making high-value transfers who want their transaction to be guaranteed to be confirmed in 10 minutes will outbid other casual transactions by a large amount. My theory is that 0-conf with pre-consensus will be the overwhelming majority of transactions on Bitcoin Cash which will take 20-30 minutes to confirm (instead of going into the next block in 10 minutes), while higher value transactions will be included in the next block, paying higher transaction fees.

The authentically developed fee-market that will happen on Bitcoin Cash got me thinking: hashrate is not proportional to price, but is proportional to the actual block reward of each chain. This means that it is technically possible for Bitcoin Cash to have a higher hashrate than Bitcoin, but still have a lower value per coin/market cap. It would be a very confusing situation because by every technical definition, Bitcoin Cash would 100% be Bitcoin, but the market would still value the legacy chain as 'Bitcoin'. It would beg the question: Which is the real Bitcoin? Either way, if this does happen, it will be interesting to watch it unfold.

Now, back to the economics of big-block Bitcoin... If Bitcoin Cash wants to become the dominant chain and be secure long-term, it needs to be have more hashrate than Bitcoin. While hashrate (at least right now) is determined mostly by price because of miners' reliance on block subsidies, Satoshi designed Bitcoin so that the block reward slowly diminishes and is replaced by transaction fees to secure the network. This brings into consideration the importance of economic activity on a chain's security, and the fact that Bitcoin Cash doesn't need to be worth more per coin to be more secure (if economic activity is high enough). I think the first step to understand the economics of Bitcoin Cash becoming dominant is to mathematically understand what would need to happen for this to take place. To do so, we can develop an equation and understand how the hashrate of the chain is determined:

Hashrate is a result of the difference between revenue generated per block on Bitcoin and the cost of mining/running a node (though the cost of mining is the same, since both are SHA 256 chains, which renders this constant useless). To illustrate this, we can generate the equation:

r = (p⋅b + t⋅f ) - e,

b & e →0

where:

r = revenue generated

p = price

b = block reward subsidy

t = transactions

f = fee per transaction

e = expenses (running a full node)

Now if we take the short-term limit of this equation:

r = (p⋅b + t⋅f )

And the long-term limit:

r = t⋅f

What we can see from this equation is the obvious conclusion: ultimately the system will rely on transaction fees instead of the block reward. But where this comes handy is when using the current figures to determine how much revenue Bitcoin miners are getting in fees per block/day.

Currently, the average transaction fee for Bitcoin is $3.15 per transaction, and there are ~305,000 transactions per day on the network. This leads to miners making ~$960k in revenue from transaction fees alone. If we add the block reward, BTC miners are making ~$10.5 million in revenue per day. For Bitcoin Cash to match that revenue with current transaction fees, there would have to be 2 billion transactions per day on-chain. I think from this information, it is clear that Bitcoin Cash won't be 100% sustainable long-term with fees this low, but we can illustrate this relationship using the previous equation discussed above to find an equilibrium between lower fees, greater security, and coin value:

Bitcoin revenue (per block)

r = ~$75k

where:

p⋅b = ~$66.5k

t⋅f = ~$8,500

Now, if we take the total block reward and divide it by the number of transactions on the network per block:

f = r/t

f = $30 per transaction

Since we want the revenue to remain constant per block, we get the equation:

t⋅f = ~$75k

And to match or overtake the revenue:

r = (n⋅t)(f/m)

= ~$75k

where:

r = revenue (per block)

t = number of transactions on the BTC network

f = fee per transaction

n = how many more transactions are taking place on the BCH network

m = a number ≤n, which indicates how much cheaper transactions are on the BCH network

So for Bitcoin Cash to be sustainable long term and have a majority share of the SHA 256 hashrate, all it needs to do is have n times more transactions than the BTC network, but also be less than n times cheaper per individual transaction, including the block reward. To illustrate this relationship in a way that is easier to visualize, I decided to graph this out as a function on excel:

This graph gives us some idea as to how much it would take for Bitcoin Cash to become the dominant chain, but it doesn't show exactly the amount of adoption (in terms of relative throughput) needed in order to get more revenue per block than Bitcoin. So to illustrate this, I created another graph of the same function, but instead with more detailed labelling:

• At Bitcoin Cash's current level of adoption (0.3 tx/s), fees would have to be ~$480.00 on average per transaction

• At Bitcoin's current level of adoption (4.2 tx/s), fees would have to be ~$30.00 on average per transaction

• At Ethereum's current level of adoption (16.7 tx/s), fees would have to be ~$7.50 on average per transaction

• At PayPal's current level of adoption (134 tx/s), fees would have to be ~$0.94 on average per transaction

• At Visa's current level of adoption (2.1k tx/s), fees would have to be ~$0.06 on average per transaction

• At Visa's + MasterCard's current level of adoption (4.3k tx/s), fees would have to be ~$0.03 on average per transaction

With this, I think it is important to understand how urgent (and I mean VERY urgent) it is for Bitcoin Cash to get transactions on its network considering the fact that Bitcoin's adoption has been set back several years. While it is less than ideal that adoption has been set back at least a few years, this gives a big opportunity for Bitcoin Cash. The race here will be for the Bitcoin Cash network to get more in transaction fees than Bitcoin does in block subsidies and transaction fees. The key misconception here is that Bitcoin Cash needs to have transaction fees <$0.01 to have mass adoption. Fees only need to be enough to incentivize miners include transactions into the next block. As we know, the price of crypto is heavily manipulated, so getting actual uncensorable transactions along with higher transaction fee revenue on the network is the only real way to become the majority chain. So it is entirely possible for Bitcoin Cash to have a lower value per coin, but still become "the new Bitcoin" while Bitcoin becomes the legacy chain.