We are reaching peak Bitcoin and this is going to change the whole ecosystem. Some even think that it could be the end of Bitcoin as we know it.

As programmers we have to admire the algorithm that Bitcoin relies on. It's not perfect, but it is clever and it works most of the time. However when Satoshi Nakamoto, whoever he is, proposed Bitcoin he limited the total number to 21 million coins. It is generally said that this is an anti-inflationary rule, although how you measure inflation in a cryptocurrency that is as volatile as Bitcoin is a good question.

The idea was that Bitcoin miners would be rewarded for their efforts by newly-minted Bitcoin. This would pay for the computational efforts needed to maintain the Blockchain. This processing in return for new Bitcoin is generally referred to as "Bitcoin mining", although any earth moving happens miles away to feed power stations. After eleven years, yes the paper Bitcoin: A Peer-to-Peer Electronic Cash System was published on October 31, 2008, we are now at a position where over 85% of the total Bitcoin have been mined. There are still 3 million or so Bitcoin to be mined and this should keep things going for a while, but there are other factors. The first is that every 210,000 blocks the Bitcoin reward halves. This is set to happen in May 2020 at the current mining rate. This halving means that it will take until 2140 to completely run out of Bitcoin, but notice that this also means that the reward to miners goes down.

It seems likely that the value of each Bitcoin will go up as we approach peak Bitcoin, but if the reward to miners is going to stay roughly the same, a single Bitcoin has to appreciate to roughly $125,000 and this seems less likely, although some are regarding it as a good bet.

The problem is that the most likely scenario is that miners' profits are set to fall and then go to zero and their costs are almost certain to go up as the hash difficulty level increases to take account of increasingly powerful hardware.

So who is going to process Bitcoin when it is unprofitable?

The simple answer is the same miners who are doing it at the moment and Bitcoin users are going to have to pay for this in transaction fees. As it is you can already offer miners a transaction fee to speed your transaction through. All this means is that the miners preferentially pick transactions with fees to include in the block they are mining. This sounds reasonable, but a new study from Cornell suggests it has negative effects:

“Bitcoin now works essentially how markets work, because if you want something to happen faster, you have to pay for it.

According to one of its authors, Maureen O’Hara, the Robert W. Purcell Professor of Finance:

“Transaction fees are not part of the original system – they just evolved. A system that’s designed by a computer scientist for security problems may not be well-designed to trade in the markets, so the development of fees is actually a good thing. But it also created all kinds of problems.”

The problem is that transaction fees easily become a significant part of the total cost to the end user meaning that Bitcoin becomes unattractive for all but large purchases. As part of the study an economic model was developed to predict transaction costs. Basically the conclusion is that transaction costs will rise to the point where users are waiting for as long as they were before the transaction costs.

It is clear that as we approach peak Bitcoin transactions fees will increase and Bitcoin will become even less attractive for small transactions - which is a pity as this was one of the early hopes for Bitcoin.

• Janet Swift is the author of Financial Functions published by I/O Press as part of the I Programmer Library written by members of our team.

More Information

Transaction fees change the culture of bitcoin, study says

From mining to markets: The evolution of bitcoin transaction fees

David Easley, Maureen O'Hara and Soumya Basu

https://doi.org/10.1016/j.jfineco.2019.03.004

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