This Time is Different; the Bitcoin Security Model
“This time is different”
That’s always the story, but is this time actually different?
For Ethereum, it is. The #1 smart contract blockchain in the world has moved to Proof of Stake due to it being more environmentally friendly and more secure than its Proof of Work counterpart.
While many have come to love and prophetically promote Bitcoin as the holy grail asset, I believe the market may not be properly accounting for the risks within its Proof of Work (POW) system.
Bitcoin is approaching yet another crucial time in its history — the Bitcoin Halving. This is when the Bitcoin security budget is cut in half, which happens every four years. While this is often touted as one of the key benefits of Bitcoin, it also creates risks due to the declining Bitcoin block subsidy, which could see future Bitcoin becoming too economically weak to secure itself from attackers.
Explained simply, the Bitcoin blockchain creates new Bitcoin (BTC) each day, which is earned by Bitcoin Miners. Bitcoin Miners are rational economic actors who set up mining facilities and purchase electricity, which are used to secure the Bitcoin blockchain. These Bitcoin Miners are paid new BTC for the security that they provide the blockchain. This BTC is then sold into the free market to pay for their expenses (operations, mining hardware and electricity), anything left over is their profit.
March 24, 2024
The approaching date that has many people, including Bitcoin Miners, very worried.
The date that Bitcoin will enter its next halving, which will reduce the daily BTC issuance by half. This means that Bitcoin Miners’ earnings are cut in half overnight.
Below are a few charts which will show you the current state of Bitcoin and why many are worried about its security.
Bitcoin Annual Issuance Rate
Creator: Satoshi Nakamoto
The Bitcoin Annual Issuance Rate is the percentage of new Bitcoin (BTC) that is issued over the course of the year, divided by the current supply. Think of this as the “inflation rate” or “how much Bitcoin is printed out of thin air” each year. These BTC are paid to Bitcoin Miners to secure the blockchain.
As you can see, since Bitcoins inception the Bitcoin Annual Issuance Rate is trending down, in line with the halving cycle every four years.
Here is the same chart but zoomed in. Bitcoin had an annual issuance rate of around 4% from July 2016 — May 2020. In May of 2020, Bitcoin went through its most recent halving which reduced its annual issuance rate to about 1.5%. As stated before, the next halving will arrive in March 2024, which will reduce the Bitcoin annual issuance rate to less than 1% (around 0.75%).
Price with Relative Strength Indicator (RSI)
Creator: J. Welles Wilder
The Relative Strength Indicator (RSI) is an indicator that shows the current and historical strength or weakness of an asset. RSI is typically used to help investors know when to buy or sell, as it reveals when it may be oversold or overbought. Typically RSI values greater than 70 are considered overbought, and values lower than the 30 are oversold.
Bitcoin currently sits at about an RSI level of 31, which has only been this low two other times since its inception. An RSI this low for Bitcoin typically signals a market cycle bottom.
If you want to learn more about market cycles, please read Bitcoin Market Cycles and You.
Daily New Issuance Value
Creator: The Free Market
The Daily New Issuance Value is the Bitcoin Annual Issuance Rate (on a day to day basis) multiplied by the Price. You can think of this as how much money is up for grabs by Bitcoin Miners each day, as they all race to collect the BTC rewards using the mining hardware and energy they pay for.
Bitcoin Miners rely on this daily issuance value in order to not only pay for their expenses (operations, mining hardware and electricity) but with hopes to turn a profit. Bitcoin being at a low price and consequently low daily issuance value puts pressure on Bitcoin Miners and requires many to close down, which lowers the security of the blockchain. Remember, Bitcoin Miners are rational economic actors who only mine (secure the blockchain) if it’s profitable for them.
Here is the same chart but zoomed in. As of 12/01/22, there is around $14M in daily new issuance value that is paid in BTC to secure the blockchain. This is causing many miners to become unprofitable and shut down their operations.
BTC Puell Multiple
Creator: David Puell
The Puell Multiple is calculated by dividing the daily new issuance value (as shown above) of Bitcoin by a 365-day moving average. This helps investors understand how profitable Bitcoin miners are at any given point in time. Typically, when the daily new issuance value is high, miners are very profitable and have incentive to secure the blockchain. The Puell Multiple helps reveal insight into how profitable mining is for Bitcoin Miners at any point in time. Typically the Puell Multiple is above 2 when miners are ultra profitable and below .5 when many miners are no longer profitable and must cease operations.
The BTC Puell Multiple currently sits at about .39, which has only been this low a handful of times in its history. This typically can be seen as an impending Bitcoin market cycle bottom. As mentioned before, this is causing many Bitcoin Miners to purge and capitulate, which reduces the security of Bitcoin.
Number Go Up or Blockchain Security Go Down
For those that didn’t follow the above charts, here is the TLDR:
- The next Bitcoin Halving is approaching on March 24, 2024.
- Bitcoin Halvings lower the Bitcoin security budget by 50%.
- BTC price strength has not been this weak since the last historic bottom.
- Bitcoin Miners only secure the Bitcoin blockchain if it’s profitable for them, and the current BTC price environment is forcing many to shut down.
- BTC price needs to go up or more miners will cease operations, which will lower security, and thus lowers the value of BTC.
Two Potential Narratives
Below are two potential narratives you may see play out within the next few years:
FUD (Fear, Uncertainty, Doubt) = Bitcoin continues to lack in price appreciation and in turn becomes economically insecure and subject to attacks. This can become a negative feedback loop where a low Bitcoin price causes more miners to cease operations, which lowers security, which in turn lowers the Bitcoin price.
FUN (Orange Coin Good) = Bitcoin proves again that it’s a honey badger. These lower prices will shake out miners that cannot compete, and the Bitcoin miner landscape will consolidate (and arguably centralize), leaving only the strong.
FUN: BTC Supply in Profit or Loss
Creator: The Free Market
The BTC Supply in Profit or Loss chart shows the percentage of coins whose price was lower than the current price the last time they moved on the blockchain. This means that when BTC is at an all-time-high, 100% of the supply is in profit. Typically during BTC market cycle bottoms, we see around 40% of the supply in profit which means that the majority (60%) of BTC are trading at a loss. You can see this in the chart above when the red crosses over the yellow.
The BTC Supply in Profit currently sits at around 48%, which may be a signal that we are approaching a market cycle bottom.
FUD: Bitcoin Rainbow Price Chart
Creator: Eric Wall
The Bitcoin Rainbow Chart is a model that was used by many to predict the long-term valuation of Bitcoin. It uses a logarithmic growth curve to forecast the potential future price of Bitcoin, which is overlaid on top of rainbow color bands. Since inception, these rainbow color bands helped investors forecast when Bitcoin may have been overvalued or undervalued.
The Bitcoin Rainbow Price Chart was recently invalidated, which helped graduate the original creator Eric Wall from a once historical Bitcoin Maximalist, to a vocal Ethereum Supporter and Apologist.
It’s important to note that not only was the Bitcoin Rainbow Price Chart invalidated this market cycle, but so was the Bitcoin Stock-to-Flow Model which was once seen as gospel to many in the Bitcoin community.
Don’t Trust, Verify
While this article has (intentionally) not dived too deeply into all the nuances of the Bitcoin security model, we are truly at a historic time in the crypto markets.
It would be hard to find a single individual who could have predicted the downfall of Terra (LUNA), Three Arrows Capital, BlockFi, Voyager, Celsius and FTX all within the same year.
Unlike those centralized and opaque ponzi-schemes, Bitcoin is entirely in the open with economics you can review, a transparent blockchain you can audit, and nearly unlimited data at your fingertips to help you make informed decisions.
Is this time different?
Don’t trust, verify.
About the Author
Anthony Bertolino is dedicated to educating the world about Ethereum and the future of finance. He studied Blockchain Technology at U.C. Berkeley and currently lives in Las Vegas, Nevada. If you want to learn more or have any questions, reach out to him on Twitter.
You are responsible for your financial decisions. This is not financial advice. I am not a financial advisor. I hold both Bitcoin (BTC) and Ethereum (ETH). I believe that Ethereum Proof of Stake is more economically secure than Bitcoin Proof of Work.