Market View
The 2024 Bitcoin halving went live on April 20th, reducing fixed block rewards from 6.25 to 3.125 BTC and dropping Bitcoin’s daily inflation from US$60M to $30M (at $67,000 BTC). At the same time, the coordinated release of Runes on Bitcoin, an alternative to the Ordinals and BRC-20 protocol, resulted in peak levels of blockspace demand. A total of 1,257 BTC was spent on transaction fees on April 20, second only to the 1,495 BTC spent on December 22, 2017. Denominated in USD, total transaction fees on April 20 set new all-time highs of $81M.
While there has been some uncertainty around miner profitability and sustainable hash rate growth in light of reduced block rewards, we think that this relative increase in variable transaction fees – in conjunction with the BTC rally during 1Q24 – could support the continued increase of network hash rate in the short to medium term. Following the halving, transaction fees have constituted 35-45% of total miner earnings after an initial spike to 75% on day one. This mirrors fee surges previously seen in May and December 2023 for Ordinals.
Since our January 30, 2024 report on Bitcoin miners (published at BTC $43,000), BTC has appreciated approximately 50%. Meanwhile, Bitcoin’s network hash rate expanded only about 10% (from ~560EH/s to ~630EH/s). Our calculations show that the current network hash rate of about 630 EH/s sits at 11% of the network’s theoretical maximum hash rate, well below the 25% soft ceiling observed during the last halving and recent bear market.
Even if Runes-driven activity subsides and transaction fees revert to 5% of total miner revenue (like they did 1-2 months after previous Ordinals induced demand spikes), the network would still only realize about 17% of its theoretical maximum hash rate at current BTC prices. This indicates to us that miners could continue to profitably increase hash rate, all else equal. Indeed, the current state-of-the-art mining rig, Bitmain’s Antminer S21, is sold out, with the next-generation machine, the S21 Pro (which further improves mining efficiency to 15 J/TH from 17.5 J/TH), scheduled to ship in Q3 2024.
More broadly, the Bitcoin layer-2 (L2) ecosystem is also continuing to expand with multiple mainnet launches scheduled in the coming months. This could be an additional source of demand for Bitcoin transactions, particularly if Runes or BRC-20s minted on the base layer see widespread usage in these L2s. Without leveraging native BTC assets, it is currently unclear how assets minted on one Bitcoin L2 would be canonically bridged to another. Looking to Ethereum as an example, many tokens on its L2s (ranging from stablecoins to DeFi governance tokens) are minted on the base Ethereum layer before being bridged over. Governance and core functionalities for major DeFi protocols like Uniswap, Maker, and Aave also still occur on the Ethereum mainnet.
That said, Bitcoin lacks the same foundational smart contract functionality as Ethereum, so its ecosystem may not be similarly anchored at the base layer. This could cause liquidity between Bitcoin L2s to be even more fragmented than on Ethereum L2s. The absence of smart contracts (or sufficiently flexible OP codes) on Bitcoin could also have broader implications for the security implementations of its L2s. With few exceptions, core rollup properties, such as the ability to force include transactions via the base layer, do not appear to be possible under many chain architectures labeled as Bitcoin L2s.
In fact, the relatively lax usage of the term ''L2'' in the Bitcoin ecosystem means that many networks labeled as L2s actually lean closer to sidechains as commonly understood by the Ethereum community. This broadstroked labeling could make it more challenging for users to navigate the various security tradeoffs between chains, particularly since there is currently a lack of community-driven transparency sources like L2BEAT for Bitcoin L2s. Furthermore, the variations in L2 bridge designs also open up a new surface area for attacks. Bridges have historically been targets for the largest hacks in the space, and the relative nascency of Bitcoin L2 designs means that bridging is far from a risk-free endeavor.
Notwithstanding the technical challenges, however, we think that Bitcoin L2s represent an exciting key development for the space amidst stagnating levels in both Lightning Network capacity and WBTC on Ethereum (see Chart 3). Historically, BTC holders have been largely sidelined while new use cases and other innovations developed on other chains, with WBTC being the primary access vector to DeFi and the Lightning Network being the main means of low-fee transactions.
The advent of – and enthusiasm around – Ordinals, BRC-20s, and now Runes demonstrates that there is indeed a large demand from BTC holders to do more with their BTC onchain than simply “hodl” it. We think that widespread interest in these solutions reflect the eagerness of the Bitcoin community to leverage their holdings as part of a more complete computing environment. Importantly, these developments could further open up DeFi and other blockchain advancements to the largest source of onchain capital, bitcoin. That said, we expect it to be several more months before long-term leaders clearly emerge as security and design tradeoffs become clearer.
