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How the Bitcoin Halving Could Affect Network Security

Meltem Erdem 2024.04.02 21:46

How the Bitcoin Halving Could Affect Network Security

  • In addition to price concerns, questions about network security in a post-halving world remain unanswered.

  • There are potential security risks due to the possibility of smaller miners withdrawing from the market as rewards are halved, leading to reduced hash rates and overall security.

  • It is estimated that 51% of the hashing power within the protocol architecture may be vulnerable to attacks.

  • However, previous halving events have had minimal impact on overall network security, and many analysts predict a smooth transition for the network itself.

The upcoming Bitcoin halving is the network’s most anticipated halving yet. The halving, a programmed reduction in the block reward miners receive for validating transactions and adding them to the blockchain, is set to significantly impact the bitcoin {{BTC}} mining industry.

This feature is part of CoinDesk’s “Future of Bitcoin” package published to coincide with the fourth Bitcoin “halving” in April 2024.

Meltem Erdem is CoinDesk Turkey's cybersecurity columnist.

The bitcoin mining industry is extremely competitive, with miners sometimes operating on razor thin margins. Scheduled to occur next month, around April 15, this halving will see the current reward of 6.25 bitcoins per block reduced to 3.125 bitcoins. What impact will this have on the mining industry?

Is the mining industry well-positioned for reduced block rewards?

The halving, which occurs approximately every four years, reduces the rate at which new bitcoins are created, thus enforcing scarcity and potentially driving up the cryptocurrency’s value. However, for miners, this means an immediate halving of revenue from mined blocks, assuming the price of bitcoin does not increase proportionately.

This could lead to increased financial strain on less efficient mining operations, even forcing some out of business, which could cause a temporary contraction in the network’s hashing power.

See also: Bitcoin Halving, Explained

The reduced block reward also has implications for Bitcoin’s network security. The security of the Bitcoin network relies on a decentralized global network of miners competing to validate transactions and secure the blockchain. The mining process, which consumes substantial computational power, is incentivized by the block reward plus transaction fees. A reduction in the block reward means that, without a compensatory rise in bitcoin’s price or transaction fees, miners could earn less for their efforts, which might reduce the incentive to mine.

If a large number of miners leave the network, it could substantially weaken network security, potentially making the network more vulnerable to attacks, at least in the short term, until difficulty adjustments occur.

Are the security protocols for halving configured correctly?

The reduction of the current block reward to 3.125 bitcoins from the current 6.25 bitcoins is a deflationary feature that contributes to bitcoin’s value proposition and scarcity. Though it also introduces challenges for miners.

In the same way that mining pools and companies have added new machines in anticipation of the event, thereby speeding up the the creation of new blocks, the same could happen in reverse as miners power down if their revenues drop.

If a significant number of miners turn off their machines due to reduced profitability, the total computational power securing the network, known as the hash rate, could decrease. A lower hash rate means the network is less secure and more vulnerable to certain types of attacks, such as the 51% attack, where a bad actor could potentially gain control over the majority of the hash rate to manipulate the blockchain.

Further, in a scenario where the hash rate drops significantly and miners prioritize high-fee transactions, the Bitcoin network could experience slower transaction processing times. This slowdown could impact the usability of Bitcoin, especially in cases where timely transaction settlement is critical.

A significant and prolonged decrease in the hash rate is unlikely, as the Bitcoin protocol includes difficulty adjustments to ensure new blocks are produced approximately every 10 minutes. However, a lower hash rate could still temporarily increase the network’s vulnerability to attacks, potentially undermining trust in the Bitcoin network’s security, its price and adoption rate.

It’s worth noting that, historically, Bitcoin has shown resilience in the face of halving events, with the price often increasing in the months following a halving, which can alleviate some of the potential negative impacts on miners. However, the dynamics around each halving can vary based on broader market conditions and technological factors, this halving is very different from the prior three.

Can we expect any beneficial outcomes the mining industry?

The best-case scenario for the mining industry following a Bitcoin halving centers around a series of positive outcomes that not only mitigate the challenges associated with reduced block rewards but also enhance the overall strength and resilience of the Bitcoin network. The most significant positive outcome would be a substantial increase in the price of bitcoin.

See also: The Bitcoin Halving Really Is Different This Time

As block rewards diminish, transaction fees will become a more significant part of miners’ revenue. The best-case scenario would see a balanced increase in transaction fees that compensates for the reduced block reward without deterring users due to high costs. This could occur through a combination of increased Bitcoin adoption, more transactions per block through efficiency improvements, new use case like Ordinals, and layer 2 solutions like the Lightning Network driving Bitcoin’s utility and demand for on-chain settlement.

Despite the reduced block reward, the hash rate remains stable or even increases due to higher Bitcoin prices and more efficient mining operations. Currently, Bitcoin’s hash rate has been reaching all time highs, which demonstrates that miners are not deterred by the upcoming block reward reduction. A stable or growing hash rate ensures the network’s security against attacks, maintaining trust in Bitcoin’s robustness as a decentralized financial system.

Increased recognition of Bitcoin as a valuable digital asset by institutional investors could drive demand and stabilize the market. Institutional investment would not only support higher bitcoin prices but could also lead to more innovative financial products and services built around bitcoin, further integrating it into the global financial system. The recent launch of spot bitcoin exchange-traded funds in the U.S. are one such example of the impact of institutional adoption on the demand for bitcoin.

The Bitcoin network continues to grow in terms of security, adoption and technological innovation, reinforcing its position as the leading cryptocurrency. The mining industry, while preparing for the upcoming adjustment to the new economics post-halving, remains profitable and sustainable, driving further innovation and investment in the sector.

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