Transaction Fees and the Future of Bitcoin

An interesting side effect of the recent Bitcoin price crash as reported by exchanges has been the drop in hashrate which has created a glimpse into the future of Bitcoin. A future where transaction fees serve their intended purpose as both an antispam measure and valuable component of the miner reward.

Beginning yesterday there has persistently been a pool of unconfirmed transactions which has at times been in excess of the maximum blocksize and sometimes spiking to several times the maximum blocksize of one megabyte. Bitcoin is all about scarcity. Most commonly people consider the scarcity of the Bitcoin tokens themselves, but the scarcity of space for transactions to be confirmed in blocks is an important emerging scarcity.

At the moment, the minimum transaction fee for a transaction to be relayed across the network and to be confirmed into a block is two cents per kilobyte of data to transmit any arbitrary amount of value using the Bitcoin value reported by popular exchanges at the moment. Some wallet implementations and users successfully manage to send transaction using a fee which is a tenth of that. For this bargain of a price you can send any arbitrary amount of value to anywhere in the world without any regard for national borders. No other method of transmitting value in history has been as cheap or indifferent to distance, and it is frankly unsustainable in the long run.

Mining, the computationally and electrically expensive task of committing transactions to the blockchain has so far been subsidized almost entirely by the issuance of new Bitcoins in coinbase transactions, but time goes on the block reward will continue to halve every four years as miners are weaned off of new coin issuance. Successfully weaning mining operations off of coin issuance and on to transaction fees as a way to sustain their mining operations is critical to the sustained success of Bitcoin. Scarcity in terms of space in blocks for transactions to be confirmed is necessary to cultivate a healthy transaction fee market.

Without the chance of a transaction languishing unconfirmed there's little incentive to pay much of a transaction fee to miners. With that chance a marketplace can flourish and miners can get paid. While this seems to preclude a future where you might go into the local coffee shop and send them a coffee's worth of Bitcoin every morning it offers a more interesting sort of future:

You may end up paying for a month's worth of coffee vouchers at your favorite coffee shop via Bitcoin (so shop scrip built on top of Bitcoin), you may end up settling your accounts monthly at the restaurant in Bitcoin (so store credit built on top of Bitcoin), you will probably cash into whatever local currency from Bitcoin (be it Unified Standard Dubaloos or Universally Simplified Dosidoes or whatever else) but all that is entirely different a story.

9 thoughts on “Transaction Fees and the Future of Bitcoin

  1. There is a fundemental economic error in this argument, and that error is that a protocol limit on block size is necessary for space in a block to be scarce.

    Space in a block will always be scarce, with or without a protocol limit, because our computers are still made of matter and still occupy space.

    The only in which space in a block would not be economically scarce is if it was possible to create and broadcast a block of infinite size at a price of zero and with zero propegation delay.

    In a free market situation, the cost of a transaction is the marginal cost of adding a transaction to a block (which will never be zero) plus a small profit margin which competition will keep low.

    What you're arguing for is a production quota to artifically fix the price of a transaction.

    Production quotas are as harmful in the transaction processing industry as they are harmful in every other economic situation.

    • Thanks Justus for injecting some sanity and sensible economics into the argument.

    • Space in a block will always be scarce, with or without a protocol limit, because our computers are still made of matter and still occupy space.

      And dollar inflation will be kept in check because the printing presses are still made of matter and occupy space. This is a spurious point to make.

      The miner who finds a block is not the only node responsible for keeping it. He would prefer that his competitors keep their blocks as small as possible, while making his own as large as possible. He isn't enforcing a block size limit against himself; he's enforcing it against other miners. If he isn't profiting from a massive block, he'd rather keep it out of the chain. Unless consensus forces him to accept it. And by "consensus," I don't mean the highest rated reddit comment; I mean hashing power.

    • This "space will always be secure" is naivite of prime order. You should do more reading of MPOE-PR, her years old posts are still ahead of the economic understanding of the "community". In this case :

      The domestic textile industry operates in a commodity business, competing in a world market in which substantial excess capacity exists. Much of the trouble we experienced was attributable, both directly and indirectly, to competition from foreign countries whose workers are paid a small fraction of the U.S. minimum wage. But that in no way means that our labor force deserves any blame for our closing. In fact, in comparison with employees of American industry generally, our workers were poorly paid, as has been the case throughout the textile business. In contract negotiations, union leaders and members were sensitive to our disadvantageous cost position and did not push for unrealistic wage increases or unproductive work practices. To the contrary, they tried just as hard as we did to keep us competitive. Even during our liquidation period they performed superbly. (Ironically, we would have been better off financially if our union had behaved unreasonably some years ago; we then would have recognized the impossible future that we faced, promptly closed down, and avoided significant future losses.)

      Over the years, we had the option of making large capital expenditures in the textile operation that would have allowed us to somewhat reduce variable costs. Each proposal to do so looked like an immediate winner. Measured by standard return-on-investment tests, in fact, these proposals usually promised greater economic benefits than would have resulted from comparable expenditures in our highly-profitable candy and newspaper businesses.

      But the promised benefits from these textile investments were illusory. Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide. Viewed individually, each company's capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes).

      After each round of investment, all the players had more money in the game and returns remained anemic. Thus, we faced a miserable choice: huge capital investment would have helped to keep our textile business alive, but would have left us with terrible returns on ever-growing amounts of capital. After the investment, moreover, the foreign competition would still have retained a major, continuing advantage in labor costs. A refusal to invest, however, would make us increasingly non-competitive, even measured against domestic textile manufacturers. I always thought myself in the position described by Woody Allen in one of his movies: "More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness, the other to total extinction. Let us pray we have the wisdom to choose correctly."

      For an understanding of how the to-invest-or-not-to-invest dilemma plays out in a commodity business, it is instructive to look at Burlington Industries, by far the largest U.S. textile company both 21 years ago and now. In 1964 Burlington had sales of $1.2 billion against our $50 million. It had strengths in both distribution and production that we could never hope to match and also, of course, had an earnings record far superior to ours. Its stock sold at 60 at the end of 1964; ours was 13. Burlington made a decision to stick to the textile business, and in 1985 had sales of about $2.8 billion. During the 1964-85 period, the company made capital expenditures of about $3 billion, far more than any other U.S. textile company and more than $200-per-share on that $60 stock. A very large part of the expenditures, I am sure, was devoted to cost improvement and expansion. Given Burlington's basic commitment to stay in textiles, I would also surmise that the company's capital decisions were quite rational.

      Nevertheless, Burlington has lost sales volume in real dollars and has far lower returns on sales and equity now than 20 years ago. Split 2-for-1 in 1965, the stock now sells at 34-on an adjusted basis, just a little over its $60 price in 1964. Meanwhile, the CPI has more than tripled. Therefore, each share commands about one-third the purchasing power it did at the end of 1964. Regular dividends have been paid but they, too, have shrunk significantly in purchasing power.

      This devastating outcome for the shareholders indicates what can happen when much brain power and energy are applied to a faulty premise. The situation is suggestive of Samuel Johnson's horse: "A horse that can count to ten is a remarkable horse-not a remarkable mathematician." Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company-but not a remarkable business.

      My conclusion from my own experiences and from much observation of other businesses is that a good managerial record (measured by economic returns) is far more a function of what business boat you get into than it is of how effectively you row (though intelligence and effort help considerably, of course, in any business, good or bad). Some years ago I wrote: "When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact." Nothing has since changed my point of view on that matter. Should you find yourself in a chronicallyleaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.

      What they aim to do is plainly evident to anyone with even a cursory acquaintance of business. That reddit is composed of retards and a good chunk of the Bitcoin enthusiasts are mere coders with very little actual understanding of the world is enabling exactly the sort of evil neither group likes to see.

      PS. The bloom filters, reserved for step two of "revolutionizing" aka embrace, extend & extinguish Bitcoin, is the bloom filter thingee that will nigh on make block propagation instantaenous and space cost zero. Think a little in depth before buying into the tinsel of the cattle herders, Justus.

    • Justus, the 21m (or 2.1 quadrillion satoshis) is a production quota also.

    • Justus: isn't the 21M BTC limit a "production quota" too?

  2. A change to the fee structure has been under discussion for a long time:

    Floating fees are coming, set by market:

    • Floating fees set by the market are already here. Most wallets now allow you to modify what they pay in fees, sometimes within limits, though it may not be as convenient as it should be.

      It has been noticeably harder to get a zero fee txn confirmed quickly recently, and that is good and how it should be.

    • Some derps talking about changing the world != "under discussion". It has to be under discussion among people who matter, not among people who like to claim and tend to pretend they do.

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