Without a profit, there is no mining. And without mining, the Bitcoin network ceases to exist.
It is important to incentivize miners on the Bitcoin network to keep their machines connected and running. They are the backbone of the network. If they all disconnect Bitcoin dies.
In essence, Bitcoin mining operations are businesses. Individuals and companies provide the necessary hardware, software and energy resources to the Bitcoin payment system to receive the mining reward in return.
In the least, they need the reward to cover the cost of buying the hardware and paying the huge electricity bill that the machines accumulate. Then give them a little more for labor and also a profit margin.
Therefore the only way to keep miners connected to the network is to ensure there is a healthy cash flow in their businesses.
The question of what happens when Bitcoin mining is no longer profitable is closely tied to the question of whether there is a possibility that the Bitcoin network could one day die because there is no one to maintain it.
The short answer to both these questions is yes, in hypothetical terms, but no, in practical terms. We will go through the two scenarios, but first, let us get the necessary backdrop.
Bitcoin is not a company
In a centralized system, like PayPal or any bank, there is a corporate entity that is responsible for sourcing and managing the hardware, software, energy and the labour needed to keep it working.
There is no similar body for Bitcoin. Instead, the Bitcoin network relies on self-seeking individuals (and companies) to provide the resources in exchange for a mining reward, initially in the form of newly released bitcoins.
If you take away the mining reward, which is their primary revenue, miners will have to close shop. And that means Bitcoin ceases to exist.
Two primary ways can lead to the end of Bitcoin mining profitability:
All bitcoins have been mined.
Bitcoin is a deflationary currency. There is a cap on how many bitcoins will ever be in circulation, and that is 21 million. The coins were not released at once at the launch but are emitted a small chunk every ten minutes until all are in circulation. This is a process that will take over a century to complete.
Every ten minutes, a few new bitcoins are released to the miner who wins in the mining lottery and puts together the next block of transactions on the shared ledger. Read here a post explaining in detail what mining does and how it works.
The mining reward amount halves every four years, therefore, forming the following supply curve.
Beginning January 2009 the Bitcoin reward (also new bitcoins released) was 50 bitcoins per block (happening approximately after every ten minutes). That amount halved to 25 bitcoins on December 3, 2013.
On July 18, 2016, the Bitcoin reward halved to 12.5 bitcoins. The next bitcoin halving will happen in May 2020. With that trend, it is estimated that the last bitcoin will be mined sometime in the year 2140.
Now, what happens after that? How do the miners get to meet the cost of electricity as well as the cost of buying the hardware?
Indeed, the shrinkage in the revenue that miners collect in the form of new coins released to circulation is not a one-time event that will wait to take place in the year 2140. Over 17 million bitcoins have been mined (over 80% of all bitcoins).
Less than 4 million remain to be mined in more than a century, which is a negligible amount. It means that the reward is already at the point where it is not to be relied on to sustain the maintenance of the network and in particular the shared ledger.
2. The Bitcoin price falling significantly
Does Bitcoin price affect mining? If yes, how?
Bitcoin miners as businesses have a special kind of cash flow. Their revenue comes in only in the form of bitcoin. Meanwhile, they have to take care of the bulk of their expenditure using fiat currency such as the US dollar and the Chinese Yuan. In particular, no power supply company anywhere on the globe accepts bitcoin for electricity bill settlement.
Therefore the exchange rate between fiat and bitcoin is a critical factor in the books of account of a miner. A mining entity might keep getting a good amount of bitcoins as mining rewards, but they end up making huge losses owing to a fluctuation of the exchange rate between the cryptocurrency and fiat currencies.
When the losses are significant, and the price of Bitcoin doesn’t recover for an extended period, the miners end up shutting down their operations. Indeed, this scenario plays out during the crypto winter phases of the crypto market cycle. A few miners have closed when the Bitcoin price is bearish.
The question though is whether all miners can close shop and let Bitcoin fail if the price fell to extreme lows.
The mining reward is replaceable
It seems like Satoshi Nakamoto thought through all the possible scenarios on the working of the Bitcoin network. The end of the bitcoin emission must have been well considered before finalization of the design. After all, Satoshi Nakamoto designed Bitcoin as a payment method that would last for years. Probably millennia.
So what will happen to Bitcoin when mining stops? What happens when all 21 million Bitcoins are mined? Or when the mining reward is no longer big enough to cover the cost of mining, an era we seem to have entered?
The mining reward is replaceable with transaction fees. A transaction fee is a small amount that a sender of bitcoins attaches to the transaction, which goes to the network.
In the early days, Bitcoin users would attach a transaction fee as a tip to miners. It was also a way to motivate the miners to give a transaction a priority in the process of confirming it on the blockchain.
It remains largely as voluntary as both a transaction with the fee attached and one that does not have it, in the end, get confirmed on the shared ledger. However, most wallets have inbuilt calculators that automatically determine the fee you need to pay for fast confirmation and adds it to your transaction.
The miner that takes the reward also takes the transaction fees. When the reward grows very thin, and after all the bitcoins that needs to be in circulation have been released, transaction fees will become the primary incentive for miners to keep their machines running and helping to maintain the shared ledger.
Mitigation against a price drop
There are two design strengths of the Bitcoin network that shields mining from the decline of the price of Bitcoin. One is the fact that the cost of mining is not the same in all countries and cities.
For example, it costs over US$ 11,000 to mine a bitcoin in Ireland. Meanwhile, it costs US$3200 in Iran. This is according to a research report published by Crescent Electric Supply Company, a US-based electric hardware supplier.
With that being the case, when the price of Bitcoin drops, miners in the countries with the highest cost of mining will close operations. Meanwhile, miners in countries with less mining cost will continue finding bitcoin mining profitable.
In addition, the hashrate, the total computing power of the Bitcoin network, drops. This, in return, forces the readjusting of the mining difficulty. The more hashing power the Bitcoin network has, the more difficult and costly it is to mine. Indeed, a bitcoin hashrate price correlation has been established.
But with the disconnection of a few mining nodes from the network, the hashrate and mining difficulty drops. This leads to the cost of mining going down. With this scenario, it means that Bitcoin mining can continue to be profitable to someone even if the price of bitcoin dropped to US$5.
Indeed, that might make the cost of joining the mining operation accessible to many more people with an impact of further decentralization of the network.
When will bitcoin mining stop being profitable? Likely never.