How high can Bitcoin go? Watch transaction fees
A major obstacle to widespread adoption of Bitcoin is the processing power bottleneck. Bitcoin transactions are enormously complex and require a tremendous amount of computing power. As a result, the Bitcoin network has a lot less capacity than competing electronic payment technologies. The Bitcoin network can currently process about 7 transactions per second, compared to 1,700 per second for Visa or Ripple.
This technology bottleneck makes it difficult to scale Bitcoin in a way that would make it competitive with traditional electronic payment processing. The result is that whenever capacity scaling has fallen behind adoption rates, Bitcoin users have had to deal with either long delays to complete a transaction or high fees in order to get faster service. Adoption rates and transaction throughput then fall off, and the miners have a chance to get ahead of demand in terms of building capacity. When capacity gets well ahead of transaction volume, investor interest rises, and that's when Bitcoin goes on bull runs. The cycle has seemed nicely predictable so far.
In 2017, just before Bitcoin went on a big bull run, the miners got the average transaction fee below 1% of total transaction volume. That's very competitive, considering Visa's average transaction fee is over 2%. Traders responded to the low fees by investing in Bitcoin. Unfortunately, the low transaction fees were partly the result of low volume on the Bitcoin network. When investor interest rose, the network eventually hit a transaction volume bottleneck at which fees began to rise. In the first half of 2018, Bitcoin's price steadily fell as average transaction fee steadily rose toward the prohibitive price of 3%.
The Bitcoin bull run in 2019 followed the same pattern. Fees fell to 2% of volume, enabling a modest gain in Bitcoin's price as investors returned to the asset. The run peaked just as the network again hit its bottleneck and fees began to rise back toward 3%.
The current price run illustrates how much progress has been made on network capacity and transaction cost. Although Bitcoin prices have surged to record levels, fees have remained low as a percentage of total volume, in the neighborhood of 1%. I suspect, however, that the problem has not been completely solved. At some level of transaction volume, we will once again hit a processing power bottleneck. At that point, transaction fees should again start to rise and Bitcoin's price should again peak.
The beauty of this pattern is that it's so logical. There are basic principles of economic theory driving this thing. Bitcoin transaction fees are set by supply and demand. When you exhaust the supply of miner processing power, fees rise. And demand for Bitcoin is partly a function of the price of usage, so as transaction fees rise, they suppress investor demand and Bitcoin's price.
This technology bottleneck makes it difficult to scale Bitcoin in a way that would make it competitive with traditional electronic payment processing. The result is that whenever capacity scaling has fallen behind adoption rates, Bitcoin users have had to deal with either long delays to complete a transaction or high fees in order to get faster service. Adoption rates and transaction throughput then fall off, and the miners have a chance to get ahead of demand in terms of building capacity. When capacity gets well ahead of transaction volume, investor interest rises, and that's when Bitcoin goes on bull runs. The cycle has seemed nicely predictable so far.
In 2017, just before Bitcoin went on a big bull run, the miners got the average transaction fee below 1% of total transaction volume. That's very competitive, considering Visa's average transaction fee is over 2%. Traders responded to the low fees by investing in Bitcoin. Unfortunately, the low transaction fees were partly the result of low volume on the Bitcoin network. When investor interest rose, the network eventually hit a transaction volume bottleneck at which fees began to rise. In the first half of 2018, Bitcoin's price steadily fell as average transaction fee steadily rose toward the prohibitive price of 3%.
The Bitcoin bull run in 2019 followed the same pattern. Fees fell to 2% of volume, enabling a modest gain in Bitcoin's price as investors returned to the asset. The run peaked just as the network again hit its bottleneck and fees began to rise back toward 3%.
The current price run illustrates how much progress has been made on network capacity and transaction cost. Although Bitcoin prices have surged to record levels, fees have remained low as a percentage of total volume, in the neighborhood of 1%. I suspect, however, that the problem has not been completely solved. At some level of transaction volume, we will once again hit a processing power bottleneck. At that point, transaction fees should again start to rise and Bitcoin's price should again peak.
The beauty of this pattern is that it's so logical. There are basic principles of economic theory driving this thing. Bitcoin transaction fees are set by supply and demand. When you exhaust the supply of miner processing power, fees rise. And demand for Bitcoin is partly a function of the price of usage, so as transaction fees rise, they suppress investor demand and Bitcoin's price.
Comment:
The fee rate shows, so far, no sign of turning upward. The network still seems very comfortably within capacity.
