Bitcoin is a fascinating invention that even at its failures, it manages to become something far more rewarding.
Bitcoin was fundamentally designed to be decentralized money, it was meant to be a currency for the masses to ditch fiat counterparts like the USD for, but it has failed at this by the hands of community consensus but in the process, it became something far more rewarding and that's being a store of value because the system is literally designed to encourage long-term storage.
Now I'm just going to go straight ahead and call it, as I've always done, that being a store of value is only going to lead to Bitcoin's supply distribution being centralized. Certainly, that would mean little because BTC is expensive and anyone buying up the supply is taking a great deal of risk doing so.
Moving on, the failures of bitcoin turning into what makes it grow at astounding rates over the years is quite a marvel of our time.
Oftentimes you'll hear people talk about Bitcoin and attribute its growth to be a result of network effects, which is a phenomenon where a product or service becomes more valuable as more people use it.
What's to be discussed here today is similar to “network effects” only that it isn't necessarily tied to the broader increase in users, but simply the increase in individual transactions.
The more transactions you make on Bitcoin, the more valuable the asset becomes. In a sense, you're longing Bitcoin by simply using it, you just don't realize it in the short-term.
Of course, one-off users are unlikely to know what I'm talking about, but active participants should have an idea at the end of the day.
Bitcoin's UTXO and block size encourages HODLing
UTXO stands for Unspent Transaction Output. It is a fundamental concept in blockchain systems, especially Bitcoin.
When a transaction occurs, it consumes UTXOs as inputs and creates new UTXOs as outputs.
Each UTXO is indivisible; it must be spent in full. If you need only part of it, the transaction creates new UTXOs (one for the recipient and another as change back to the sender).
Bitcoin's block size refers to the maximum amount of data that can be included in a single block on the Bitcoin blockchain. It directly affects how many transactions can be processed per block. — GPT
When we say that Bitcoin is cursed to expand the lending market, we're essentially saying that the chain’s design disincentivizes spending BTC but instead, encourages using it as collateral if a need to leverage the asset's value arises or simply using services that require exposure to debt to function efficiently.
This reality also proves that Bitcoin's supply will inevitably become concentrated to a few institutional wallets to which point most transactions will mostly occur on secondary off-chain solutions like the lightning network.
The big question is how this theory is true?
The theory becomes an accurate assessment if the network of participants do not find justifiable reasons to pay high % fees to move their assets around. The network doesn't fundamentally “try” to force people to hodl their coins, but the realities of UTXOs and the chain’s block size can lead to investors being trapped.
The average small time investor can afford to buy $10 of bitcoin daily while larger investors can go as high as $1,000. This is $3,650 for the small fishes and $365,000 a year for the big guys. If a user buys $10 every day for a year, they would have made a total of 365 transactions.
If the user decides to perhaps move that BTC to a new address at the end of the year, the user would pay about $72.29 in fees at current fee rates and that's approximately 1.98% of his investment value.
Not great, is it?
This is true only if he's been paying into a taproot address as that's the most cost-effective and fees would be higher for any other address formats.
But that doesn't explain the high fees right? The fee is that high because the user has a total Bitcoin balance that includes UTXOs from 365 different transactions. As a result, to move all his balance out, the transaction will include 365 inputs and the average taproot transaction with 1 input and 1 output costs 111vB in space, which in turn costs 238.65 sats($0.20) to process.
If the user bought $1,000 worth of bitcoin daily across 10 different transactions($100 each) for a year, he would have made 3,650 transactions at year end to acquire $365,000 worth of bitcoin.
It would cost $722.89 in fees to move his $365k worth of BTC at year end. That's approximately 0.202%.
Evidently, this disincentivizes small investors from selling below or close to their cost-price. The only way to offset the cost is to hold to higher prices. Essentially, each purchase becomes a long position because liquidating early leads to a negative PnL.
It would also be important to note that we've not factored in the fees paid in the process of purchasing the Bitcoins in the first place and the onchain cost of moving it into a non-custodial wallet. When we add it all up, it's a great disincentive. This also proves why smart contracts cannot exist directly on Bitcoin in its current design and how a direct onchain dex for Bitcoin would be too expansive.
Now, it might look like this problem only affects small investors but it also would be a huge problem for businesses, if they accepted BTC onchain as payment for goods and services.
Imagine a business receiving millions in transaction payment counts, whilst each is valued $10 or below. The cost to liquidate would be through the roof, making it simply not worth adopting.
The solution for businesses would be to take collateralized loans on their income to avoid the fees or simply opt to use lightning payments as opposed to receiving bitcoin onchain.
Both scenarios lead to the expansion of the lending market because even when you adopt lightning payments, you'd indirectly be working with institutions that can afford to handle long-term exposure to Bitcoin and the only way to do that would be through low interest loans that allows them to acquire bitcoin and facilitate off-chain payments for various businesses.
It's simply wild to think that the future of Bitcoin involves expanding the lending market, which in turn pumps its price.
Whether or not this is a good thing, I guess is left for time to tell.