Dynamic User Competition and Miner Behavior in the Bitcoin Market

TL;DR

This paper presents a dynamic model of the Bitcoin market analyzing user fee bidding, miner behavior, and congestion effects, highlighting how block rewards influence market efficiency and social welfare.

Contribution

It introduces a novel dynamic model of Bitcoin market behavior, revealing the impact of congestion and block rewards on efficiency and proposing optimal reward levels.

Findings

Users adjust bids based on congestion levels.

Miners delay operation during mild congestion, reducing welfare.

A positive block reward can improve market efficiency.

Abstract

We develop a dynamic model of the Bitcoin market where users set fees themselves and miners decide whether to operate and whom to validate based on those fees. Our analysis reveals how, in equilibrium, users adjust their bids in response to short-term congestion (i.e., the amount of pending transactions), how miners decide when to start operating based on the level of congestion, and how the interplay between these two factors shapes the overall market dynamics. The miners hold off operating when the congestion is mild, which harms social welfare. However, we show that a block reward (a fixed reward paid to miners upon a block production) can mitigate these inefficiencies. We characterize the socially optimal block reward and demonstrate that it is always positive, suggesting that Bitcoin's halving schedule may be suboptimal.