Bitcoin market inefficiency?

bitcoin market inefficiency

I’m doing another “lazy” Twitter-conversation-regarding-bitcoin post.  I think this one teaches a valuable economic lesson.  A lot of people have been criticizing the high transaction fees of bitcoin as making it “unusable.”  I think it’s important to point out that bitcoin is not unusable, but rather expensive to use.  There’s an important distinction there.  And in a related wrongheaded approach to the cryptocurrency, people are referring to some software issues as bitcoin transaction fee market inefficiency.

John: Total fees for the latest two-week retarget period were 11598.2 BTC.  At an average BTC price of ~$15k, that’s $174M.

Some see evidence of Bitcoin’s failure.

Some see a $4.5B annual bounty for smart, efficient, scalable engineering.

Chris: It is really interesting to see this market inefficiency.  Someone is going to exploit this for profit eventually.  I’m not super familiar with ‘Channel Factories’ but I would think this might be a way to do this[.]

Rollo: How is this a market inefficiency?  Space is limited and price went up.  It’s functioning exactly how a market would be expected to.

Chris: The fee market is EXTREMELY inefficient.  Why would there be 1000 satoshis/byte and 50 sat/byte for transactions in the same block.  Someone is paying an extra 950 sat/byte! Decentralized fee estimation is hard.

Rollo: Isn’t the higher fee there to ensure that a higher priority is placed on adding that transaction to the block?

John: I think Chris’s point is that 51 satoshis/vbyte would be sufficient for the higher fee transaction to be included.  Anything above that is a donation to the miner.

Rollo: That’s only in hindsight though, right?  It’s a risk/reward proposition and it shows that people are willing to pay a premium to include their transactions in the next block.

To speak generally, since there’s a limited number of transactions able to be recorded on each block, people who have higher priority transactions increase their transaction fees in order to make sure their transactions are processed as soon as possible.  They don’t necessarily have the benefit of knowing what the lowest transaction fee to get on the next block will be (assuming they’re not referencing the mempool), so they make a judgement call.  Since the competing transaction fees are unknown at the time of their bidding, they care about being on the next block versus not being on the next block as opposed to minimizing the difference between their fee and the next highest.

The fact that there’s a large range between fees in a given block is not evidence of bitcoin market inefficiency.  It’s actually evidence of the opposite.  Since the people bidding the highest for their transactions are getting included in the next blocks, it’s proving market efficiency.  In other words, the highest bidders are getting rewarded first—exactly as one would and should expect.

But this isn’t exactly the argument of my Twitter debaters.  Their point is more that many transaction fee estimators aren’t doing a good enough job (or people are just not choosing optimum transaction fees), so transactions are getting backed up and included in later blocks.  Yet this isn’t an issue with the market for transaction fees but instead with the software and/or with the users.  Again, the market is functioning as it should, but there are opportunities for improvement.  Leaving money “on the table” is not the fault of the market.

We wouldn’t blame the car market if I bought a car for $10,000 without realizing the same car was available down the street for $5000.  And even though I would have preferred to only spend $5000, I did agree that the $10,000 was worth trading for the car, so be careful what we attribute the “mistake” to.

I don’t mean to go after either of my Twitter debaters especially considering I think we were talking past each other.  I think they used the term “market” rather loosely which would explain some of the disagreement.  That said, the conversation presented a good reason to talk economics about an issue that may not be obvious.


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