In my last article I went over the Market-cap/Thermocap ratio, a tool used to call major market tops/bottoms, this time I want to go over something a little less trading-centric, the Fee Ratio Multiple (FRM).
FRM isn’t something you want to be using to make million dollar trades, but might be worth looking at if you’re evaluating long term blockchain investment opportunities, as it serves as a proxy for a blockchains long-term value proposition… let me explain;
What is it?
FRM is calculated as follows: Miner revenue (block reward + fees) / fees.
This calculation returns a value which, if multiplied by the fees, would be equal to Miner revenue. Therefore, we can figure out how far the networks total fee revenue deviates from current total security budget.
Why is this important?
Well, Bitcoin relies on miners to secure the network, validate transactions and create new blocks to submit to the chain… but that takes a lot of computing power due to mining difficulty (the work part of Proof of Work), and therefore requires copious amounts of electricity, so they wont do it for free, this is what makes bitcoin secure, because to create an invalid block and double-spend your bitcoin would require you have 51% of all mining power, which would be incredibly costly, and since motivated by monetary gain, counter-productive for the hacker.
However this also creates an ‘incentive problem’. The question to ask from here is, ‘how to we incentivise miners to do this?’, and the answer, as per usual, is money.
The Bitcoin protocol allows each miner of a new block, to issue new tokens to himself, as payment for his work… only problem is, this reward allowance is being cut in half every 4 years, and eventually will be 0 so we need another incentive; transaction fees.
You would be right to assume that the higher the incentive for security, the higher the security, therefore, a good long-lasting blockchain would need to be able (eventually) to accommodate for a high security budget, regardless of block reward, and so, an FRM value closer to one is desirable (an FRM multiple of exactly 1 would mean miner reward was 100% funded by transaction fees).
There is no need to be worried with BTC FRM sitting comfortably inside the 20–100 range, as we are still very early in evolution of the chain, so block reward is still very substantial at 6.25 BTC ($294,200 USD at time of writing this article) (also 20–100 is very low compared to most other tokens eg. Litecoin’s FRM = 624).
In a perfect world, we go on to see FRM gradually approaching 1 as time progresses, without seeing a major decline in hash rate (measure of total computing power dedicated to security).
Conclusion/Critique of FRM… and why Bitcoin wins in the end;
FRM is a very interesting metric to look at when evaluating a blockchain investment opportunity, however, I believe it is more useful to just understand, than to actively use as an indicator, heres why;
1: FRM is noisy, it is easily and heavily swayed by natural day to day fluctuations in mem-pool congestion (the queue to get your transaction submitted to the block, which incentivises using higher transaction fees as a sort of “skip the queue pass”) …and considering block reward remains relatively stable (in-between halving events), at some amount of bitcoin roughly every 10 minutes, depending on which halving you are in;
This means that FRM becomes essentially an inverse proxy for measuring transaction fees, something much easier to understand, higher fees = more usage, more usage = higher network value.
Here is BTC FRM plotted against miner revenue from fees, they are essentially just plotting inverse charts from one-another, FRM rises, fees simultaneously fall:
But I don’t want to be too harsh on FRM as it does serve as a good measure of how heavily the security budget is subsidised by block reward, and since block reward is lowering to zero, a good measure of how much transaction fees would have to increase to achieve current levels of network security should block reward disappear… current levels being the operative phrase here, and that leads me to my second criticism of FRM:
2: FRM assumes current hash rate is necessary for a successful blockchain. Hash rate, or network security if you’d like, is good enough so long as acquiring 51% of the total computing power of the network is economically infeasible, so long as that fact remains true, Bitcoin remains secure, and FRM can dance around as much as it likes, but it wont change the intrinsic value proposition of the network.
This is why Bitcoin wins in the end… Satoshi already thought of everything.