Understanding the Effects of Bitcoin Halving

With the unanticipated spike in the prices of Bitcoin in the beginning of the first quarter of 2019, the altcoins followed suite and experienced a marginal price increase over the said time period. This came after a year long winter that saw Bitcoin prices plummeting to a new low, settling around USD 3500. This volatility in prices spurred a debate among cryptocurrency enthusiasts and trade analysts, and gave rise to different theories as to the cause. This happening almost a year prior to the next Bitcoin halving event has further raised much speculation on possible implications regarding Bitcoin’s price, as well as the prices of the rest of the cryptocurrency market. However, prior to drawing any conclusions, it is imperative to fully understand the concept and impacts of halving.

What is Bitcoin Halving?

Bitcoin halving is an event that marks the halving of the Bitcoin reward for mining new blocks. This means that the miners start receiving 50% less rewards (denominated in Bitcoins) for the transactions that they validate. This phenomenon occurs whenever 210,000 blocks get verified and validated, adding to the existing chain of blocks in the Bitcoin blockchain. With a block verification requiring an average of around 10 minutes, a total of 144 blocks can ideally be verified with a day, which amounts to four years to reach the milestone of 210,000 blocks. This implies that the event occurs approximately every four years. Bitcoin halving, together with the general increase in the complexity of bitcoin’s cryptographic algorithms, ensure that the total finite supply of 21 million Bitcoins are not minted and circulated within a short time frame.

Why is Bitcoin Halving important?

Halving prompts a drop in the number of new Bitcoins generated by the network, translating to a fall in the growth rate of the Bitcoin supply. The cryptocurrency market, much given to speculation, has historically showed an inclination for greater volatility prior to this much awaited phenomenon.

Many proponents of the event believe that Bitcoin’s halving results in a long-term and positive impact on its prices. One of the more common theories as to why this happens is the fundamental mechanism of the economic forces of demand and supply. With miners’ rewards falling over time, the greater scarcity of Bitcoin supply automatically increases Bitcoin’s value. Furthermore, miners are not traditionally inclined to sell their Bitcoins unless the sale covers the cost of the mining.

Admittedly, such occurrences create a pool of arbitrage opportunities for traders, although it must be clearly noted that the final result can differ across events, depending on the circumstances at the time of each halving event.

The Economic Model of Bitcoin

Unlike the traditional monetary system of fiat money that the current world operates on, Bitcoin’s monetary model is completely (and refreshingly) the opposite. The total supply of Bitcoin has been fixed at 21 million since its inception, meaning that no new Bitcoins can ever be created once the last Bitcoin is mined. If miners were to mine at their own pace – presuming an increase in prices – the total supply of Bitcoin could possibly even be exhausted sooner. Bitcoin’s feature of scarcity and utility is akin to gold. The inelasticity of its supply explains the extreme volatility in its prices; even small changes in demand, among other things, may lead to huge price fluctuations.

Timeline of Bitcoin Halving: Upcoming and Previous

The next Bitcoin halving is estimated to be scheduled for the week of May 18, 2020 and represents the third such event in the history of Bitcoin, with the blocks reaching the 630,000 tally. With that, the mining rewards will be reduced to 6.25 Bitcoins from the current 12.5 Bitcoins per block, meaning that a miner would be rewarded with half of the rewards from the successful validation of a block (of transactions). With reduced Bitcoin rewards at every consecutive event, the growth rate of Bitcoin’s supply would gradually decline. By 2140, it is expected that all 21 million Bitcoins will already have been mined, putting a stop to this event altogether.

Between 3rd January 2009 – the date of Bitcoin’s launch – to the current day, there have been two halving events. The first one occurred on 28 November 2012 which saw Bitcoin’s rewards coming down from 50 to 25 Bitcoins. The second halving event happened on 9 July 2016, witnessing a further fall from 25 to 12.5 Bitcoins, (today’s mining reward amount).

According to the calculations above, with a halving event every 4 years, future event dates can be speculated well in advance until the run is exhausted in 2140. The fourth halving is expected in 2024, where the rewards will further reduce to 3.1245 Bitcoins, and the fifth halving event, predicted for the fall of 2028, will reduce rewards to 1.5625 Bitcoins. This will be the last event to witness rewards higher than 1 Bitcoin.

The Effects of Bitcoin Halving

Bitcoin halving has multilateral effects on various vectors within the cryptocurrency landscape.

Impact on Bitcoin Pricing

Both of the previous halving events saw a significant surge in Bitcoin prices. The first event witnessed Bitcoin’s prices going up on the day of the event itself, rising to $12 from $11 a month before. The price rose exponentially to reach $1,038 a year later.

Similarly, the second event also observed an increase in pricing, with the resultant price being $650 on the day of the event, rising from $576 a month prior, and within a year rising to $2526. In both the events, this significant surge happened despite much speculation regarding its price volatility. According to these observations, Bitcoin halving is believed to have a profound and inextricable effect on the price of Bitcoin – and to a large extent the greater cryptocurrency market – as it decreases the total mineable assets in circulation.

Impact on the Cost of Mining

The dynamic of Bitcoin halving which implies lesser rewards after each subsequent event has high cost implications. It requires more amount of time, effort, and greater energy consumption to solve the complex algorithms for verifying a block, only to yield half the amount of Bitcoins it did earlier. In the long run, it is expected that the cost of mining will perpetually be higher with the rewards falling and algorithms becoming more complex.

Impact on Miners

With every Bitcoin halving event, miners need to evaluate their costs. This assessment implies that in some cases, mining will no longer be profitable due to high cost implications, attributed to high power consumption and hardware requirements. However, if the prices and fees compensate for the decrease in reward value, miners will likely continue mining — as without such compensation, they could stop mining altogether. Furthermore, while some miners could give up, others will hold on to their Bitcoins until the prices are on the ascent. Irrespective of all this, however, the speed of mining blocks would not be compromised as the algorithm adjusts its complexity to maintain a steady pace.

Impact on Mining Fees

Miners are incentivised in two ways: block rewards and mining fees. As described above, block rewards are directly driven by the halving event, but this is not the case with mining fees. The mining fee is independent of the block reward, and is based on the demand for using the network. Given this, transaction fees have recently been on the rise, and are expected to provide some relief to the miners from the third halving event.

Impact on Hashrate

As some miners drop off the network due to a lack of profitability, the hashrate sometimes tends to fall. Rises in the hashrate could be attributed to the increased interest in mining Bitcoins prior to the third halving event; it is anticipated that prices could recover by a large margin, given the past history of the previous halving events as well as the current recovery of the overall cryptocurrency market. The hashrate are unlikely to fall significantly if:

  • Miners believe that the prices will make up for the lost rewards
  • Miners reinvest their past earnings from profitable mining
  • Miners obtain access to more advanced hardware

Another support for the hashrate is that as per the Bitcoin protocol, the complexity of the mathematical puzzle is reduced automatically when hashing power leaves the network.

Impact on Economics of Bitcoin supply

The Bitcoin mining rate has always been highly predictable and unlike other commodities, the supply of Bitcoin is transparent and predetermined. This attribute of Bitcoin accounts for its perfectly inelastic supply and with halving at periodic intervals, the rate of growth in supply will decrease with every passing event until 2140. A combination of fixed supply and uncertain demand renders volatility in its prices.

Conclusion

Whilst there is no official explanation for the integration of halving in Bitcoin’s protocol, it is speculated that the event has been programmed to incentivize individuals to join the network as soon as possible and start participating in the ecosystem. Empirical evidence has shown that there is a net increase in the short term and long term prices of Bitcoin after halving. However, caution is advised, given the volatility of the market, plus various other dynamics which could have an adverse impact on prices. No one can accurately predict what will happen. Prominent ecosystem stakeholders believe that the 2020 Bitcoin halving will positively impact prices without taking a considerable hit to the hashrate.

* The information above does not constitute any form of financial or investment advice and should not be relied upon. Investing in Digital Assets carries risk. For more information please see our risk warning.

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