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Everything You Need To Know About Bitcoin Halving

“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.” – Satoshi Nakamoto

The pseudonymous founder of Bitcoin, Satoshi Nakamoto, designed the digital currency to be a deflationary currency. In this programmatic model, fewer bitcoins are produced over time, and the digital currency will theoretically become scarcer gradually. 

Miners produce new bitcoins with electronic equipment and receive bitcoins in the form of block rewards. Every 210,000 blocks the total number of bitcoin that miners can potentially earn for their work is halved––that is, cut by a factor of two. This takes place approximately every four years. Halving prevents inflation by slowing the rate at which Bitcoin are produced.

Policymakers, on the other hand, control the economic policy of fiat currencies, leading to stimulus packages as high as the $8 trillion-$10 trillion coronavirus response by the Federal Reserve. Such policies, known as monetary debasement, can lead to decrease in purchasing power, inflation, and hyperinflation.

The underlying technology to Bitcoin––which many contend is the true innovation of the system––is called a blockchain. It keeps track of which addresses have how many bitcoins. This distributed database is extended by one block approximately once every ten minutes. The blocks contain all of the transactions. When miners reach consensus about the transactions that took time during the duration of a block, a new block is added.

Bitcoin’s issuance over time is transparent. We know there will only ever be 21 million bitcoins in existence, and we know the approximate schedule by which they will be released. At the time of writing, approximately 18.36 millions bitcoins have been mined. Russ Roberts, professor of economics at George Mason University detailed this policy in comparison with governments.

“Elaborate controls to make sure that currency is not produced in greater numbers is not something any other currency, like the dollar or the euro, has,” said Roberts. “That is considered very destructive in today’s economies, mostly because when it occurs, it is unexpected. In a Bitcoin world, everyone would anticipate that, and they know what they got paid would buy more than it would now.”

Generally, predicting when exactly a halving will come to pass is hard, for the time it takes to generate new blocks is not constant. Between now and 2140, when the last of the bitcoins are mined, we expect there to be 64 bitcoin halvings. 

Nakamoto set the Bitcoin protocol to start at 50 coins produced every ten minutes, which miners receive in the form of block rewards. In 2012, this was cut to 25; in 2016, to 12.5; and now, in just a few days,  this will be cut to 6.25 coins. Any changes to these rules must requires all Bitcoin nodes and miners to agree. When the last bitcoin is mined, miners will still be needed to secure the network; instead of being rewarded with bitcoins, they will be compensated via transaction fees.  

The first halving took place on Wednesday, November 28, 2012, as the block reward was cut from 50 to 25. As this was the first halving in Bitcoin’s history, the Bitcoin community did not know what to expect. Would the block reward decrease cause a “supply shock,” thus sending the price higher? This line of reasoning recognizes that miners must profit from the act of mining. If the block reward is cut in half, then the price increase must go up so as to incentivize mining. From performing calculation to mine bitcoin to the real estate and equipment needed to store and maintain mining equipment, the process of mining is energy intensive. 

Others believed halving and supply shock had been priced into the market, since the block reward schedule has been known since Bitcoin founder Satoshi Nakamoto released the protocol into the wild. Traders, therefore, anticipating the halving, purchased bitcoins with the intention to sell them at a profit after the block reward had been reduced, thereby ensuring there would not be a major disruption to the supply of bitcoins to the market.  Bitcoin’s block reward halved in 2016 for the second time from 25 to 12.5 bitcoins.

Halving Effects on Price

In early halvings, many people contended the cut in supply would lead to an increase in price, while others argued the halving had already been priced in. Ahead of the 2016 halving, the bitcoin price increased approximately 50 percent in the three months ahead of the halving. In the hour before the first 12.5 bitcoin block had been mined on halving day 2016, however, Bitcoin dropped in price by more than 5 percent.

In the months after a halving, the price typically increases. Bitcoin gained 8,000% in the 12 months following the 2012 halving. After the 2016 halving, the price rose %1,000 percent. Whether or not there is a causation between halvings and price increases can’t be certain. For instance, interest in bitcoin increases over time, so perhaps the price increases are the result simply of higher demand. 

Halving Days

Halving days are the source of much excitement in the industry. As early as the first halving, people were throwing virtual halving day parties

As they approach, there is increased attention placed on Bitcoin, particularly from within the blockchain community. Some, to be sure, criticize the deflationary model of bitcoin. The Bitcoin white paper is titled “Bitcoin: A Peer to Peer Electronic Cash System.” However, some claim Bitcoin is more akin to digital gold than digital cash–that is, a store of value. They cite the deflationary nature of Bitcoin as a reason why. With production decreasing over time, this encourages hoarding of Bitcoin, thereby undermining a spending economy.

If the price of Bitcoin declines for a sustained period of time after the halving, it is possible that mining organizations with smaller reserves may begin to capitulate and shut down their machines and operations. When mining was done on personal computers, this wasn’t as big of a deal, as miners could simply turn off their computer or halt mining temporarily. However, today’s largest Proof of Work network is run by a series of large pools and companies with expected revenue streams, costs of business, employees and more.

Though such a scenario could result in a short term shakeout of mining groups, it is just as likely they could be replaced by new stakeholders. I wouldn’t be surprised if several mining groups have anticipated a short term price decline and have prepared ahead of time. We could very well see some mining groups operate at a loss based on the assumption that bitcoin price surges have historically come some months after the actual halving date.