For everyone that has been following Bitcoin lately, there’s been a lot of talk about a “Bitcoin Halving” that is coming “really soon”.
So, what is this Bitcoin halving? How will it impact the crypto market and what does this mean for the coin’s future value? Has this happened before? And if so, what were the consequences? These are a few of the questions that I will try to answer in this article.
Before we do so, however, we need to take a step back and cover some basic notions about Bitcoin and the way new coins are issued.
Since its creation in 2009, Bitcoin acts as a better way to exchange value. Certain rules had to be established in order for it to be more effective and advantageous than the traditional methods like fiat currency or bank transfers.
As a peer-to-peer currency, the Bitcoin network collectively manages all transactions without any central controlling authority, such as a bank or financial institution.
Apart of that, Bitcoin has, by design, a limited supply of 21 million Bitcoins. New Bitcoin is generated daily by a process called mining, which is estimated to conclude by the year 2140, when the last coin will be mined.
This controlled release of new coins is impeccable for the coin’s value. In short, this means that once we reach the supply cap there will be no possibility to mine new Bitcoin. As a result, people expect that both the value and scarcity of the coin will increase.
Does this ring any bells?
Gold is one commodity that follows a similar notion. We do have a general idea of its limited supply and the demand is high, which has increased the price of the precious metal over time.
Having said that, let’s take a look at one basic differentiator between the method of mining gold compared to mining Bitcoin.
What is Bitcoin Mining?
Bitcoin is not mined with shovels in top-secret mining sites.
No, mining cryptocurrency is a completely digitalized process.
By doing this, miners are rewarded with newly created Bitcoins and transaction fees. And as the network’s popularity grows and more people use Bitcoin, rewards from transaction fees increase even more.
There are 3 things that occur through mining Bitcoin:
Issuing new coins
This is pretty self-explanatory. In order to eventually reach the cap of 21 million Bitcoin, miners that complete all transactions of a block receive newly mined Bitcoins. This means that there is an average of 1800 new Bitcoins created daily as, currently, there are approximately 144 blocks currently mined per day (144*12.5=1800).
Confirmation of transactions
A transaction is only secure and complete once it is included in a block and embedded in the Blockchain. Miners confirm transactions in order to prevent double-spending of the same Bitcoin. Simply put, it eliminates the risk of a transaction reversal and double-spending.
Security of the network
Miners make the Bitcoin network more secure by making it more difficult to attack. The more miners, the safer the network becomes.
Bitcoin is the leading cryptocurrency with the most miners, making its Blockchain the most secure at this moment. In order to reverse a transaction, the attacker must have more than 51% of the network’s combined hash power.
All in all, mining is crucial to Bitcoin’s existence; as long as Bitcoin and its Blockchain exists, there will be miners and vice versa.
The evolution of Bitcoin mining over time
The first two people that mined Bitcoin were the cryptocurrency’s creator Satoshi Nakamoto and early adopter Hal Finney. The latest is even rumored to be Satoshi Nakamoto himself.
Here’s a cool fact: Bitcoin has intricate rules for mining. The more mining power the network has, the harder it is to confirm transactions. This means that the difficulty of the mathematical problems that need to be solved in order to issue new Bitcoins is adjusting automatically as the computational power of the network increases.
As such, it was necessary for miners to improve hardware solutions in order to remain profitable.
The first mining upgrades happened during 2011. CPUs couldn’t keep up with mining demands so miners started using their GPUs (Graphics Processing Units). The latest has more processing power and can, thus, solve more complex mathematical problems.
Then, around 2013, the ASIC (application-specific integrated circuit) miners were introduced to the scene and have since then become the mining standard hardware. To put things in perspective, one ASIC miner has the power of around 700 GPUs. This is why, to this day, the ASIC dominates the mining market.
Bear with me as this is all relevant to the halving of mining rewards.
The reasons behind the Bitcoin Halving
Satoshi Nakamoto created Bitcoin with the intention of it being and remaining valuable through time.
As such, a set of ground rules were coded within the Blockchain to render the cryptocurrency resistant to inflation.
In the case of fiat currencies, government banks are able to print more money each year and therefore decreasing its value. By doing this, they enter an inflationary economic model where they incentivize spending now rather than later. This system is steered towards high leverage practices such as debts, loans, and credit.
The inflationary model is detrimental, especially in the long term. The value of people’s savings reduces over time and, by the time they retire, their lifelong financials are worth only a fraction of their original value.
Let’s take the buying power of 100 US dollars as an example. Because of inflation, that amount of money in 1970 would have approximately the same purchasing power of $700 today. That is quite a difference in 50 years.
This is the reason behind the Bitcoin halving principle. Satoshi Nakamoto wanted the value of Bitcoin to increase, instead of decrease, over time.
So how does this model work?
Bitcoin Halving – What is it and how does it work?
Satoshi Nakamoto introduced the halving mechanism, which essentially stands for the slashing of miners’ rewards by half, approximately once every 4 years. Every time 210.000 blocks are mined, the reward decreases and a new “reward era” starts.
Looking back in time, there have been 2 more halvings that already occurred, and we are now in the 3rd reward era, where one mined block grants 12.5 Bitcoins.
Bitcoin fighting inflation
In a deflationary economic model, the issuance of new currency lessens over time, which means that it will be worth more later on. Taking into consideration the scarcity, mining difficulty and the controlled supply of Bitcoin, what you get is a foolproof model of a commodity that increases in value over time.
Satoshi Nakamoto explained the idea behind the halving:
“If the coinage does not increase as fast as demand, the opposite of inflation will occur, and early holders of the currency will see its value increase. In an economy, money has to be distributed and produced somehow, and a constant rate seems to be the best formula.”
There have been criticisms of this model in the past. Wouldn’t this create another problem, namely collecting Bitcoin and never actually spending it? This question often comes up:
“Why would anyone want to spend Bitcoin, if they are certain that it will be worth more in the future?”
The answer is quite simple, really. Even though deflation discourages spending, you can never eliminate the need for it. Basic necessities are not something we can put aside. Commodities and luxuries become a timing preference instead of an artificial need. People get to choose if they want to spend now or later.
As such, one can use Bitcoin both as a store of value and as a currency. Only, instead of its value decreasing and stagnating over time, as is the case with government-based currencies, Bitcoin increases its worth over time, leading to increased mainstream adoption.
Previous Bitcoin halvings and their impact
The first Bitcoin halving occurred on the 27th November 2012.
Block 210000 was solved by a Radeon 5800 GPU, one of the most popular GPUs at that time used for mining. The graphics card was later sold at a significant markup to Chaang Noi, an early Bitcoin investor.
In the following year, market prices of the leading cryptocurrency skyrocketed. A new peak price was reached about one year after the halving took place. The price of Bitcoin increased from 12$ to a new high of 1.120$. The price corrected in 2014 and a long bearish market installed some doubt in the investor minds. Market sentiment was at a low point for certain, as Bitcoin’s price fell in the 300$ range, retracing by more than 70%.
And then, the second halving happened. It was this halving of July 2016 that opened the path for the crazy 2017 bull run of Bitcoin where we saw prices reach new highs once again. From 657$ at the moment of the second halving to a still unbeaten record of 19.780$ by December 2017.
Based on the above, and by further analyzing the effects of the prior halvings on the coin’s price, we can see that the price increase was never immediate. Instead, what happens after each halving is somewhat of an “awareness” timeframe for investors and speculators to absorb the idea of increased scarcity.
In both occurrences, the halving has been a precursor of incredible bull runs and tremendous gains in value versus the US dollar.
The Bitcoin Halving 2020
All of this brings us to May 2020.
In less than a year, the 3rd reward era is will be ending and the reward for mining new Bitcoins will be cut in half (6.25 coins per block).
For miners, this might seem counterproductive, as the reward barely covers their current electricity costs. Some even say mining is nothing but a “dead-end” and will soon be a thing of the past.
But consider this: In the first halving cycles, there wasn’t enough relevant data for miners to fall back on and have any kind of expectation about an increase in the price of Bitcoin. They had to rely on theoretical speculation on scarcity and a general belief in the cryptocurrency’s viability.
This is different now.
As a consequence of the reward halving, there is a high expectation for an increase in the coin’s price. It is now apparent that the halving cycles result in a new incentive to buy Bitcoin on the market, driving the prices up.
If the market behaves as it has in the past we can certainly be excited of what 2020 and 2021 will bring to the table.
Bitcoin is a cryptocurrency that, by design, increases in value over time. By coding the halving mechanism into the network, inflation remains in check and scarcity increases over time.
Here is what you should remember:
- When a Halving occurs, mining rewards are reduced to half.
- Less issued Bitcoins leads to an increase in scarcity and value.
- The mining difficulty increases as more miners enter the network.
- Bitcoin halving has always been a prerequisite for an increase in the coin’s value.
Hopefully, the Bitcoin halving of 2020 will act as another milestone in the maturity of the cryptocurrency market. At this moment, there are clear signs of recovery.
And even though we cannot predict how the halving will affect Bitcoin’s price in the long run, we can positively predict that the trend will continue throughout 2020 and after the halving.