The Third Bitcoin Halving
With the third Bitcoin halving looming closer on the horizon, what is going to happen? What can we expect?
Bitcoin’s third halving event has been at the heart of recent debates and discussions, generating polarising views on the effect it will have on the cryptocurrency and the ecosystem. To understand why this is such a widely anticipated event, let us first talk about Bitcoin mining and block rewards.
What are block rewards?
When bitcoin miners successfully add a “block” of transactions to the blockchain, they receive block rewards on top of transaction fees. Since Bitcoin is decentralized, block rewards are not issued by any organisation or central authority. Instead, it is hard-coded in the Bitcoin protocol to create and issue new bitcoins as an economic incentive to miners for their participation. It also acts as a method to distribute new coins into circulation.
About 18.1 million bitcoins have now been mined. The hard limit to the total supply of bitcoin is 21 million, which means only about 3 million bitcoins are left to be introduced into circulation. The last bitcoin is estimated to be mined in year 2140.
Why does Bitcoin halve its block rewards every four years?
To keep Bitcoin’s inflation under control, Satoshi Nakamoto designed the monetary policy such that the block rewards are reduced by 50% after every 210,000 blocks, which takes roughly four years.
According to Vitalik Buterin, the founder and lead developer for Ethereum, the main purpose of halving is for Bitcoin to simulate a commodity, like gold.
“One of the major faults of traditional fiat currencies controlled by central banks is that the banks can print as much of the currency as they want,” says Buterin, “and if they print too much, the laws of supply and demand ensure that the value of the currency starts dropping quickly, leading to a hyperinflationary spiral. On the other hand, there is only a limited amount of gold in the world, and with every gram of gold that is mined, the gold that still remains becomes harder and harder to extract. As a result, gold has maintained its value as an international medium of exchange and store of value for over six thousand years.”
Prior to 2012, miners were rewarded with 50 bitcoins for every new block discovered, which occurs almost every ten minutes. That sounds like a lot, but at that time, each bitcoin was worth only $31 at its highest point in June 2011, and it fell to $2 before the turn of the year.
Bitcoin’s first halving event took place in November 2012 and miners began to receive 25 bitcoins for each block thereafter. Block rewards were again reduced to 12.5 bitcoins after the second halving event in July 2016.
When is the next halving happening?
In May 2020, Bitcoin will be undergoing its third halving event. Block rewards will be 6.25 bitcoins, thus generating only 900 new bitcoins daily. This is a significant milestone for Bitcoin as its inflation rate will fall below 1.8%, which is lower than the target inflation rate of central banks of 2% and closing in on the mining supply growth rate of gold at 1.6%.
Who will be affected by the halving?
Miners are likely to be the most affected by halving events, as block rewards represent the main source of revenue for their operations.
Before the halving, miners stand to receive 12.5 BTC, plus some transaction fees, for every block they verify. At the current market price of $7,200, that equates to slightly more than $90,000 for one block approximately.
Right after the halving, the incentive for each mined block will drop to slightly above $45,000 (6.25 BTC + transaction fees). Assuming that the price of Bitcoin remains relatively constant, the halving will directly affect the profitability of mining operations, since most operational costs such as manpower overhead and electricity costs are fixed.
With a lower operating revenue, smaller or more inefficient miners with costly electricity or outdated hardware will be either (i) squeezed out of the competition, (ii) forced to move to another location where electricity is cheaper, or (iii) invest more capital into more efficient ASICs to enjoy economies of scale and higher efficiency.
If many of the smaller miners are forced into capitulation, then we could expect some market consolidation as larger players gain bigger market share.
Marco Streng, CEO of Genesis Mining, believes that the halving event is an organic way to consolidate the industry.
“The (miners) with larger hashing power and access to cheaper sources of energy will squeeze out from the market operations that need higher margins to survive and make a profit — The halving is a brutal wipe-out event. It knocks out the miners who are not efficient enough immediately and shows no mercy.”
How will it affect the price of Bitcoin?
The short answer is: “No one knows”.
Many people have tried to discern a pattern in bitcoin prices by extrapolating from previous Bitcoin halving events. In both cases, a bullish trend for Bitcoin occurred, usually about a year post-halving. However, past performance is no guarantee of future results.
The monetary policy of Bitcoin incorporated in the protocol does not magically cause Bitcoin prices to surge after a halving event. Though, there is no doubt that halving events will introduce price fluctuations and volatility to the currency:
- Many small miners could sell bitcoins from their stockpile to try and sustain operations, or to liquidate in capitulation;
- A significant event like the halving would increase media attention, and invite more speculative retail investors to join the market;
- Many investors continue to accumulate and increase their position.
Furthermore, the scarcity of Bitcoin — specifically measured by the stock-to-flow model — will change drastically upon a halving event.
The stock-to-flow (S/F) ratio shows how many years are required to achieve the current stock at the current annual production rate. This figure measures scarcity: the higher the number, the more scarce the commodity.
Gold, for example, has an annual mining production of about 3,000 tonnes and has a current stock of about 190,000 tonnes ever mined.
S/F of gold = 190,000 / 3,000 ≈ 63.33
On the other hand, there are about 18 million bitcoins in circulation. Currently, 657,000 new bitcoins are mined every year.
Current S/F of Bitcoin = 18,000,000 / 657,000 ≈ 27.39
Right after the next halving event in May 2020, there will be approximately 18,375,950 bitcoins in circulation, and the annual production rate of Bitcoin will be 328,500:
New S/F of Bitcoin = 18,375,950 / 328,500 ≈ 55.94
After the third halving, the S/F value of Bitcoin will be much closer to gold. As the production growth rate of Bitcoin slows down, the price should rise accordingly as demand rises.
Over the long term, it is probably more productive to approach the price question by examining the maturity of the crypto industry:
What is the overarching trend for Bitcoin and other digital assets and cryptocurrencies?: How have governments and large institutions reacted to Bitcoin? How has the public perception towards Bitcoin changed over the years?
Why should more people adopt Bitcoin?: How have the use case and adoption of Bitcoin for consumers and institutions changed over time?
How can more people adopt Bitcoin?: How have the product landscape and technical development surrounding Bitcoin made it easier for the layperson to interact with the cryptocurrency?