The Bitcoin community is abuzz right now about the Bitcoin halving that’s going to take place around May 12th, 2020. Halving is a mechanism that was integrated into the protocol to keep the overall circulating supply of Bitcoin in check. After every 210,000 blocks, the Bitcoin protocol initiates halving to cut down the supply of new Bitcoins entering the ecosystem in half. This upcoming halving is going to cut down miner block reward from 12.5 BTC to 6.25 BTC.
Why does Bitcoin have a halving protocol?
Fiat currency is inflationary and governed by a centralized entity. For example, The Banque du Canada or Bank of Canada controls the Canadian Dollar (CAD) and they can simply inject more cash into the ecosystem at their discretion. This is the reason why Bitcoin hard-coded a hard upper-limit of 21 million BTC, so that nobody can arbitrarily inflate its supply. However, the problem with this system is that, if not kept in check, the miners could theoretically pump out all of the Bitcoins from the ecosystem. This could skew Bitcoin’s supply and demand equation.
Bitcoin supply & demand
For any asset/product, its price will vary in a competitive market until it achieves economic equilibrium wherein the quantity demanded by the market is equal to the supply available. The equation has two characteristics that you need to keep in mind:
- The supply available is too high and the market demand is too low, leading to a decrease in the price of the asset/product.
- The supply available is too low and the market demand is too high, leading to an increase in the price of the asset/product.
A deflationary mechanism like halving makes sure that the supply doesn’t go out of control and Bitcoin stays as close to the economic equilibrium as possible. As you can see in the graph below (Blockchain.com) the halving mechanism ensures that Bitcoin’s circulating supply over time is a curve instead of a straight line.
- 2009: Mining starts with 50 BTC block reward.
- November 28, 2012: Bitcoin goes through its first halving and reward reduces to 25 BTC.
- July 9, 2016: The second halving takes mining reward down to 12.5 BTC
- May 12, 2020: The third and upcoming halving will drop the reward to 6.25 BTC.
- 2140: Bitcoin 64th and final halving event. After the last Bitcoin has been mined out, the miners will be fully dependant on transaction fees as a means of revenue.
Effects of halving on Bitcoin protocol
Hashrate is a term used to measure the computational power of a decentralized protocol. A high hashrate can mean that more miners are participating in the protocol, they are using more sophisticated equipment, or both. The speed and security of the network are directly related to the overall hashrate. Now, since the miners depend on block rewards as a major source of income, they should act negatively in the short term, right?
Well, let’s take a look at how the halving really affects the network hashrate. All the charts below have been taken from BitInfoCharts.
2012 was when we witnessed our first halving event. As per the historical hashrate graph, within two weeks of the event, it fell from 27.61 THash/s to 19.98 THash/s. However, the hashrate eventually rose to 60 THash/s around six months later.
Following the 2016 halving, the hashrate of the network fell from 1.56 EHash/s to 1.40 EHash/s before eventually improving to 3.85 EHash/s in seven months. Interestingly enough, while the hashrate improved, the Bitcoin mining profitability curve shows us something else.
As you can see, it has become significantly less profitable to mine Bitcoin post the 2016 halving.
A low hashrate can be devastating to the network because of the following reasons:
- Transactions will not be processed fast, which will decrease the overall network throughput.
- The network will not have the firepower needed to fight a possible 51% attack.
If mining gets even less profitable following the next halving, it can plummet the network hashrate. This is why miners must find a way to keep mining profitable to maintain the overall hashrate. Here are some measures they can take to retain the network’s profitability:
- Opt for alternate and cheaper sources of power.
- Opt for hardwares such as Dragonmint T16 and the Antminer S9, which are relatively energy-efficient.
- Move their mining operations to places with colder climates to reduce overall energy consumption.
So, how does the Bitcoin price react following a halving event? As you can see below, the price definitely has an uptick, but how drastic is it?
- 2012 halving: The price rose a bit from $11 to $12 immediately following the event and then jumped up by 9,336.36% to $1,038 in just a year.
- 2016 halving: A month before the halving event, BTC/USD, the bulls started accumulating, which pushed the price up from $576 to $650. A year after the halving, the price jumped to $2,526.
As you can see, halving always has a positive effect on the price. Going by the precedent, it makes sense to believe that Bitcoin is going to catapult higher, maybe even return to its all-time high levels, post next month’s halving.
However, what about the flipside of the equation? Is the price action post-2020 really going to be that impressive?
One thing that we must keep in mind is that Bitcoin’s situation now is a lot different than from back in 2012 and 2016. So, instead of being overly optimistic, do keep the following points in mind before predicting Bitcoin’s price action:
- The trading volume of Bitcoin is higher than ever before. The amount of Bitcoin mined is minuscule compared to the total volume traded every day. As such, the halving won’t have that much of an effect on the price.
- The Bitcoin Futures market is thriving more than ever. The thing to keep in mind is that you don’t need actual bitcoins to do futures trading. This makes the actual circulating supply less important.
- The miners may choose to immediately sell-off their block rewards to take advantage of the market while it was in the green. This sudden sell-off will negatively affect the price.
So, while certain factors may inhibit exponential growth, it is hard to argue against the fact that it will still have a positive effect on the asset. Currently, investors have started accumulating Bitcoin to prepare themselves for the halving. As you can see in the daily BTC/USD price chart below, following a massive drop on 12th March, the price has steadily started increasing. It should be kept in mind that the 12th March dip directly happened as a result of the economic turmoil caused by the Coronavirus.
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