The Bitcoin Halvening

The Bitcoin halving, sometimes just called “The Halvening”, sounds like something out of The Hunger Games. And while you do want the odds to be in your favor, it’s not a sinister event. In fact, it’s the Bitcoin community’s most highly anticipated event. On May 11, the number of Bitcoins entering circulation will drop by half, an event that has already happened twice before.¹ The supply of Bitcoin entering the system will suddenly shrink while the demand will theoretically stay the same, and there are many passionate discussions about how the market will respond to this event. But it’s the prospect of an increase in cryptocurrency’s price that’s helping this event gain public attention.

But the current price fluctuation may have less of a consequence than the cyclical decline of Bitcoin's mining rate. The block reward is an essential element of Bitcoin; it's fundamental in securing this ungoverned system. As halvings continue and block rewards dwindle to zero, the economic incentives at the heart of Bitcoin's security will be far less viable. 

We’ll dive deeper into what The Halvening is, why it matters and what the possible outcomes may be. 

Bitcoin Halving Explained

The Bitcoin network issues new Bitcoins every 10 minutes. These Bitcoins enter circulation as block rewards produced by “miners” who use specialized hardware to earn/mine them.² In the first four years of its existence, there were 50 new Bitcoins issued every 10 minutes. Every four years that number is cut in half. The Bitcoin halving has already happened twice before, in 2012 and 2016 respectively. The 2020 halving will see the amount of Bitcoins issued drop from 12.5 to 6.25.¹ And we should note, the halving is not scheduled by date, it’s scheduled by block height. The halving occurs every 210,000 blocks, which means the 2020 halving will occur on block 630,000 and the 2024 halving will happen on block 840,000.¹ 

But why must we stick to this schedule? Why would we want the mining rewards to shrink? In short, because Satoshi Nakamoto said so. Nakamoto is the mysterious creator of Bitcoin, and we say mysterious because they used this pseudonym to publish the Bitcoin white paper and devise the first blockchain database, and then they disappeared about a year after putting the software out into the world. Essentially, their thought process behind it was “coins have to get initially distributed somehow, and a constant rate seems like the best formula.”³ Unlike government-regulated currencies, which are controlled by humans and political processes, Bitcoin’s monetary policy is written into its code. Changing it would involve a massive undertaking and would require the entire community of Bitcoin users to coordinate and agree upon the new policy. 

Also unlike national currencies, there is a finite amount of Bitcoins that can ever exist, and the inflation schedule is predictable. There will only ever be 21 million Bitcoins in existence, and given the fixed schedule, we know they’ll all be mined by the year 2140. Though it’s estimated that over 98 percent of Bitcoins will be mined by 2030.¹ 

What Does This Mean for Bitcoin’s Price?

Honestly, no one really knows. Based on the two prior halvings, we could guess the price will increase after the halvening, as it has done in the past. In 2012, no one was sure what a sudden decrease in mining rewards would mean for Bitcoin’s worth, but the BTC/USD price rose from $11 to $12 shortly after the halving, and then shot up to $1,038 in a single year, resulting in a remarkable 9,336 percent increase in price.⁴ That increase made the 2016 halving a highly anticipated event; however the day of the halving the price dropped 10 percent, falling to $610 before rising to $758.81 150 days after the halving. Exactly one year after the second halving, on July 9, 2017, the price of Bitcoin had increased to $2,526, a 288.60 percent increase in value.⁴ 

While those trends seem promising, the coronavirus and its economic fallout could be a trump card that affects the ultimate price. However, there are hefty predictions from the big players in Bitcoin, estimating a range of price increases from $250,000 or more, while one investor predicts it could eventually reach an astronomical $333 million per Bitcoin.⁵ While the world undergoes an enormous financial shift, we’ll have to wait and see how the Bitcoin market reacts to the potential for deflation or hyperinflation following the implementation of the Federal Reserve’s stimulus plan. 

What Happens When Rewards Get Smaller?

It’s important to keep in mind that mining is an extremely resource intensive activity. It takes a lot of electricity and money to mine Bitcoins. So the block reward is meant to be an economic incentive for miners to participate in the process, and to do it honestly. As the rewards get lower, there is a fear that the incentive to mine or to make honest transactions will decrease. There are basically only two ways for miners to work dishonestly or attack the system, assuming they have enough computer power to pull it off: Double spending coins or preventing transactions from going through. But participating in these activities would mean risking the loss of their block rewards. According to Michael Dubrovsky, co-founder of mining R&D nonprofit PoWx, game theory is what secures Bitcoin. It requires that 1) miners have an incentive to mine honest blocks and 2) there’s a cost when miners attempt dishonesty.³ Essentially, if you don’t follow the rules, you’re going lose money. 

We should also note that mining rewards are what pull in more computing power to Bitcoin, strengthening it against attacks that try to bypass the network’s rules.⁶ So if the rewards for miners dwindle down to nothing, would the temptation to attack the system grow, and would its defense be able to handle the attacks? Nakamoto assumed that once the mining reward grew too small, the transaction fee would become the main form of compensation for miners. The question of whether or not transaction fees would suffice for miners, or exactly how much money and power it will take to keep the Bitcoin network secure is unknown. But it’s a question the cryptocurrency community will need to ponder and answer as we get closer to 2030. 

Sources:

1. Retrieved on May 4, 2020, from buybitcoinworldwide.com/bitcoin-clock/
2. Retrieved on May 4, 2020, from bitcoin.org/en/faq#how-are-bitcoins-created
3. Retrieved on May 4, 2020, from coindesk.com/bitcoin-halving-explainer
4. Retrieved on May 4, 2020, from blockgeeks.com/guides/bitcoin-halving
5. Retrieved on May 4, 2020, from forbes.com/sites/lukefitzpatrick/2020/04/27/bitcoin-halving-a-new-class-of-bitcoin-millionaires-may-emerge/#7375b23861fc
6. Retrieved on May 4, 2020, from bitcoin.org/en/faq#is-bitcoin-secure