Bitcoin halving explained in layman’s terminology

Bitcoin halving is the programmatic reduction in the number of new bitcoins that are mined and brought into circulation.

The way that I like to think about it is a bowl and a faucet. The bowl represents the number of bitcoins that have already been mined and brought into circulation. By February 2019, about 17.5 million bitcoins had been mined. The faucet represents the new bitcoins that are currently being mined and draining into the bowl and essentially being added to circulation.

Over the course of time, this faucet is slowly being turned off. This is what is referred to as bitcoin halving. Every 4 years, that nozzle gets turned off a little bit more, until ultimately over the course of the next century, that nozzle will be completely off, and no more bitcoins will be created and added into circulation. What we’ll have left in the bowl will then be the maximum supply of bitcoins, which is 21 million.

The technical foundation of bitcoin halving

When Satoshi Nakamoto first created bitcoin in 2009, he made a decentralized design where bitcoin could be distributed without the involvement of any person or group of people. The innovative idea of bitcoin mining was that miners would be given bitcoins as a reward for successfully generating a new block by verifying bitcoin transactions.

To determine how these bitcoins will be distributed among the miners, Satoshi Nakamoto set up some rules in the bitcoin protocol. The first rule was that bitcoin will have a limited supply of 21 million, that is, only 21 million bitcoins can be created and mined in the world. The second rule was that every time 210,000 blocks were mined in the bitcoin blockchain, bitcoin reward would be halved. This will continue happening until all 21 million bitcoins are mined.

This event of bitcoin reward being halved every time 210,000 bitcoins are mined is referred to as bitcoin halving.

Initially when bitcoin was started in 2009, miners used to get 50 bitcoins as a reward upon successfully mining one block. The first bitcoin halving took place in 2012, when bitcoin reward was reduced from 50 bitcoins to 25 bitcoins. The second bitcoin halving event occurred in mid 2016, at block number 420,001, when bitcoin reward was further reduced to 12.5 bitcoins. In this way, bitcoin rewards will keep getting halved upon each subsequent 210,000 blocks being mined, until all 21 million bitcoins are mined. This is expected to happen in year 2140.

Why is the supply of bitcoin limited?

The key question here is why was the supply of bitcoin kept limited from the start, and why was this halving event established? The simple answer lies in the law of supply and demand. If the supply of bitcoin was unlimited, and it was continuously generated at a fast rate without any halving event, too many bitcoins would have entered circulation in the market in no time, reducing its value to a minimum.

Let’s take the example of fiat currencies, which have an unlimited supply as central banks can print as many of these currencies as they want. This is the underlying fault in the traditional fiat currencies, whereby if a central bank prints more of a currency than is needed, according to the law of supply and demand, its value will start dropping. Thus if the circulation of a certain fiat currency keeps increasing, its purchasing power keeps decreasing. This is what causes inflation.

Satoshi Nakamoto created bitcoin, keeping in mind this inflation-causing fault of fiat currencies. Bitcoin follows the mechanism of commodities like gold. Gold has a limited supply on earth, and was easy to be mined in the start. But as more and more gold is mined, it becomes more difficult to extract and mine new gold. Since there is a limited supply of gold on earth, it has been able to hold its value for the past 6,000 years. To leverage on this feature, Satoshi Nakamoto made the properties of bitcoin similar to gold by keeping its supply limited, giving it a store of value, and making it harder to mine bitcoin as more and more coins are circulated. The purpose was that bitcoin could also sustain its value over the years, like gold.

What will be the impact of the next bitcoin halving in 2020?

If we observe the price chart history of bitcoin, its price has also been overall increasing over the years, just like gold. In fact, the price of bitcoin starts increasing at a faster rate after every halving event. So far, there have been 2 halving events, and every time bitcoin price has hit its peak right after its previous halving.

The third bitcoin halving is expected to occur in May 2020. If this time also, bitcoin follows its price pattern of the previous 2 halving events, its price could rise up to $11,000-$16,000. After this halving, by December 2020 or early 2021, there is a chance for the previous all-time high record of $19,000 per bitcoin could be broken.

But remember, this is just an opinion. This is not financial advice, and I am not a financial advisor.