On November 24, 2019, I wrote an article to talk about the upcoming bitcoin halving event and the hype around it. You can access the post by clicking here.
Today I’m here to once again talk about this bitcoin halving or “halvening” event that will take place in May of 2020.
Whether you are a beginner in the crypto space or have been trading crypto for a while now, this post will prove to be valuable for you in building up your foundation of knowledge about cryptocurrency, so that you can take more informed decisions regarding your investments in this supposedly booming industry.
I will first go over what halving is, why halving takes place, and what implications halving has for the future of bitcoin.
There are three key concepts about the bitcoin network that you need to know, in order to make Bitcoin halving easier to understand.
What is the bitcoin blockchain?
First, let’s briefly talk about the bitcoin blockchain. The bitcoin blockchain is basically a live running record of all bitcoin transactions. The simplest way to understand what blockchain means is by separating the word ‘block’ from the word ‘chain’. Imagine records of individual transactions, like payments sent to or from one person to another, getting listed or indexed one after the other. Once a certain amount of transactions in the list has been reached, a block is formed. This is because each block has a maximum amount of transaction data it can store.
Once the maximum amount of transaction data for the block has been met, the block is added behind the previous block of transactions. Now imagine these blocks of transactions linked together with a chain. So block chain simply refers to groups of transaction data that are linked together.
The basic structure of the bitcoin blockchain consists of a network of computers around the world, with bitcoin software installed on them. When bitcoin transactions occur, the data is communicated to this network of computers that validate the transaction, add the transaction to their copy of the bitcoin ledger, and then broadcast the ledger changes to the other computers on the network. There’s a maximum amount of data that can be saved per block, so approximately every 10 minutes a new block of bitcoin transactions is created, verified and published to the bitcoin blockchain.
What is bitcoin mining?
Next, let’s talk about how all of these bitcoin transactions are getting verified on the bitcoin network. The verification and posting of transactions on the blockchain is completed by miners via a process called ‘mining’. Miners are people or pools of people that use computer processing power to maintain the bitcoin blockchain. This includes keeping the ledger of bitcoin transactions clean, consistent and permanent by grouping new transactions into blocks and broadcasting them to the rest of the bitcoin network for verification.
Each new block of transactions has a cryptographic hash of the block published before it, which is what links all of the blocks of transactions together to form the blockchain. So for a new block to be accepted by the network, miners are required to follow a proof-of-work system, which involves creating a new cryptographic hash of the newly completed block. Thus new blocks of transactions have a unique hash from the previous block, and to get published to the ledger, it requires the creation of another unique hash which will go through a validation process and then get passed on to the next block, and so on and so forth. To create a new unique hash for the block of transactions, miners compete with each other using computer power to try to be the first one to come up with a 64 digit hexadecimal number or the hash that is less than or equal to the current difficulty target of the network.
The basic concept you need to know about bitcoin mining to better understand the bitcoin having event is that miners are rewarded with bitcoin each time they verify a new block of transactions. Mining rewards are a combination of newly mined bitcoin units that were not previously circulating, and transaction fees of bitcoin that were already circulating. These rewards are in place to incentivize miners to participate in the mining process to ensure the bitcoin network continues to be audited and essentially maintained cool.
What’s the supply of bitcoin like?
Let’s move on to the concept of bitcoin supply. Bitcoin is a digital currency developed by an unknown person or group of people that go by the pseudonym ‘Satoshi Nakamoto’. The more you learn about and start to understand bitcoin, the more similarities you will see between bitcoin and gold. This is because Satoshi developed the digital currency bitcoin to intentionally harbor characteristics of the precious metal gold. We recognized this in the mining process we previously discussed. Prospecting for new gold deposits building out a mine and operating in mine to extract gold is laborious similar to the immense computing power required by bitcoin miners to perform guesswork to create the new unique hashes to validate new blocks of transactions.
Another gold light characteristics Satoshi programmed into bitcoins is a maximum supply. The total number of bitcoins that can ever exist is 21 million units. This 21 million-unit maximum was established to mirror gold’s stable inflation rate. You’ve probably read and watched the content explaining how Bitcoin is inflationary while other content explains how Bitcoin is deflationary. Click here to read about bitcoin price prediction for 2020 and ahead. The article talks about the two most popular models for predicting the fluctuations in the price of bitcoin.
It’s important to understand that there are two different definitions of inflation. The most modern and common use of the word ‘inflation’ refers to a decrease in the purchasing power of money. The older traditional use of the word inflation refers to an increase in the supply of money that is not backed by gold in the modern context of inflation. Bitcoin is deflationary because over time, its purchasing power will increase instead of decrease due to its fixed supply. One way to understand this concept is to consider in the future when new gold prospects become extremely rare. In mining, costs of new prospects increase until it becomes too expensive to mine new gold. As a result, the fixed supply of pre-mined gold will increase in value over time, since gold cannot be created. Makes sense, right?
In the traditional context of inflation, bitcoin is inflationary because the supply of bitcoin, which is not backed by gold, is increasing as miners mine new bitcoin through validating new blocks of transactions. Currently, around 18 million bitcoins are in circulation of the 21 million total supply. According to its current track, the last bitcoin will be mined in the year 2140, which is 120 years from now. So in our lifetime, the supply of bitcoin will continue to increase. Great!
So what is bitcoin halving?
Now that you’ve learned a little bit about the bitcoin network, bitcoin mining, and a fixed supply of bitcoin, let’s talk about what halving is, why halving takes place, and what implications halving has for the future of bitcoin.
Halving in terms of bitcoin refers to the reduction in the bitcoin block rewards issued to miners by half. Currently, the block reward for miners is 12.5 units of a newly mined bitcoin that were not previously in circulation. When the halving occurs, in May of 2020, the block reward will half or reduce by half which will give miners 6.25 units of a newly mined bitcoin per validated block.
Halving was programmed to occur every 210,000 blocks, and since a new block of transactions is completed roughly every 10 minutes, this works out to an average halving event every four years. When bitcoin was first developed in 2009, the block reward was 50 bitcoins in 2012. The first halving reduced the block reward to 25 bitcoins, and in 2016, the second halving event reduced the block reward to what it is now, which is 12.5 bitcoins number.
Why does halving occur?
Satoshi Nakamoto programmed the halving of newly mined bitcoin every two hundred ten thousand blocks to prevent inflation from decreasing the purchasing power of bitcoin. Satoshi also factored in the increase of technological advancement over time into bitcoins algorithm, so the faster new blocks are validated, the more difficult creating new unique hashes for new blocks will become. At the current block reward rate of 12.5 bitcoin per block, which occurs roughly every 10 minutes, about 1,800 new bitcoins are mined daily, making the inflation rate in the traditional sense about 3.8 percent. After the halving of the block reward rate to 6.25 bitcoin in May 2020, about 900 new bitcoins will be mined daily, decreasing the annual inflation rate to 1.8 per cent, which will make bitcoin less inflationary than the US economy!
Halving the amount of newly mined bitcoin in segments controls the rate at which the finite or fixed supply of bitcoin is titrated into circulation over time. Similar to gold, this creates a predictable and constantly decreasing inflation rate that will eventually reach zero.
What are the implications of bitcoin halving?
Now let’s talk about what implications halving has for a bitcoin. Gold is considered one of the best stores of value because of its fixed supply, and since the supply is not extremely abundant, gold is scarce. This scarcity is imposed by nature since we’re not able to create gold to increase the supply. Similarly, the algorithm that imposes bitcoin’s fixed supply was designed to make bitcoin even scarcer than gold. So if demand remains steady or increases for the fixed scarce supply of bitcoin, the price of bitcoin will experience positive long-term effects. And after the halving in May, the supply of bitcoins will become even more scarce.
Let’s look at what happened after the previous bitcoin having. Bitcoin was around $11 when the first halving occurred in November 2012. Then in 2013, an entire year later, bitcoin spiked to $1100 – the highest bitcoin had ever been at that time, before dropping back down to around $220 and remaining under $1,000 for the next few years. In July of 2016, during the second halving, bitcoin was around $600 and then spiked to 20,000 near the end of 2017, which was around 18 months later. So historically, the 12 to 18 months immediately following a halving event, bitcoin pricing didn’t show much movement. Also, it’s not quite clear that the spikes in price in 12 to 18 months after the halving events actually correlate exclusively with the halving. The first bitcoin price spike to 1100 happened an entire year after the halving event, and it seemed to correlate with the Cyprus bailout. The second bitcoin price spike to $20,000 happened an entire 18 months or year and a half after the halving took place, and it seemed to be caused by market manipulation as cryptocurrency was being featured in mainstream media and attracting attention from the masses.
So did the halving have an effect on the spike to $20,000 in late 2017? Maybe not the spike, but it’s more probable that it’s been playing a role in maintaining bitcoin’s price over 3,000 dollars since then. So what does this historical data tell us about the upcoming halving event into May of 2020? As bitcoin has become more popular since the last halving in 2016, the upcoming halving in May is likely already priced in and has been for a while. There’s a lot of hype coming out about the impending halving, so it’s likely that the price of bitcoin drops significantly following the halving event, due to so many inexperienced people and investors operating off of the assumption that bitcoin’s price will increase immediately after or shortly after the halving event.
So what do we conclude?
As with previous halving events, I wouldn’t expect to see any drastic lasting changes exclusively due to the halving event, Without a correlating positive or negative outside force like government regulation, market manipulation, an economic event or similar. There is a lot of room for opposing theories, opinions and predictions about the future of bitcoin pricing, with regards to the halving in May of 2020 and the years following. So it’s important to do your own research and draw your own conclusions about the impending bitcoin halving.