What Is Bitcoin Halving and Why It Matters

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Every four years, the amount of bitcoins allocated to miners is halved. This recurring event is known as “Bitcoin halving. “ Let’s examine why it is so important and why so many people talk about it.

Bitcoin is often compared to gold because, like the precious metal, it is a valuable and rare asset that somehow resists inflation. However, unlike gold, Bitcoin is digital; its exact supply or scarcity is known and can be verified by anyone.

Limited Supply of Bitcoins

To understand Bitcoin halving, we first need to understand Bitcoin’s supply theory. Bitcoin’s inventor, Satoshi Nakamoto, believed that scarcity could create value where there was none before. After all, there is only one Eiffel Tower and only so many paintings by Claude Monet, and there is a finite supply of gold on Earth. Bitcoin is revolutionary because, for the first time, it has made a digital product scarce. Only 21 million bitcoins will ever be available.

The Gold Standard

Limiting the supply of Bitcoins is in stark contrast to how fiat currencies such as the euro or the dollar work. Fiat currencies were initially created with strict rules. The US government had to hold a certain amount of gold in its reserves to create one US dollar. This was known as the gold standard.

Over time, these rules have been eroded as modern world economies have printed more money to stimulate struggling economies during periods of extreme financial uncertainty, such as the Great Depression and World War II. Over time, these rules have evolved into today’s system where. In practice, governments can print money as often as they like. Well, that is why Satoshi Nakamoto thought that this debasement of fiat money could have disastrous consequences. As a result, the code prevented a single party from being able to print more Bitcoins.

What is Halving (»Halvening«)?

bitcoin halving

So, the Bitcoin code has a finite limit—21 million coins—built into it. New bitcoins are created through mining in the form of block rewards. Miners maintain and secure the Bitcoin ledger, and in return, they are rewarded with newly created bitcoins.

However, every four years or so, the reward for mining new blocks is halved. This event is known as halving. Each halving reduces the number of new bitcoins in supply until, in 2140, no more new bitcoins are created.

Why Halving Is Such an Important Event?

  • Scarcity: Halving makes it more likely that the value of a bitcoin will increase by issuing fewer bitcoins over time. This is in stark contrast to fiat currencies, which tend to decline in value over time due to inflation—which is why 20 years ago, you paid, say, 50 cents for a coffee. Halving is one of the ways in which the Bitcoin protocol maintains scarcity. Naturally, scarcity is one of the reasons why millions of people demand Bitcoin.
  • Decentralization: If a person, group, or government is trusted to set up a money supply, it must also be trusted not to play games with it. Bitcoin is supposed to be decentralized – no one controls it, and no one needs to be trusted. Because no one person or group controls Bitcoin, there must be firm and defined rules about how many Bitcoins are created and how they are released. 

Historical Milestones 

2009 – Satoshi Nakamoto creates the first block. Bitcoin mining reward starts at 50 BTC per block

2012 – first halving reduces mining rewards to 25 BTC per block

2016 – at the second halving, mining rewards are reduced to 12.5 BTC

2020 – at the third halving, mining rewards are reduced to 6.25 BTC

2140 – the 64th and final halving occurs when no more new bitcoins will be created

What Does Halving Mean for Bitcoin Miners?

Miners invest money in specialized mining hardware and the electricity they need to run their machines. The cost of this is offset by rewards for mining, but what happens when their rewards are halved?

Halving reduces the mining rewards, and the incentive for miners to work on the Bitcoin network is reduced over time. Resulting in fewer miners and less network security. Therefore, after the last bitcoin is mined (barring major protocol changes), miners will receive rewards in the form of transaction fees for maintaining the Bitcoin network.

Currently, transaction fees represent a small proportion of miners’ revenues. They currently “mine” about 900 BTC (about $30 million) per day but earn 60-100 BTC ($1.8-3.0 million) in transaction fees every day. This means that transaction fees currently represent only 6.5% of miners’ revenues, but this will rise to 100% in 2140.

Potential Change to the Protocol

It is also possible that the bitcoin reward mechanism changes before the last block is mined. Bitcoin currently operates on a proof-of-work mechanism, which has been widely criticised for its high energy consumption and carbon footprint.

Competing cryptocurrency Ethereum is in the process of switching from proof-of-work to a less energy-intensive proof-of-stake mechanism, where the network is secured by validators locking (staking) their cryptocurrency. According to the London-based Centre for Blockchain Technologies, proof-of-stake blockchains consume several magnitudes less energy than proof-of-work blockchains.

It is quite possible that Bitcoin will eventually follow this path. But despite environmental groups calling for a move to proof-of-stake, it is unlikely that a sufficient number of validators would support any kind of hard fork that would shift the network to an alternative mechanism.

Bitcoing Halving and the Impact on the BTC Price

The debate on whether halving affects the price of a cryptocurrency or whether it is already priced in continues to rage. According to the laws of supply and demand, the decreasing supply of bitcoins should lead to an increase in demand, which would presumably lead to a price increase. One theory, known as the stock-to-flow model, calculates a ratio based on the current supply of bitcoins and the amount that comes into circulation, with each halving event influencing this ratio. However, some have challenged the fundamental assumptions underlying this theory.

In the past, the price of bitcoin did increase after previous halving, but not immediately, as other factors were also involved. Vitalik Buterin, co-founder of Ethereum, is also not convinced about the link between the BTC price and halving. Let’s look at two examples:

  • In June 2016, the price of Bitcoin was around USD 660; after halving, Bitcoin continued to trade horizontally until the end of the month before crashing to USD 533 in August. After this crash, by the end of the year, the price of Bitcoin had climbed to an all-time high of more than USD 20,000, an increase of 2,916%.
  • Similarly, the price rose from just over USD 9,000 after halving in 2020 to over USD 27,000 by the end of the year but failed to surpass USD 10,000 in the two months after halving. It is also important to note that Bitcoin’s bull run in 2020 was also influenced by other factors, most notably the growing institutional investments by companies such as MicroStrategy and PayPal’s decision to allow its users to buy and hold Bitcoin.

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