The Bitcoin Halving: How It Works and Why It’s Important

Following on from our insight on inflation we continue on to Bitcoin issuance rate and halving events. One of the key factors that make Bitcoin unique is its controlled supply mechanism, which is closely tied to a series of events known as “Bitcoin halvings.” In this insight, we’ll delve into the significance of Bitcoin halving events and explore why they are so important in the world of cryptocurrencies.

One of the fundamental features of Bitcoin is its fixed supply. There will only ever be 21 million Bitcoins in existence, making it a deflationary currency.

The Bitcoin supply is gradually decreasing, and this inflation rate is trending towards zero. Satoshi Nakamoto programmed a mechanism to halve Bitcoin’s mining reward roughly every four years. This ensures that Bitcoin issuance will eventually stop completely. Many believe that this mechanism is key to Bitcoin’s value proposition. It ensures that the Bitcoin supply will never exceed 21 million. This scarcity is in stark contrast to fiat currencies, which can be printed in unlimited quantities, potentially leading to inflation.

Bitcoin Halving: A Brief Overview

Bitcoin halving is an event that occurs roughly every four years (or every 210,000 blocks). During the halving, the number of new Bitcoins created and awarded to miners for adding new blocks to the blockchain is cut in half. Originally, the block reward was 50 Bitcoins, but the first halving in 2012 reduced it to 25. In 2016 it further reduced it to 12.5, and most recently in 2020 lowered it to 6.25 Bitcoins per block. The next halving is expected in early 2024, at which point the block reward will be reduced to 3.125 Bitcoins.

The fact is that Bitcoin mining is very power-intensive and expensive is a reason why miners are rewarded with Bitcoin. Miners are disincentivized from attacking the network because they would lose too much money if they did.

Why the Bitcoin Halving Matters

It controls inflation

Bitcoin is designed to be a deflationary asset, meaning that its supply will decrease over time. The halving helps to achieve this by reducing the rate at which new Bitcoin is created.

Scarcity and Value

Bitcoin halvings are crucial because they reinforce the cryptocurrency’s scarcity. Just like gold or other precious metals, the limited supply of Bitcoin makes it inherently valuable. As the reward for mining new Bitcoins decreases, the rate at which new coins are introduced into the market slows. This contributes to a steady increase in value over time. Image below from River Financial.

Economic Incentive

Halvings affect the economic incentives for miners. Miners play a vital role in securing the Bitcoin network and validating transactions. When the block reward is reduced, it becomes more challenging for miners to earn new Bitcoins, but the decreased supply can drive up the value of the coins they do earn. This delicate balance ensures the security and decentralization of the network.

Market Expectations

Bitcoin halving events are highly anticipated by the Bitcoin community and investors. They often lead to increased media coverage, which can spark a renewed interest in Bitcoin. The expectation of future scarcity drives demand, potentially leading to price surges in the run-up to a halving.

Historical Performance

Historical data shows that Bitcoin’s price has experienced significant rallies following previous halving events. There is a strong correlation between Bitcoin halvings and bull runs. Historically, the price of Bitcoin has increased significantly after each halving.

“Stock-to-flow” (S2F) proponents argue that a reduced inflation rate and the resulting supply squeeze will drive up the price of Bitcoin. They reason that if buying demand remains the same as before the halving, the price must go up because there will be half as many new bitcoins entering the market from miners. Others disagree that the halving directly correlates with Bitcoin price increases. They argue that the halving does not create demand in and of itself, even if it does make the Bitcoin supply more scarce over time. They reason that just because miners may be selling fewer bitcoins each day does not mean that the overall amount of Bitcoin being sold on the open market will decrease.

It is difficult to determine whether Bitcoin’s price action following the halving is caused by the reduced supply of new Bitcoin, a coincidence with the traditional economy, or a combination of both. This will be an interesting development to watch as the 2024 halving approaches.

The 2012, 2016 and 2020 halvings were followed by impressive bull markets. While past performance doesn’t guarantee future results, these patterns have cemented the idea that halvings can be catalysts for Bitcoin price increases.

In the image below, the vertical blue lines indicate the previous three halvings (2012-11-28, 2016-7-9, and 2020-5-11). Note how the price has jumped significantly after each halving.

Long-Term Investment

Bitcoin halvings are a reminder that Bitcoin is designed to be a long-term investment. They discourage short-term speculation and encourage a more patient approach to holding and accumulating the cryptocurrency.

Network Security

The halving is likely to make Bitcoin mining more expensive, as miners will need to invest more in hardware and electricity to maintain their profits. It could also lead to increased competition among miners, as they will be competing for a smaller pool of Bitcoin rewards.

The security of the Bitcoin network depends on miners investing significant computing power to maintain the blockchain. The reduced block rewards not only affect miners’ profits, but also ensure that only the most dedicated and efficient miners continue to support the network, making it more secure.

Conclusion

Bitcoin halving events are pivotal moments in Bitcoin’s history, affecting its value, economics, and long-term prospects. These events are not just about the reduction in mining rewards; they symbolize the core principles of scarcity, decentralization, and economic incentives that underpin the Bitcoin network. While they don’t guarantee immediate price increases, Bitcoin halvings underscore the importance of taking a long-term perspective when considering investments.

As Bitcoin continues to evolve and gain mainstream recognition, its halving events will remain essential milestones, reminding us of the unique features and disruptive potential of this groundbreaking digital currency. Understanding the significance of these events can help both seasoned and novice investors navigate the exciting and ever-changing world of Bitcoin.

Unlike fiat currencies like the British pound and the Euro, whose money supply can be increased at any time by central banks, the supply of Bitcoin is fixed, predictable and transparent. This makes Bitcoin an attractive asset for those who want to preserve their wealth over the long term.

You can track the countdown to the next halving here.