The Bitcoin Halving Phenomenon
Bitcoin has had an extraordinary life, and in only 11 years has seen more change and volatility than most “real” currencies. But should we even call it a currency? It is not issued by a government or controlled by anyone and bears more resemblance to a commodity, like gold. I think that Mr / Mrs Nakamoto probably modelled Bitcoin on a commodity like gold, as they call the validation process “Mining”. Mining is really, really important, and rather than just making the miners rich (or not, as we will see) it guarantees the security of the Bitcoin network, and the surety of the transactions that go through it.
An important feature of a commodity is that you can get more of it, but it gets harder and more expensive to get more (like digging for gold further into the Earth). Mining is the process that Bitcoin uses to make more Bitcoins. In order to guarantee the security of the network and transactions, miners race to be the first to confirm a bunch of transactions, called a block, by solving a complex mathematical cryptographic calculation. If they manage to get there first, then they earn 12.5 Bitcoins, which is worth about £90,000 today. Nice!
But hang on…. It is not that easy, and to get there first they need a huge number of custom-built computers (100s of thousands of CPUs) that use a massive amount of electricity to run and be kept cool. For this reason, miners must be in areas with very cheap electricity and, preferably, a cool climate.
So what is the issue then if the miners are all happily making money? It is called the “Halving”, or sometimes the “Halvening”. For those familiar with The Hunger Games, this is like the Quarter Quell, but rather than every 25 years, it is every 4 years. Every halving reduces the amount paid to miners by half, so from roughly 12th May 2020, miners will only earn £45,000 per block mined, rather than £90,000 as they do today.
How will Bitcoin Halving Affect the Price of Bitcoin?
The interesting thing to analyse is how this affects the price of Bitcoin and to do that we need to look at the previous halvings. The last 2 halvings showed similar patterns, with the price of Bitcoin rising for about 12 – 18 months before the halving and then gradually declining for 12 months afterwards. There is speculation that this time it will not be the same as the miners cannot make enough money to fund the electricity and cooling that is required. The Bitcoin Network does automatically cope with this as it adjusts the complexity of the mathematical cryptographic calculation to match the computation power of the mining network, but at only 6.25 Bitcoins per block mined the economics of mining become tricky.
How will Bitcoin Halving Affect Miners?
I suspect that many miners will exit the business as the number of transactions is not very high and therefore there is not enough money to be made. Another consequence may be an increase in transaction fees that the miners charge all end users (in addition to the mining Bitcoin they earn). Another speculation, or rather a “hope” I suspect, is that the price of Bitcoin will increase to match the reduction due to the halving, but I very much doubt this will happen.
Hang on to your hats as this will be a volatile time, coming at the same time as Covid-19, but it will stabilise, as it was designed to do.
The real question for Bitcoin is what happens when the mining fee goes to £0 once all the Bitcoins have been issued by 2140? Luckily, that is one for our great, great, great-grandchildren to sort out!
Tom Higgins, CEO, Gold-i