What is ‘the halvening’?
Sounds right out of a scary movie doesn’t it? Well, it’s far less exciting I’m afraid. Simply put, the halvening is the name given to when the amount of bitcoin that enter the circulation on each block reward (usually around every 10 minutes), cuts by half. OK, that sounds confusing I know, so let’s try and break it down.
For bitcoin to be available to people, or to ‘enter circulation’, they have to be ‘mined’. This in laymen terms, is usually a person or persons with extremely powerful electrical equipment pillaging the energy supply of their household in order to produce them. We won’t go into the technicalities of how mining works, but as you can see, this is quite some task taken by miners. So what motivates them? Well, it was designed such that, as we mentioned, every 10 minutes miners are given ‘rewards’. So basically, the more you mine, the more you’re rewarded. This is why you have some people or companies solely dedicated to mining bitcoin, in order to receive that sweet free bitcoin. Some are so big, they’re called ‘mining farms’.
When the original code was written (let’s say by Satoshi Nakamoto for now), the idea was there would never be more than 21,000,000 bitcoin in circulation, and it was ‘his’ idea to encourage people to mine these into circulation by creating these rewards. Initially, when BTC was starting out, this was 50 BTC per each block (imagine that now!). However, the code stated that after every 210,000 blocks were mined (around 4 years), these rewards would be cut in half. This would happen until the rewards were completely reduced to zero. So, for all 21 million coins to finally be in circulation, that would mean 64 halvenings. And with a little bit of math, it would be in 2140. So, what’s the reasoning behind these mechanics?
Well unfortunately, whoever Satoshi Nakomoto is (or ‘are’), they haven’t stayed around long enough to explain to us the exact reasons for this schedule and algorithm. There have, however, been some clues left laying around, mostly from some early emails written by Nakamoto.They elaborated very little on why they chose the particular formula simply saying “Coins have to get initially distributed somehow, and a constant rate seems like the best formula.”
Not very helpful right? If we dig a bit deeper though, it does start to make sense. In another email ‘Nakamoto’ discusses the effect these halvenings would have on demand through potential lack of supply. It explains that the idea of halving rewards would producs a ‘deflation’ of sorts, increasing purchasing power. Here’s a direct excerpt from the email:
“The fact that new coins are produced means the money supply increases by a planned amount, but this does not necessarily result in inflation. If the supply of money increases at the same rate that the number of people using it increases, prices remain stable. If it does not increase as fast as demand, there will be deflation and early holders of money will see its value increase.”
So now we have a rough idea of what the halvening means and the thought process behind it, but what does this all mean for us, or investors, or the wider digital currency world?
In May of this year (2020), we are entering the third halvening and the block rewards for the miners will drop from 12.5 to 6.25 bitcoin. So, if we assume Satoshi’s vision of deflation to be valid i.e the supply of bitcoin entering circulation will suddenly halve (if miners have less to sell then there is less to buy) and the demand will stay the same, then in theory things will go up right? I mean it doesn’t take an economics degree to work out that if the supply of something drops and demand stays the same, that the value of the asset will indeed increase. Is this the case though? Has this been the case?
Well, yes and no! Bitcoin has obviously trended upwards since the days of it being a tenth of a penny. But this doesn’t necessarily show a direct correlation with the time of each halvening. In theory, you can make any uptrend patter fit to a certain event in time. The fact is, one year after the first Bitcoin halving event in November 2012, the Bitcoin price reached what was then an all-time high of $1,000, and then the subsequent halvening led to the famous 2017 ‘bull-run’ resulting in an mind-blowing $19,000 per coin. This does not definitively revolve around the halvening event though.
As Chris Wilmer, economics professor at the University of Pittsburgh points out: “Historically the cut has had very little immediate impact, although the price usually rose after” and prominent Bitcoin Analyst Glen Goodman states “Previous halvenings have shown negligible impact on Bitcoin’s price. This is because — rather like a much anticipated interest rate cut — everybody already knows it’s going to happen way in advance,”
So the fact is, there is no mathematical or guaranteed formula to know whether or not the halvening will indeed increase the value of Bitcoin. There are too many factors in play now, especially as the more exposure it gets, that will indeed cause the market to be even more volatile, and presumably more interest would mean more demand. And one can tend to agree that if people are expecting the halvening to make a positive impact with it being so close, this would have already been priced in by both investors and miners.
So, we shall see what May will bring. On paper, the supply vs demand argument will certainly make a difference if demand does remain the same or increase. Either way though, at least we can attribute another string to the intellectual bow of Satoshi in his paper, and if not just a clever idea, it certainly keeps the market interesting!