Bitcoin halving
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Dear readers,
I hope you all enjoyed the market and bitcoin price performance last week as I did. Lot of my friends wanted to buy bitcoin and were asking me about the upcoming halving. This made me write this piece, a sort of an educational one. This is actually a part of a monthly report that I share with a group of closely known friends. I hope this will help you in some way.
Bitcoin halving
All eyes are on bitcoin halving, sometime also referred to as “Halvening”, at the moment. This could potentially be the most awaited halving event in the history of bitcoin. As seen from the Figure 01 below, the search trends in google for the term “Bitcoin halving” has seen the highest interest over the time November 2011 to date.
Figure 01: Google search trends for Bitcoin Halving
Source: google trends
The first two halvings brought down the mining reward from 50 coins to 25 and 12.5 coins respectively. As of writing, there’s roughly around 10 days left now. It is expected that around 12 May 2020 11:03:17 UTC, the halving would take place and the bitcoin miner block reward will drop 50% to 6.25 coins from current 12.5 coins. This means that the increase in bitcoins (or commonly called the bitcoin inflation rate) would also drop from ~3.69% to ~1.79%. Eventually mining reward would come down to zero and the miners would have to rely solely on the transactions fees to produce new blocks.
As we speak, 18,355,113 bitcoins have been mined (roughly around 87.41% of the total maximum coins to be ever produced). As per the underlying protocol of the bitcoin network, everything related to bitcoin is embedded in its software. Being a Proof-of-Work consensus network, miners spread across the globe contribute their hashing power to secure the network. Every time a new block is created the miner is rewarded with newly minted bitcoins. Upon mining 210,000 such blocks (roughly around 4 years since the bitcoin network mines a block every 10 minutes on average), the mining reward reduces in half.
Figure 02: Bitcoin inflation
Source: https://charts.woobull.com/bitcoin-inflation/
Why has the bitcoin halving become so important this time? Well, there are several reasons.
Historical price performance pre- and post-halving: In investing, we always relate events, prices, etc to historical price movements or to other relative assets. Similarly, people try to relate the upcoming halving to past and so look at price performance pre and post the last two halvings. It sounds like a too small sample to infer the outcome of the next halving. Nevertheless, at least there are two samples. As depicted in Figure 03 below, we calculated the pre-halving return so far in the one year (10 more days to complete 365 days) run up to the upcoming halving. It appears that positive returns have prevailed. However, not a triple digit return like the other two halvings. Will this relationship be broken or persists over the next 10 days? Well, a 10 days period is a long time in bitcoin terms, meaning that the price could change drastically up or down.
Figure 03: Historical bitcoin halving performance [pre-halving]
Source: Coindesk, Bitcoin: The Halving and Why It Matters, March 2020. *my calculations. Data from CryptoCompare (11 May 19 – 02 May 2020)
Last two bitcoin halvings were followed by significant price increases for BTC/USD. As a result, everyone’s keen to know whether history would repeat. If that is the case, no one wants to miss out on this. If not, one would have to wait for another four years for the next halving. Some skeptics are of the view that history would not repeat and it could be different this time. We can’t completely disregard this potential outcome as well. But time will only tell us.
Figure 04: Historical bitcoin halving performance [post-halving]
Source: Grayscale Insights: The Next Bitcoin Halving – Evaluating a Potential Repricing, March 2019
Constraining supply and increased demand: Theoretically speaking, the halving is definitely going to reduce the supply of something which has seen increasing demand over time. As an example, the total number of unique blockchain.com wallets created has increased from ~37 million to ~48 million as of now, a year-on-year growth of 31%. This could be a good approximation of the increased demand for bitcoin, among other currencies. Currently, there are over 7,000 bitcoin ATMs around the world. There are also more than 148,000 service providers that are facilitating bitcoin to cash transaction and vice versa. What’s more? A lot of other developments are taking place pertaining to bitcoin, namely; derivatives markets, different investment funds with exposure to bitcoin, etc. Nonetheless, on a separate note, we also like to note that the discussion around bitcoins’ adoption as a payment mechanism/day-to-day use currency has kind of waned at present. Another key fact connected to the demand supply equilibrium is the long term holding of bitcoins, most commonly known in the crypto asset space as the Hodling. These are the coins held in wallets and unmoved for 3 – 5 years’ time or longer. Hodling has also contributed meaningfully to squeeze the supply of bitcoins.
Connected to the demand/supply aspect is the Stock-to-Flow (S2F) that is discussed in the last point.
Figure 05: Bitcoin hodl wave
Source: https://charts.woobull.com/bitcoin-hodl-waves/
Concerns over maintaining the security of the network: The bitcoin network’s security is ensured by the miners who contribute hashing power to secure the bitcoin blockchain. In doing so, they have spent a significant amount of capital in mining facilities. Cost of electricity is a significant operational overhead. Most of their capital expenditures and on-going expenses are paid in fiat currencies. However, their revenue is mainly derived from bitcoin. Thus, in a situation where their revenue in bitcoin terms drops 50% and BTC/USD did not increase to compensate enough or transactions fee increase significantly, most miners would become un-viable (some of them would go out of business and there is no body to bail them out!). On a positive note, this phenomenon has been now tested for about 11 years. The solution to this is built in the bitcoin software where the difficulty is adjusted to ensure that blocks are mined every 10 minutes on average. Another concern in regards to security is the no block reward scenario where miners would have to secure the network via transactions fees. This is however a discussion to be had in like a decade from now, however if you are interested this article sheds some light on that as well.
Changing bitcoin narrative: We have seen that bitcoin has evolved through changing narratives (a clear articulation here) and so did the market analysis. Further, rational investors seek a justification to any price/valuation. In this backdrop, Stock-to-Flow (S2F) analysis became popular. There is no other time to discuss more about S2F than when the Flow is going to be halved. I encourage you to read Plan B’s articles to familiarize yourself with this idea.
Well, in less than two weeks from now, third bitcoin halving will be history. Let’s see how it plays out.
I think that’s it for now. Hope you have a pleasant weekend and be safe and healthy.
Thank you.
bcrypt.
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Disclaimer
Please note that I do not provide financial or tax advice here and this is for educational purposes only. Please do your own research.
Photo credit: Andre Francois Mckenzie