Bitcoin Halving 101
If you own bitcoins or are thinking about investing for the first time, you may have seen references to the upcoming halving. There are online countdowns anticipating this moment and a lot of speculation about what might happen in May 2020, when the next halving is set to occur. But maybe you don’t know exactly what the halving is, or why it’s happening in the first place. Welcome to Bitcoin Halving 101, where we will explain the concept of halving, why it happens, and what that might mean for May 2020.
To understand why halving is important, you first need to understand how bitcoin differs from fiat currency. If you watch the news these days, you can easily see the difference. Central banks are creating money out of thin air to boost their economies during the Covid-19 crisis. With the push of a button, no work required, there is suddenly more money available, and it is in the hands of the central banks to distribute as they see fit. They have done this in the past as well, most notably for the financial crisis of 2008.
Fiat currencies work only as long as trust in them remains. And how long can that trust remain if money is continuously being created from nothing? As an alternative to inflationary currency, Satoshi Nakamoto, an individual or a group of likeminded people, created a digital currency on an open-source platform, based on beliefs of decentralization, privacy, self-sovereignty, and independence.
There are a finite number of bitcoins that will ever be available: 21 million, and that limit will be reached in 2140. Halving puts limits on the bitcoin mining reward, the number of bitcoins available at any given time, and the number that will ever be in circulation — forever.
How does halving do this? What exactly is halving?
First we have to talk about blocks. Blocks are cryptographically secured collections of transactions. Blocks are created and added to a blockchain during the mining process. And what is mining? Well, miners use their resources (computing power/electricity/time) to run an algorithm and provide proof of work. The proof of work is verified by nodes, computers connected into the Bitcoin decentralized network. Mining confirms transactions, and as a reward mining leads to the creation of new bitcoins with each block. Mining is not easy. If the number of miners creating blocks increases, the difficulty of mining increases, and vice versa. Mining was designed this way to ensure that the rate of new blocks created is relatively steady — approximately one block every 10 minutes.
When bitcoin was first mined in 2009, 50 BTC were awarded per block. After the first halving in November 2012, that number was reduced to 25 BTC per block. In July 2016, that value was halved again to 12.5 BTC per block. The next halving is set to occur again when block #630000 is mined, and with it the reward will drop to 6.25 BTC per block. Halving is simply the reduction, by half, of the reward for mining a block.
Eventually, the reduced reward for mining will be so low and no more bitcoins will be mined. No amount of wishing will create more bitcoins. The price of bitcoin is not based on anyone’s ability to quickly create them from nothing, leading to inflation like fiat currency. The price of bitcoin is based on supply and demand. If there are a low number of trades on an exchange, the price goes down. A high number, the price goes up. There is no governing body anywhere in the world that controls bitcoin price. It is truly a global currency.
The first halving occurred in November 2012, when the price was $11 per bitcoin. After one year the price increased by about 100x, to almost $1200 in November 2013, and then dropped in price significantly. The second halving occurred in July 2016 and after 1.5 years, the price reached a high of almost $20,000 in December 2017. Of course this did not last for long. In both circumstances, there wasn’t too much of an immediate market reaction, the price increased quite dramatically, and then the price decreased, losing about 85% of its value each time. Currently, the price is around $1000 per bitcoin.
This time around, there are once again many opinions of how the halving will affect the price of bitcoin. Some think the price will go up, while others believe the halving influence is already built into the price (since this happens every 4 years). Dominik Stroukal shared his ideas in his article Investing in Bitcoin? The Current Crisis Underlines the Importance of Bitcoin.
The world today is a different place than it was during the previous halvings, but the more things change, the more they stay the same. We are still dealing with economic instability, central banks that create money from nothing, and governments that infringe on our privacy. And so the need for bitcoin, a secure, decentralized currency, remains.
By now you should have a good idea of what halving is and how important it is to the deflationary nature of bitcoin. To learn more, reach out to the Bitcoin Solutions team anytime!