Upon its creation at the very beginning of 2009, Bitcoin immediately presented as a fascinating economic supply model on top of its obvious use as a digital store of value and as a means to transact globally. Bitcoin operates with a fixed total supply and a geometrically decreasing rate of issuance until that fixed cap — 21 million coins — is reached. In simpler terms, every four years the number of Bitcoin issued per day is cut in half, in what is often called the ‘halvening’. The timeframe is itself based on a set block schedule: every 210,000 blocks, which given Bitcoin’s ten minute block time leads to a roughly four year interval. The next halving event is due at block 630,000, expected around the 23rd of May 2020. At this point, the reward will be reduced from 12.5 BTC to 6.25 BTC, or from 1,800 BTC per day to 900 BTC per day. This will be further reduced in 2024 to 3.125 BTC per block and 450 per day, and so on.
In anticipation of the reward halving event, much will be made of the potential impact to Bitcoin’s price — understandably so. It is prudent, however, to examine other areas where effects may be seen. How, for instance, will this impact the enormous Bitcoin mining industry? How will it affect the fees, and thereby the usability of the network to the average person? In all of these cases, we can take some lessons from history and ascertain how the previous halvings have manifested and brought us to where we are today.
Impact on price
Looking at Bitcoin’s price fluctuation over the past ten years, it is impossible to deny a correlation between block reward reduction and increased average valuation. The below graph, posted on Reddit last week to much attention, demonstrates that halving events have lined up historically with periods of significant price growth (extrapolating that a similar phenomenon may be likely in 2020).
It is obviously not difficult to form an argument positing that this link is causal and not simply correlated. Each halving brings a reduction to Bitcoin’s inflation, slowing the movement towards the fixed 21 million coin ceiling while massively reducing selling pressure from miners. It is also true that the ‘halvening’ tends to bring attention to the currency, as it is celebrated as an occasion akin to a birthday for Bitcoin with parties taking place around the world.
More interestingly, with the next halving event we will come closer to transitioning from a slightly inflationary currency to a slightly deflationary one. We have written an article on exactly this phenomenon, but to summarize: research suggests that between 2.78 and 3.79 million Bitcoins had been lost by November 2017. Losing Bitcoin permanently can of course be achieved in numerous ways: with losing ones private keys, sending to an inactive address or dying without explaining the purpose of ‘seed words’ to ones family being the most common. Incidentally, almost one million of these lost BTC are the famed Satoshi coins — those mined en masse by Bitcoin’s creator which have not since moved. If Mr., Ms., or the group of individuals now known as Satoshi Nakamoto still persist, they would be at least among the world’s wealthiest people, and certainly the world’s most patient. It is difficult to predict how many coins will be lost moving forward, but if we took Chanalysis’ upper prediction as of November 2017, that would be an average of almost 1,300 coins per day over those eight years. Were that trend to continue, we would see deflation from the moment the halving occurs in May 2020.
In any case, it seems inevitable that a time will come when more BTC is lost per day than created, reducing circulating currency and increasing scarcity. Previous halving events have coincided with large spikes in Bitcoin’s value, so it is fair that many expect a similar outcome during the next event, but it must be noted that the spikes in price have been less extreme with each event — both percentage wise and in the amount of time before a new high was reached. If the next reward reduction follows this trend, we can expect a more modest growth period lasting more than a year.
Impact on mining
To more practical concerns, the halving very clearly impacts Bitcoin miners, obviously reducing the reward in BTC terms they will receive for their input to mining pools. If there is an increase in Bitcoin’s value, this will offset much of the negative financial impact miners will be hit with. As that cannot be assumed, there is a worry that a substantial hit to mining revenue will cause smaller scale or individual contributors to mining pools to stop contributing to Bitcoin’s proof-of-work mechanism.
However, the scale of Bitcoin mining has to date been roughly inversely correlated with block rewards. That is to say, as block rewards have fallen from 50 BTC to 12.5 BTC, the amount of power put towards its hashing function has increased by orders of magnitude — peaking in August 2018 but remaining very high in the meantime. This means it is unlikely we will see an enormous rolloff of total hash rate after the reward reduction, and instead found point towards an increase. It is likely that older, less profitable mining rigs are removed from the network and replaced by more powerful machines, but this is an active process under all circumstances, not merely at halving events.
With this in mind, there is no clear link between reduced block rewards and a reduction in the overall mining scale. Bitcoin’s enormous price growth outpacing the decline of block rewards is likely a key contributor in this. The majority of miners will take the reward reduction into consideration and plan accordingly, such as by upgrading equipment before this happens or taking older units offline. They will also rely more on the fees generated from individual transactions, as we discuss in the following section.
Impact on fees/usability
Lastly there is the effect on end users, as they make transactions using the network. Assuming no great price boom, transaction fees will become more important as a source of revenue for miners. Given the competitive nature of mining already discussed, fees are rarely a problem during those periods when blocks are not full and the network is not under stress (as it was in early 2018 and again in May 2019). It is only during those times that we begin to see worrisome fee recommendations and delays for transactions. Late 2017 to early 2018 was particularly extreme as not only did the Satoshi value needed to incentivise rapid transaction validation increase, but the fiat equivalent of Bitcoin was also very high — leading to absurd cases of $55 average fees just before and during the new year. For the majority of 2018 and 2019 to date, the fees have generally been in the $0.30 range. A doubling of this average presents little concern, but periods of intense transaction volume remain a test of Bitcoin’s real world usability, as even the most hardcore cryptocurrency enthusiast is unlikely to pay a $55 or greater fee for a coffee at Starbucks.
Looking back to look forward
It is very difficult to be certain regarding any trends over such a short time as Bitcoin’s lifespan to date. It may well be that this halving event subverts our expectations, as so many TV shows and films have done in recent years. With that said, if all of the past trends around reward halving hold up next year, we would get a picture like this: a considerable increase in Bitcoin’s price (though more modest than the growth in 2016 and 2017), no significant decline in mining hash rate, and a gradual but likely reasonable increase in transaction fees. As much attention as halving events have received and as anticipated as that of 2020 no doubt is, they have no enormous impact on Bitcoin’s functioning, as evidenced by the experience of miners and users up to this point. The problems of scaling and the increasing energy demands of proof-of-work appear to have little to do with Bitcoin’s block rewards.
Article by Byron Murphy, Editor at Viewnodes. We help clients establish and maintain masternodes for the currencies which currently support them. To contact us for information on our masternode services, please submit this contact form.