Demystifying Bitcoin’s Halving
Bitcoin’s supply issuance is arguably one of the most discussed subjects used to support investment theses in the cryptocurrency. Bitcoiners often cite its halving — through which the amount of Bitcoin issued per block drops by 50% every four years — as a key factor contributing to Bitcoin as “sound money”. More dogmatic proponents of Bitcoin may even go as far as stating that Bitcoin’s supply reduction is Satoshi’s way of programming the asset to accrue value over time, often citing Stock-to-Flow models.
A year after Bitcoin’s third halving this begs the questions, how has the halving affected Bitcoin so far and what will its future impact be?
This piece aims explain first what exactly the Bitcoin halving is, then we scrutinize the popular stock-to-flow model based on Bitcoin’s issuance, and finally we examine the effect miners and the halving have on the security and demand of Bitcoin.
Bitcoin’s Monetary Policy
Bitcoin’s fixed monetary policy has been applauded by many as an effective way to guarantee its scarcity. As many will know, the supply is set with a maximum of 21 million Bitcoin to ever be in circulation and with its issuance decreasing by 50% every four years. The so-called Bitcoin Halvening leads to Bitcoin’s rate of inflation to decrease predictably over time.
As Satoshi Nakamoto describes it,
“As computers get faster and the total computing power applied to creating bitcoins increases, the difficulty increases proportionally to keep the total new production constant. Thus, it is known in advance how many new bitcoins will be created every year in the future.” — Satoshi Nakamoto
Bitcoin’s emission schedule is visualized below.
As can be observed, the additional supply issued by the Bitcoin blockchain reduces significantly every halving. Through the decreasing inflation, the block subsidy drops sharply as it approaches zero, with issuance expected to stop by the year 2140.
At the time of writing 18,700,000 or 89% of the total supply has been mined throughout Bitcoin’s 12-year history. Therefore, the total additional amount of Bitcoin issued for the next 119 years is less than 2,300,000 (11%).
The low supply growth is often referred to as a lever adding to Bitcoin’s intrinsic value. The idea behind this reasoning is that its low inflation makes Bitcoin scarce and more attractive as a store of value.
Debunking the Stock-To-Flow Model
Historically, the increase in commodity’s supply has been tracked through their stock-to-flow. Many in the Bitcoin community may be familiar with this indicator, which tracks the existing supply of an asset relative to its rate of supply growth. Currently, this would be Bitcoin’s 18,700,000 circulating supply over approximately 328,500 Bitcoin mined on a yearly basis, which would provide a stock-to-flow value of 56.93. This means that it would hypothetically take nearly 57 years for Bitcoin’s current stock to be mined based on its present issuance (were this not to decrease through upcoming halvings).
Perhaps better known are the price prediction models derived from this indicator, in particular from the pseudonymous author known as Plan B. Based on the reducing issuance of Bitcoin, Plan B has proposed a model to predict Bitcoin’s price.
While the stock-to-flow model has thus far been highly correlated to Bitcoin’s price trajectory (0.95 r-squared), it does not come without its limitations. For one, it is worth stating that correlation does not imply causation. In other words, even though the model does fit the trendline, it does not mean that the stock-to-flow is the reason for the price movement.
As well, it should be noted that the correlation is obtained using the moving average of stock-to-flow (463-day MA in the image above) as the independent variable, rather than the metric itself. These moving averages can be arbitrarily tweaked for the data to better fit the relationship at play, creating better results retroactively.
More importantly, although these models have thus far shown accurate results, they are unlikely to sustain as Bitcoin’s block subsidy approaches zero. To support this, let’s look at the formula for the stock-to-flow (SF) model proposed by Plan B:
Model price (USD) = exp(-1.84) * SF ^ 3.36
Now let’s plugin Bitcoin’s stock-to-flow 7 years from now, after its fifth halving.
SF = Supply / Annual Issuance = 20,343,750 / 82,125 = 247.72
Model price (USD) = exp(-1.84)* (247.72) ^ 3.36 = $17,562,610
At this price Bitcoin’s market cap would be $363,052,082,712,877, or $363 quadrillion. This would be greater than all global wealth, at least by one estimate. Needless to say, the stock-to-flow model falls short with predictions on longer time horizons.
Moving past the stock-to-flow model, mining and the halving have regardless impacted Bitcoin throughout its history. From security to incentive alignment, here is how the halving impacts Bitcoin.
Bitcoin Mining‘s Complex Role
By solving cryptographic problems through Bitcoin’s proof-of-work consensus algorithm miners get rewarded with the block subsidy, 6.25 BTC at current time. Through this process miners secure the network, as resources invested into validating transactions make it costly to attack or attempt to tamper the blockchain. The best way to account for this is through the blockchain’s hash rate. The hash rate represents the aggregate computing power devoted by miners to process transactions.
In Bitcoin’s case, its hash rate has grown exponentially as miners globally are rewarded for participating in the network’s consensus. This leads to the network being more secure with potential attackers requiring more and more resources to attempt to attack the network, making it prohibitively costly for anyone attempting this.
Therefore, the incentives coming from the block subsidies (as well as transaction fees) directly impact the security of the Bitcoin network. Despite undergoing three halvings so far, Bitcoin’s daily block subsidies continue to grow.
Here we can observe that miners’ revenues have increased despite the halvings, with miners currently netting approximately $52 million from block subsidies. However, when putting this number into context as a percentage of the total on-chain volume, it is evident that mining revenues are meager in comparison. (Note the logarithmic axis below).
The vertical purple lines in the graph denote each of Bitcoin’s previous halvings. As may be expected, the decrease in block rewards led to sharp declines in the percentage of the volume represented by mining revenues. Since the last halving in May 2020, this percentage has averaged only 0.06% out of the total on-chain volume taking place on the Bitcoin network.
This declining level points to the decreasing relevance of miners as halvings go by. This is also one of the reasons why the stock-to-flow model is likely to fall short; supply is only one part of the equation and with most of the supply already being in circulation, miners are likely to become less dominant over time.
Ultimately, my thesis is that it is mostly up to demand indicators to drive Bitcoin beyond its current levels. This demand may very well be fueled by having a predictable supply, but this apparent scarcity alone does not mean Bitcoin fulfills the role of a store of value. At the same time, though, it is worth reiterating the added value miners provide from securing the network.
For the purpose of this piece, I restricted myself to Bitcoin’s supply-side economics. If you are interested in learning more about the reciprocal impact with Bitcoin’s demand I encourage you to sign up for my upcoming webinar where I’ll discuss this and much more. I may also work on a second piece to follow through with key Bitcoin demand indicators. More on this soon…
