The Bitcoin Halving, Explained
The third Bitcoin Halving is set to occur on May 13, 2020 and everyone is talking about it. Don’t know what this means, why it’s important, or what to expect? Not to worry, Ryze Research has you covered.
What is the Bitcoin Halving?
The Halving is a preprogrammed functionality of supply in the Bitcoin protocol that reduces the block reward by 50%. This means that the amount of new bitcoin that is created every day will be cut in half as a result of the Bitcoin Halving. The Bitcoin protocol is the set of rules that governs the Bitcoin network, and the block reward is the amount of Bitcoin that is created approximately every 10 minutes.
Confused about blocks, Bitcoin, and blockchain? Here’s a quick refresher.
The Halving occurs roughly every 4 years (every 210,000 blocks to be precise). The Bitcoin network programmatically decreases how much new Bitcoin is “minted,” reducing its rate of supply. Subsequently, this reduces Bitcoin’s annualized inflation rate from ~3.7% to ~1.8%, lower than the average global inflation rate.
An important aspect of the Halving is that it is predictable, nearly down to the date. Bitcoin’s production is on a predetermined schedule, as the network self-balances to adjust for higher or lower transaction volume. Thus, we can predict that the 630,000th block will occur on May 13, 2020. The Halving’s predictability can create bullish market hype around the event.
Mining and Block Rewards
The block reward incentivizes people to validate transactions by mining Bitcoin. Bitcoin mining discovers the hash to validate the next block of transactions on the Bitcoin network. Think of the hash as the answer to a complicated math problem. Miners put in computational power and use specialized computers known as “mining rigs” to discover the hash. The first miner to discover the hash gets the reward.
Though a deeper dive into mining reveals that it’s not as simple as described above, the key takeaway is that the Halving reduces the rate of supply for Bitcoin. It cuts the amount of Bitcoin produced every 10 minutes in half.
The Halving’s Impact on Bitcoin’s Scarcity
You might be wondering — “why should I care and what does this have to do with the price?” To answer this question, we need to examine Bitcoin’s monetary policy and understand why it is a scarce resource. Bitcoin is scarce for two reasons: its supply is finite, and the rate of supply decreases over time.
Cryptography pioneer Nick Szabo states:
“What do antiques, time, and gold have in common? They are costly, due either to their original cost or the improbability of their history, and it is difficult to spoof this costliness…precious metals and collectibles have an unforgeable scarcity due to the costliness of their creation.”
This means that things that are hard to create, and whose creation can’t be faked, have value. Bitcoin, like gold and other precious metals, has both of these properties. Mining Bitcoin requires large amounts of electricity and computational power. In fact, the Bitcoin network uses a similar amount of energy every year as the entire country of Venezuela.
Finite Supply
Think of Bitcoin as digital gold. Mining either asset produces more of the asset, and in the case of Bitcoin, newly minted Bitcoin is given to miners as a block reward. Like gold, Bitcoin has a fixed supply. Only 21 Million Bitcoin will ever exist. Bitcoin’s fixed supply is one of the reasons it has value.
Resources with a low supply are intrinsically valuable simply because they are hard to obtain. The scarcity principle of economics dictates that a low or fixed supply and increasing demand results in an increase in price over time.
Rate of Supply
A second factor contributing to Bitcoin’s scarcity is its decreasing rate of supply. Since the block reward is halved every 4 years, the amount of new Bitcoin that gets created decreases over time.
Before the first Halving, the reward was 50 Bitcoin per block. In 2012, this was reduced to 25 Bitcoin. In 2016, it was reduced again to 12.5 Bitcoin. In May 2020, the block reward will be reduced to 6.25 Bitcoin.
Halving the block reward results in a reduction of the flow, or the yearly production, of Bitcoin. The value of precious metals can be determined by a measure of scarcity known as stock-to-flow (SF). This is the ratio of the total supply (stock) to annual production (flow).
Stock-to-Flow
The Stock-to-Flow model first posited by analyst Plan B is among the most interesting arguments as to why Bitcoin’s price will increase after the 2020 Halving. Stock-to-Flow (SF) is a ratio that measures the existing supply of Bitcoin to the new yearly supply of Bitcoin.
In gold and precious metals, this is the ratio between the amount of metal that’s already been mined to new metal extracted every year. The higher the SF, the scarcer the metal, and the higher its market value.
Plan B measures Bitcoin’s SF as the ratio of Bitcoin in supply to the amount which is minted every year as new blocks are validated. After the 2020 Halving, Bitcoins SF will be 50, between silver’s SF of 22 and gold’s SF of 62.
This model purports that Bitcoin’s stock-to-flow is statistically co-integrated with its price. PlanB predicts that Bitcoin will have a market value of $1 Trillion after the 2020 Halving, and the price will be upwards of $55,000 per Bitcoin. Though the math behind this model has been verified by third parties, it’s important to note that its core premises are purely theoretical. It shouldn’t be used to make investment decisions.
Analyzing Previous Bitcoin Halvings
We only have 10 years of history with 2 Halving events, but the story has been similar both times. A large correction precedes the Halving, prices rise before the Halving, and reach an all-time high after the Halving.
2012 Bitcoin Halving
The all-time-high (ATH) before the 2012 Halving was around $30 in June. A 93% correction lead up to Halving as prices fell down to $2.01 exactly 378 days before the Halving. Prices steadily rose to 5 $11.50 at the time of the first Halving on 11/26/2012.
Prices continued to climb to a new all-time high of $270, four and a half months after the Halving. From pre-Halving local minimum to post Halving ATH, Bitcoin’s value increased 13,304%.
2016 Bitcoin Halving
The 80%+ correction in 2012 and 2013 resulted in a price drop from nearly $1100 in late 2013 down to $164 in January 2015. In between, we saw the Mt. Gox debacle and the shutdown of the Silk Road. A one-and-a-half year consolidation from Jan 2015 to July 2016 led to a price of $658 on the day of the second Bitcoin Halving, 7/11/2016.
524 days after the 2nd Halving, Bitcoin reached its ATH of $20,074. During the 1080-day cycle from pre-Halving minimum to post-Halving maximum, Bitcoin’s price increased 12,140%.
2020 Bitcoin Halving: What to Expect
Well, what’s happening this time? The Halving is in mid-May 2020, and at the time of writing, Bitcoin is down 14% this year. Since the Dec 2017 ATH at $19,891, we are down 69%. So far, the pre-Halving pullback is in-line with the narrative established by previous Halvings.
If history can tell us anything, it’s that:
- Prices could reach a new all-time high after the Halving
- A new ATH won’t come immediately
Some analysts think that the Bitcoin Halving is “priced in,” meaning that it won’t have a significant impact on its price in the long run. Others think that it’s not priced in, and that Halving events in cryptocurrency markets have a significant impact on price.
In the most recent sell-off earlier this month, we saw Bitcoin fall from ~$8,000 down to as low as $3853 on some exchanges. We believe this may have been caused by institutional sell-offs in light of global macroeconomic events. Alameda Research CEO Sam Bankman-Fried speculates that a negative feedback loop triggered by liquidations on BitMEX could have exacerbated this sell-off.
In spite of the recent dip, retail investors still seem to be buying. Some platforms are seeing more retail activity in March 2020 than ever before, and 69% of Bitcoin trades on Coinbase are buys.
Strong Fundamentals Before the Halving
The narrative established by previous Halvings isn’t the only reason the price could go up this time around. In comparison to the last Halving, fundamental measures of network and transaction activity are strong or have significantly improved.
Hashrate, a measure of the computing power that secures the Bitcoin blockchain, is up 2x in the last year and 7x since the Dec 2017 ATH. The number of unique Bitcoin addresses is up 62% since the 2016 Halving.
The NVT Ratio, an experimental indicator created by Willy Woo, is within healthy ranges. The NVT Ratio (Network-Value to Transactions) measures the market cap of Bitcoin to the total volume of transactions on the blockchain. This metric can help determine if Bitcoin is overvalued or undervalued.
Woo says that a high NVT potentially indicates that “the price is in an unsustainable bubble.” Currently, the NVT is around 68, above the “oversold” level at 61 and below the “overbought” level at 115.
Price increased significantly after the two previous Halvings, and given the points made above, there may be good reason to believe that the narrative will continue. That being said, a lot has changed since the last Halving in 2016. These changes need to be taken into consideration when evaluating the potential effects of the May 2020 Halving on Bitcoin’s price.
Since the last Halving, we’ve seen a tremendous influx of retail investors, and more consumers are aware of Bitcoin than ever before. Most of them missed out on the last bull run and are likely to buy Bitcoin if a rally follows the May Halving. As Blockchain Capital published,
“Despite the bear market…Bitcoin awareness, familiarity, perception, conviction, propensity to purchase, and ownership all increased/improved significantly.”
Perception of Bitcoin has changed from the currency of the black market to an asset class legitimized by financial institutions and the media. More people are likely to purchase Bitcoin than before the 2016 Halving, and it’s gotten so much easier for them to do so with the growing popularity of apps such as Coinbase, Square Cash, and Robinhood.
Retail investors caused the 2017 pump to $19K, and if more of them enter, we’ll see an even larger bull run. As Unchained Capital points out in HODL Waves, there is a record number of Bitcoin investors silently HODLing, waiting for the next rally.
The Macroeconomic Picture
A factor to consider when thinking about the upcoming Halving’s impact on price is the precarious macroeconomic situation we find ourselves in today as a result of COVID-19.
This unpredictable pandemic is a “Black Swan” event with far-reaching ramifications. COVID-19 has introduced a large amount of uncertainty, and consequently, fear, into the market.
As a result, the global economic and fiscal landscape is starkly different from previous Halvings, and this is important to keep in mind. Central banks are printing trillions of dollars around the world, similar to what was happening when Bitcoin was created in 2008. The economic impacts of COVID-19 could set the stage for Bitcoin to shine as a hedge against inflation, and replace fiat currencies in developing nations.
For a deeper dive, check out our report on Helicopter Money, Inflation, and the Bitcoin Standard.
Price action following previous Halvings, strong fundamentals and the stock-to-flow model all give credence to the argument for Bitcoin’s price to appreciate after the May 2020 Halving. A spike in retail interest, and the state of global affairs with COVID-19 should both be taken into consideration when evaluating the impact of the Bitcoin Halving on Bitcoin’s price.
It’s hard to predict what will happen, and we’ll be watching closely. Stay tuned for our upcoming article — “The Bitcoin Halving’s Impact on Miners.”
We hope that this has been a useful explainer and helps you better understand the Bitcoin Halving.
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-Abhay, Srikar, and John from Ryze
