Bitcoin Halving — The Endgame for Bitcoin Miners
By Isaac Coffie on The Capital
Since its invention in 2008 by the pseudonymous creator, Satoshi Nakamoto, Bitcoin has remained one of the successful cryptocurrencies in present times. Just like any other crypto, Bitcoin is a digital currency that allows people to make payment for goods and services via digital channels. One key attribute that differentiates the crypto from fiat currency (e.g. USD) is the fact that Bitcoin is decentralized. Stated differently, Bitcoin is not regulated by any central authority, but by everyone on the internet who runs the software. You might wonder, “Since Bitcoin is a currency, and isn’t regulated by a central bank, how do the crypto control money supply and inflation?”. The short answer to this question is simple: Bitcoin has an inherent deflationary mechanism implemented in the software. More precisely, it does so by “regulating” the amount of Bitcoin that are released and circulated into the ecosystem every ten (10) minutes. The long answer can only be explained by a concept called Bitcoin Halving, which I shall explain below.
Bitcoin Halving
A Bitcoin halving event occurs when the amount of Bitcoin paid to miners as rewards are halved or cut in 2, approximately every four years. Perhaps, to be able to grasp this event, it helps to understand who Bitcoin miners are. Bitcoin miners are users whose work involves validating and assembling blocks of transactions on the Bitcoin blockchain. On average, about 3,500 transactions are assembled every 10 minutes as a block. Due to this tedious work of validating and processing transactions, miners are often incentivised with BTCs. In 2009, miners were rewarded 50 BTC per block. This amount was later halved to 25 in November 2012. By July 2016, it was further halved to 12.5. Yet another, on May 11th, 2020, this amount was also cut into 2, reducing the reward to 6.25 BTC currently. One crucial advantage of this halving event is to control inflation and the amount of BTC in circulation. While this mechanism has positive benefits, sadly, miners are heavily affected by this event since their revenue is equally halved.
But, hey, before we make any speculations about the impact of current halving on the price of Bitcoin, it will be beneficial that we learn one or two clues from the halving history.
The graph below shows the price of Bitcoin following the previous halving events.
The value of Bitcoin is relatively volatile compared to a stock price. However, the halving events in 2012 and 2016 have both proved that the price of Bitcoin can rise quickly following the event (see the graph above). For instance, when the reward for Bitcoin was halved in November 2012 from 50 to 25, the price of Bitcoin rose from $12 to $1,038 per BTC by November 2013 [1]. That’s about 600% rise within a year. Similarly, after the reward was halved to 12.5 in July 2016, we saw another rise in the price of Bitcoin from $650 to $2,526 in July 2017, before peaking in December 2017 at $20,000 per BTC [1].
So, Should I Invest in Bitcoin Now?
To make any investment decisions, it helps to interpret the above observation from an economic perspective. When the supply of a commodity decreases, with demand being constant, it is reasonable to observe an increase in price due to the shortage that will be created in the economy. This reasoning may hold true for Bitcoin, and we could infer that the price of Bitcoin can be correlated with the halving event. While this may be true in the past, there is no guarantee that history may repeat itself. For instance, Bitcoin was relatively new during the previous halving events. So, the interest in the new crypto in the market drove the price higher. More so, there are now competitions in the crypto market; hence the demand for bitcoins may not necessarily increase as buyers can find alternative cryptocurrencies to invest in. Based on these reasons, it will be risky to invest in Bitcoin merely on the assumption that history will repeat itself.
Could Miners Leave the Bitcoin Network?
Well, potentially! People are motivated by incentives, so are miners. Since the reward for miners is now 6.25 BTC instead of the previous 12.5, many miners may be discouraged as their revenues will be significantly affected. Some may shut down their mining operations. This event may also reduce the Bitcoin hash rate proportionately, creating delays in validating transactions. But there’s a piece of good news. Besides the reward earned from participating in the mining process, miners also get incentives from other means. One of such avenues is called a transaction fee. Similar to the charges paid for making credit card transactions, Bitcoin users may optionally include a transaction fee when making a transaction. This fee is particularly for users who want their request to be processed faster and included in the blockchain. The fee ranges from $2 to $20 depending on the size of the transaction. Since there is a limit on the mining pool (currently 1 MB per block), rational miners will only include transactions that have bigger fees attached to it. Besides the transaction fees, the difficulty level for mining Bitcoins may also be reduced to compensate for the lower reward.
In Conclusion
While the halving event may come in as bad news for Bitcoin miners, it, however, isn’t the end. Miners can still get some amount of money by participating in the network and validating transactions through transaction fees. Finally, it will be a haste decision to invest in Bitcoin on the assumption that the previous two halving events have both led to a surge in the price of Bitcoin. History may never repeat itself! So let’s trade cautiously!!!
