(Disclosure: Author holds an investment in bitcoin.)
On May 20, 2020, an event will take place that could change the value of bitcoin forever. Yet, even with increased public awareness and media attention around bitcoin, it’s an event that few are talking about or understand — despite the fact that it’s already happened twice before.
I’m talking about the next “Halving.” Today I’ll explain what this is, why it can be significant for your portfolio and the crypto markets as a whole, and what you can do to prepare.
The Bitcoin Halving Explained
Unlike fiat currencies, which can be printed by central banks at will, the supply of bitcoin is limited algorithmically. There will only ever be 21 million bitcoins in existence. This, by definition, makes it a deflationary asset, as opposed to an inflationary one.
Every 10 minutes, a “block” of bitcoin transactions is solved by miners and added to the bitcoin blockchain. This is complicated and expensive work, demanding a lot of electricity and specialized hardware. So why would anyone do it in the first place? Because the algorithm rewards miners with new bitcoins, which are generated and added to the circulating supply every 10 minutes. This distribution of new BTC is known as the “block reward.”
When bitcoin first appeared, the block reward was 50 BTC. This means that every 10 minutes, somebody, somewhere, was getting 50 bitcoins delivered to their wallet. This was back in the days when BTC was worth pennies and you could mine it using only a laptop.
So does this mean money is basically falling from the sky on those people running giant warehouse-sized mining rigs? Yes, but they’re not earning anywhere near as much BTC for their efforts. Currently, the block reward is only 12.5 BTC.
What happened? The block reward was cut in half — twice. This is a feature programmed into bitcoin, and occurs every four years (210,000 blocks). Once that number is crossed, the block reward is cut in half. This process is predetermined and will continue until the last bitcoin is mined sometime in the year 2140.
This process is referred to as a “halving,” and it can have long-term effects on the price of BTC. It’s set to happen again about 1 year from now.
How Halvings Affect The Price Of BTC
The block reward halving tends to have long-term positive effects on the price of bitcoin. Why does this happen? There are a lot of theories, but one common one comes down to simple supply and demand: If fewer bitcoins are being generated, the newly increased scarcity automatically makes them more valuable. But this doesn’t happen right away.
For a more nuanced explanation of why halvings correlate with eventual price changes, one needs to examine the role of miners. On average, 4,380 blocks are mined each month and added to the bitcoin blockchain. As of this writing, the block reward is 12.5 BTC with a price of around $5,000, which I’ll use for this example. Crunching the numbers shows that 4,380 x 12.5 x 5,000 = $273,750,000 per month. This is approximately how much in dollars miners are earning each month in total revenue.
After the next halving, only half as many BTC will be generated per day. (4,380 x 6.25 x 5,000 = $136,875,000 per month). When this occurs, one of two things will happen: Miners will simply give up, or they will refuse to sell bitcoins generated at a price below $10,000 (otherwise known as “HODLing”).
So how has this played out in the past? History shows us that it ends up being a mix of both. Some small number of miners will indeed give up, while the majority will instead choose to keep mining and hold.
The first halving occurred in November 2012, when 1 BTC went for around $11 USD. The following year, the price began to climb dramatically, reaching a new all-time high of over $1,100 in 2013. The price then crashed down to the $220-$240 range, where it would remain for the next few years.
The next halving occurred July 9, 2016. BTC stayed in the $580-700 range for several months before slowly rising toward the end of the year. This time, some in the industry anticipate that history might repeat itself. Investors remember what happened in 2017, don’t they?
What To Expect With The Next Bitcoin Halving
Using CoinDesk data, I analyzed bitcoin prices through this April and found that large volatility events seem to occur around 12-18 months after each halving. The first time, BTC went from around $11 to around $1,100 and back down to $220. The second time, BTC went from around $230 to around $20,000 and back down to around $4,000.
So what about the next halving? I’m not in the business of making predictions, but history can have a tendency to repeat itself.
It’s important to note that with each halving, there were different variables at work. With the first, it was the first time a halving ever happened, and no one had any real idea what to expect. The second time, the rise of Ethereum and initial coin offerings was a new factor that was not happening in 2012.
The biggest changes in the crypto ecosystem this time around will be the higher public awareness around bitcoin and the interest of institutional investors. If financial institutions begin taking big positions, it could affect bitcoin in ways investors have never seen before.
Regardless, the main takeaway from today’s history lesson is this: There is a clear correlation between bitcoin reward halving and price volatility afterward. These supply side changes happen every 4 years, and keeping that in mind can help build a better picture of what influences the price of bitcoin at different times.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
