What is the Bitcoin “Halving” and Why does it Matter?
What is the Bitcoin “Halving” and Why does it Matter?
This week we discuss the upcoming Bitcoin Halving event and provide a framework for our investor community to understand what the halving (or “halvening”) really is and the short and long-term implications on Bitcoin’s supply, demand and price.
Context is Critical – What was before Bitcoin?
When Satoshi Nakamoto published the original Bitcoin whitepaper, (which we think everyone should read), the overarching goal wasn’t unfamiliar. It’s the same thing the fintech industry had been working towards for 30 years – cheap, real-time, global payments and secure transfers of value.
We’ll get to Bitcoin, which allows that to happen in novel and unique ways, but an appropriate legacy fintech comparison might be the Visa payments network – which is one of the leading global payments networks, moving around $12 trillion annually. Visa is essentially a network of computers operated by Visa which are connected to peers in the industry.
By working together and connecting their networks, the companies can offer their customers more extensive global payments coverage, facilitate more payments and drive more revenues. And for customers, it feels like digital dollars. You can send dollars to buy products and services around the world and your banks and payment companies “talk” to each other; it looks and feels nearly instantaneous.
But Our Financial Infrastructure Only Feels Digital
But this system, as we’ve covered many times, is built on largely analog infrastructure and lacks natively digital money. Regular readers will know this is core to our thesis. (More on that here).
While we’ve figured out how to send messages and content around the world almost instantaneously, at almost no cost, it is still very costly and slow to send dollars around the world. And in those cases where payments appear digital and instantaneous to customers, on the backend, institutions must route these transactions through analog networks over the course of days or even weeks to balance their ledgers. The cost of this system is passed onto the customers through exorbitant fees. (More color on that here).
An alarming degree of the backend of our global payment networks and banking systems is also done on paper and over the phone – both of which are increasingly insecure. What’s more, AI is enabling advanced deep fake technology and phishing, social engineering and financial manipulation on a new scale. (Software scales well, good or bad). And the high concentration of payments networks amongst individual operators creates significant centralization risk, exposing large single points of failure in the networks we rely on to send trillions of dollars around the world.
So What Makes Bitcoin Different?
The innovation of Satoshi Nakamoto’s Bitcoin whitepaper was that it suggested a way to do this – operate a global network for the transfer of value – but in a manner that was more secure, in which the general public could verify transactions in a transparent way, and share in the rewards and fees generated by doing so.
By utilizing a peer-to-peer system, BItcoin bypasses those myriad institutions and fee takers. Moreover, by splitting the network up amongst more and more computers in the general public, it also becomes much more durable (e.g., harder to hack). Together, this makes a network like Bitcoin cheaper, more secure, and more transparent for transmitting value globally.
Decentralized parties around the world, known as “miners,” do the backend work to verify transactions and record new information to the ledger. As a result, people anywhere can transact value globally in a decentralized, secure system that is cheap, fast and transparent. (Or “Natively-digital”, as we call it, in contrast to our existing financial infrastructure which is built on exceedingly analog rails).
But how do you actually incentivize the broad public, in a non-centralized, non-authoritarian manner, to set up all these computers and do all of that work?
How is this Accomplished? And Why do Miners Participate?
This is where much of the genius of Satoshi comes into play. He/She/They built in a software-mediated incentive system to incentivize miners to buy the hardware and maintain the network.
At a high level, miners use powerful computers to solve computationally complex math problems to prove that transactions happened and are valid, much like the banks and payments networks “talking” to each other to balance their internal ledgers. (However, this happens magnitudes quicker on Bitcoin, at a fraction of the cost).
The first miner to solve the complex problems verifying the transaction gets the privilege of adding a new block to the blockchain, like adding an entry or a page in an accounting ledger. And for doing so, miners are rewarded with a block subsidy. Essentially, they are automatically awarded a little chunk of newly created Bitcoin for doing that work. Bitcoin’s unique structure also allows Bitcoin users to prioritize their transactions by offering higher or lower fees as added incentives for miners to add users’ transactions to the ledger, giving miners a second revenue stream.
This incentivizes miners to keep running their computers and validating transactions, keeping the network going for all of us. But the goal was that over time, block subsidies would decrease to zero as transaction volumes rose, such that miners could eventually subsist just on transaction fees from the network.
That’s why every 4 years we have the halving, or the ‘halvening’ as some like to call it – the recurring event during which that block subsidy is halved. I.e. when the rate of new Bitcoin awarded to miners for adding blocks gets cut in half. With the expectation that as prices and volumes grow, that subsidy will eventually be cut down to near zero and transaction fees alone will fully sustain miners (who sustain the network for all of us).
So, again.. What is the Bitcoin Halving?
The halving is the recurring, software-mediated event in which the rewards given to miners for validating the transactions on this user-owned network are systematically cut in half. With the expectation that eventually, prices and volumes will rise enough that miners can live profitably off the transaction fees alone, as the block subsidy moves toward zero (but never reaches zero).
Hence, the halving does not refer to a halving in the total Bitcoin supply or the price, nor will it affect the amount of Bitcoin in anyone’s wallet. Rather, it refers only to the recurring reduction of mining rewards for adding new blocks to the chain – i.e. the systematic reduction in the rate of new Bitcoin created.
This is a built-in feature of Bitcoin, designed to curb network inflation and limit the amount of new Bitcoin entering circulation. And it means that eventually there will be a day when there will be no more new Bitcoin created ever.
How and when does this happen?
The actual mechanics behind this are all mediated by software and halvings occur automatically, in a predetermined fashion, when specific blocks are mined. This is the actual code that governs the process:
As seen above, the halving occurs every 210,000th block specifically. Thanks to a mechanism called the “difficulty adjustment,” new blocks are created roughly every 10 minutes. This means that the 210,000th block typically arrives every four years. In practice, this varies slightly with the changing computational power in the network, meaning the precise timing of the halving can only be estimated (see here). But it’s basically every 4 years.
When Bitcoin launched in 2009, the block subsidy awarded to miners for successfully adding new blocks to the chain was 50 Bitcoin (~$3m at today’s prices). Since then, there have been three halving events;
The 1st halving occurred on Nov 28th, 2012 – and the block reward was cut from 50 to 25 BTC
The 2nd halving occurred on July 9th, 2016 – and the block reward was cut from 25 to 12.5 BTC
The 3rd halving occurred on May 11, 2020 – and the block reward was cut from 12.5 to 6.25 BTC
The fourth halving is currently set to take place today, on April 19th, and will bring the block reward from 6.25 BTC per block down to 3.125 BTC per new block. In practice, this means that the amount of new Bitcoin issued to miners each day will fall from 900 to 450. In other words, Bitcoin’s annual inflation rate will fall from an already low 1.8% to an even lower 0.85%.
And halvings will continue like this, until all 21 million Bitcoin have been mined and the block reward is effectively zero, which is estimated to happen around the year 2140. And it is this fixed halving schedule that affords Bitcoin its unique status as a programmatically disinflationary asset.
What Does this Mean for Prices?
You might think this should all be priced in ahead of time, given Bitcoin’s emission schedule is predetermined. And some folks believe it already is, there is much debate. However, the halving marks the most public face of Bitcoin’s unique disinflationary nature, calling attention every 4 years to the fact that Bitcoin is exceedingly scarce and different from other assets like dollars, gold, or oil.
As demand increases for assets like oil or gold, more resources can be applied to finding them and more can be found. As the government needs more dollars, more can be printed. But as demand increases for Bitcoin, there will eventually be no more to be found. And we’ve already mined 19.68M, or 93.7%, of the 21M Bitcoin that will ever exist.
What do the Economics Dictate?
In the long run, assuming demand for Bitcoin increases, then the price will necessarily increase. Simple economics dictate that in a world of capped supply, increasing demand will drive prices to a higher equilibrium. In economic terms – as more people compete for the same limited amount of resources, they are willing to pay higher prices to obtain what they need or desire. Bitcoin, in this case.
And that is exactly what we’ve seen so far this year – demand has increased significantly, driving the price up. Just as we predicted last November in our 2024 Blockchain Predictions report; Bitcoin has reached new all time highs in 2024 driven by the Bitcoin Spot ETF approvals and by the upcoming halving. (More on the ETFs here).
The world’s institutions are quickly revealing that they are, in fact, quite interested in digital monies, commodities and assets, driving demand in droves. The Blackrock and Securitize partnership announced recently is an example of just that. It may have seemed abrupt, but it was years in the works. And financial institutions like Blackrock, Fidelity and JP Morgan have been watching this industry and playing with this technology internally for years. Now they are coming out to play.
In the first two months alone, demand for the new US Bitcoin ETFs outpaced new Bitcoin mined by more than 7x. And the recent ETF inflows still largely exclude wirehouse banks, sovereign wealth, state pension funds, and the like. So there is still plenty of untapped institutional capital and the demand outlook continues to look very strong for Bitcoin. Hence, economically speaking, the price outlook is favorable.
What does History tell us?
Historically, the periods around these halving events have seen significant appreciations in Bitcoin’s market value, specifically post-halving. This can be seen in the price chart (or in the higher quality copy here) above and the table below, which paints this trend quite clearly. And since the whole crypto ecosystem is so closely correlated to Bitcoin, these events have typically ignited industry-wide growth waves.
Looking at 2024… a year before the halving slated for tonight, the Bitcoin price was at roughly $29k. Heading into the 4th halving event now, the price is trading between $60 and $70k. Meaning so far this year, things are looking quite familiar.
What does this Mean for Miners?
Publicly traded Bitcoin mining companies (like Riot and Marathon Digital) have a collective market cap of more than $17B currently and with Bitcoin at all-time-highs you might assume the miners are as well. Yet according to Glassnode, the median mining company has experienced a market value decline of ~37% YTD.
But understanding the mechanics of the halving, this makes sense. This sell-off is largely related to concerns around the upcoming halving, which by design, will cut miners’ block subsidy revenues in half overnight. Which might seem like a nightmare business scenario, but this is often wholly misunderstood.
This is built into their business models and it simply forces them to continually find new revenue streams, more efficient ways to mine and lower energy cost, which is their key expense input related to profitability. This also means there is a pre-existing, built-in incentive for miners to tackle the Bitcoin energy consumption problem.
One way large-scale Bitcoin miners are driving new revenue streams, for example, and improving their environmental footprint, is by utilizing the heat produced by mining computers in industrial and manufacturing applications. As it turns out, Bitcoin mining is one of the most efficient ways we know of to generate heat, since 95% of the energy that goes in comes out as heat, which can be captured and fed back into industrial processes.
Nearly 50% of worldwide industrial electricity usage already goes simply to generating heat, so the total addressable market (or “TAM”) on such a market is massive. And this is excluding commercial heating of buildings and homes. So large scale miners are not facing a doomsday scenario; rather they are simply forced to get smarter and more efficient.
So What should Investors be Watching in 2024?
First of all, we should note that we have only limited historical data to support these trends around the halving. Three halvings to date is not a statistical sample by any means. Bitcoin also does not operate in a vacuum and is affected by macroeconomic factors far-removed from the industry. Nor are we traders – we are early stage venture investors.
That being said, there are a few things worth keeping in mind during this cycle. As we’ve noted already, much of the recent demand for Bitcoin has been driven by institutions, which have fundamentally changed the market and the Bitcoin holdership base. Institutional investors have markedly different trading patterns than retail investors, often holding investments for years and even decades, which may redefine the floor and support levels for the Bitcoin price fundamentally. So we will be watching ETF inflows closely.
Broader institutional adoption is also worth watching and will likely be a critical price catalyst for Bitcoin this year. We anticipate seeing a handful of further announcements like the Blackrock & Securitize partnership as the year progresses, which will bring attention and further legitimacy to this asset class. We are also hearing rumblings of an Ethereum ETF out of Asia, which would only spur these trends for the ecosystem.
Additionally, the IPO window is expected to open later this year and we may begin to see some of the 100+ late-stage blockchain unicorn enterprises make the transition to public markets. Landmark IPOs are not out of the question. And with US elections on the horizon in November, we may soon see a new regime take shape at the SEC that is pro-innovation with regards to digital assets.
Overall, the halving is an event that should be watched closely, as it decreases the rate at which the supply of Bitcoin is increasing. This event should be viewed alongside the above catalysts, as the market price of Bitcoin has multifaceted inputs, like any other global asset class. Like any asset, it’s difficult to predict the price Bitcoin will have in the short term. We won’t pretend to know the halving’s impact on the price next week. However, given Bitcoin’s monetary policy and the potential catalysts ahead, our team remains confident in Bitcoin’s long term potential.
Author
Christopher Nelson
Head of Digital Asset Research