What was all that fuss about halving and is it worth talking about this much?
In the last couple of months, wherever you looked in the Bitcoin community, from subreddits to crypto twitter, blog posts to medium articles, most of the posts were about infamous Bitcoin halving. Finally, long-waited Bitcoin halving took place on 11th of May, 2020 at block height 630,000.
To understand this concept better, let’s look at its definition first:
Every 210,000 blocks mined, or about every four years, the reward given to Bitcoin miners for processing transactions is cut in half. This cuts in half the rate at which new Bitcoin is released into circulation(Investopedia, 2020).
It means that Bitcoin has a code that divides its supply rate by half approximately in every 4 years. Therefore the miners, who are being rewarded to facilitate the transactions, were being rewarded with 12,5 BTC in every block they find, which happens every 10 min on average, are now being rewarded with 6, 25 BTC for their efforts. Therefore the miners who are still allocating the same amount of processing power and paying the same amount of electric bills are now getting only half of their previous returns. If you want to understand why halving is needed, you may check my previous article here to understand the logic behind:
Then why the miners keep mining?
So far, we’ve covered what is halving and if you’ve visited my previous article, now you know why there is such a need for halving. So, let’s focus on another important aspect of halving, the miners. The main question here is that if we halve the incentives for miners, wouldn’t they switch their equipment to mine other cryptocurrencies? To this day this problem is resolved based on a theory and it has worked well in the previous 2 halvings:
Reward is halved → half the inflation → lower available supply → higher demand → higher price → miners incentive still remains, regardless of smaller rewards, as the value of Bitcoin is increased In the process(Investopedia, 2020).
What this theory suggests is that even the reward is cut by half, lack of supply will not be able to serve the demand and will lead the price to higher levels.
You may see in the graph above that each time halving took place, although there hasn’t been any impact on the price in the short-term timeframe, it even stayed constant in the first and dropped in the second, the price had a significant increase in the long-term after each halving. We don’t know if this is going to be the case for the third time but the only way to make a forecast in this situation is to look back and take past halvings as reference.
Another theory that supports the argument that cutting the supply of Bitcoin by half will lead the prices to higher levels is called the stock-to-flow ratio. According to Monetary Metals:
Stock to Flow Ratio is the amount of a commodity held in inventories divided by the amount produced annually(2020).
This ratio is generally used to calculate the value of commodities. According to this theory, there is a direct correlation with commodities’ annual supply rate and their price. When we implement this ratio on Bitcoin to calculate its potential future value, we come across the following graph:
Indeed so far, Bitcoin’s price seems to have followed the stock to flow ratio closely and if it can maintain this correlation, Bitcoin’s price may reach significantly higher levels and maybe to 1 Million Dollars at some point.
All these theories and the fact that halving systematically reduces the inflation rate of Bitcoin to lower levels, lower than U.S. dollars with this halving with 1.80% and lower than gold with the next halving in 4 years with 0.90%, there are many pro arguments for Bitcoin to reach all perma-bulls’ target price of a million. However, there is no guarantee for these estimations to be fulfilled.
As an antithesis, there is a possibility of miners to leave Bitcoin and allocate their hash rate to coins that can be mined easier, if they don’t think the price will go high enough to compensate their energy expenditures, since relying solely on transaction fees won’t be profitable enough at the current prices. You may even see a sharp drop in Bitcoin’s hash rate since the most recent halving here:
If this drop in hash rates continues in long term and fewer miners facilitate Bitcoin transactions, it may lead the fees per transaction and the time for a transaction to take place to significantly higher levels, which would only harm the adoption and the price of Bitcoin in a negative way. As a measure to prevent this, Bitcoin adjusts the mining difficulty dynamically based on the hash rate and aiming to get the attention of miners back, but if the drop in the hash rate is too much, this softening effect may mot be able to fully absorb the impact.
Therefore, both bulls and bears may come up with arguments on the direction of Bitcoin’s price for the future. It’s all up to you to decide which arguments are more convincing and where the price will end up eventually.
Stay safe and see you next time!
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Disclaimer: This article is provided for informational or educational purposes only and is not any form of individualized advice. Use this information at your own risk.