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Bitcoin (BTC) has come a long way from its 2009 launch. As a digital currency powered by cryptographic math and internet networks, its perception has gone from shady experiment to mainstream acceptance. This year, even one of the world’s largest banks, JPMorgan Chase, forecasts Bitcoin as eventually supplanting gold as a safe-haven asset.
With Bitcoin busting through the $20k price resistance recently, would you like to know how the cryptocurrency’s halving mechanism is related to its price fluctuation?
What is Bitcoin Halving?
Also referred to as halvening, to understand what it means, you must first gain a firm grasp of Bitcoin’s infrastructure. As the term blockchain itself infers, Bitcoin is composed of data blocks that are cryptographically chained across network nodes. Each of these nodes, which is a network-enabled computer, contains the entirety of blockchain’s history of transactions. Currently, there are about 50,000 Bitcoin nodes.
This feature gives Bitcoin its formidable security as it eliminates central authority. Each data transaction on the blockchain must be verified across all nodes, rendering Bitcoin virtually unhackable without having access to private keys.
Now that you understand what is underpinning Bitcoin, its halving is closely tied to Bitcoin mining. The term “mining” was simply adopted from its traditional meaning to apply to computing. Although you can employ your computer to serve as a Bitcoin node, that doesn’t mean it becomes a miner.
If you want to turn your computer into a Bitcoin miner, you would have to produce PoW — Proof of Work — to process Bitcoin transactions. As PoW verifies your contribution in verifying a transaction, you receive rewards for expending your computer’s processing time and electricity. Of course, certain types of computers — mining rigs — are more adept at being cost-effective than others. This has become a lucrative sub industry of Bitcoin as the popularity has grown over the years.
As each transaction is verified, this data block is added, thus forming the blockchain. After 210,000 mined blocks, which occurs approximately every four years, Bitcoin’s protocol cuts in half the reward for processing Bitcoin transactions — the halving.
Why is Halving Done?
Bitcoin had been envisioned as a direct monetary counter to the centrally planned monetary system. This makes sense as the cryptocurrency arose from the 2008 Financial Crisis, which saw the biggest bailout of American banks. In the wake of the coronavirus pandemic, this intervention from the Federal Reserve was subsequently dwarfed, as you can see from the Fed’s balance sheet below.
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The Fed drastically increased the money supply, which served to stave off market crashes, especially this March. However, this has its own consequences. One of them is possible hyperinflation, which wreaked havoc on many economies in the past. The purchasing power of the dollar is continually eroded as new money is brought into the supply - rendering everyone's money worth less than previously.
To make Bitcoin innately deflationary, it doesn’t only have a finite pool of 21 million BTC that could ever be mined. It also has an artificial inflation mechanism — halving protocol — by which new Bitcoins are released into circulation. Cutting in half this release rate every four years will go on up until approximately 2140 when all Bitcoins are mined and in circulation. After 2140, miners will receive fees from users instead.
In short, halving combined with Bitcoin’s finite pool makes the cryptocurrency a form of digital gold. Increasingly, it is being used as such, as a hedge against inflation risk and a weakening dollar.
What Does Halving Mean for Bitcoin’s Price?
So far, there have been three Bitcoin halvings:
- November 2012 - mining rewards reduced to 25BTC per block.
- July 2016 - mining rewards reduced to 12.5BTC per block.
- May 2020 - mining rewards reduced to 6.25BTC per block.
Each time, the halving corresponded with the rise of Bitcoin price. If you understand basic economics — the law of supply and demand — this makes perfect sense. The more the supply of something is reduced, and the more the demand for it continues to rise, the higher the price must go.
To make this clearer, imagine if we had a cost-effective way to mine asteroids. Moreover, if we find a close-by large asteroid abundant in gold. Would this increase or decrease the price of gold?
Of course, because the supply of gold would drastically expand, its price would also drastically plummet!
Since we neither possess an asteroid mining technology nor can we point to a gold-filled asteroid, all we have left is the finite amount of gold on planet Earth. Therefore, for many centuries, gold served as a store of value.
With Bitcoin, which is a virtual entity, we don’t have such concerns of finding a Bitcoin-filled asteroid. Moreover, there are no security and transportation costs associated with the cryptocurrency as there are with gold. Bitcoin also gives a guaranteed way to verify its circulating supply, something which is only estimated with gold.
Bitcoin represents a true currency of the internet age — digital, decentralized, immutable, scarce, and transparent.
Understanding Bitcoin’s Halvening In Keynotes
The best way to understand why Bitcoin halves every four years is to understand its mimicking of the economic law of supply and demand:
- Scarcity serves as a bulwark against inflation.
- If there is a large money supply — inflation — the value of the currency drops.
- Bitcoin prevents this by mimicking and improving on the key feature of a commodity like gold — scarcity.
Therefore, in addition to Bitcoin’s restricted pool of 21 million BTC, the only inflationary force exerted on the cryptocurrency is tightly restricted via halving of mining rewards.