The turbulence of the 2008 financial meltdown and the prolonged recovery that followed, gave birth to an unwanted child: digital currencies. The promise was clear from the beginning: a world of finance free from intervention by the government or any other centralized entity.
Unshaken by the notions of the authority, and resilient to those shocks that may inflict other markets. However, like any other new thing, the new market has been in the making. The rise of the crypto market and its crown jewel, Bitcoin, have not been steady, with more than a few bumps and slumps in its short history of existence. But it seems that something is changing. After all, there are new developments in the market, among which one is extraordinary and very technical. Speaking of technicality, let’s delve a bit into how Bitcoin works
How Bitcoin Works?
Imagine a collection of computers all around the world, each storing all of Bitcoin blockchains—i.e., history of Bitcoin transactions. The promise was safety through transparency; no computers would accept a dubious transaction—a transaction exists when everyone can see it. All of them are within sight of every miner’s naked eye.
These computers are owned by Bitcoin miners who, through participation in Bitcoin’s blockchain network, act as a transaction processor. The system rewards miners for the time and energy with which their computers run, solve equations, add transactions to the end of the block, and create chains of transaction blocks, by nothing but Bitcoins.
At the same time, Bitcoin vows not to go the “evil way” of the fiat money, where a monetary authority can change the flow of money into the economy, disregarding its effect on the value of funds at the disposal of the holders. At the heart of the Bitcoin system, there is a governor that dictates the anti-inflationary decree.
Bitcoin Halving Explained
The Bitcoin system acts in a way to slow down the pace of production of coins to ensure its value in times of inflation. More important, though, is that the supply of Bitcoin is finite. So, up until 2140, there will be 21 million Bitcoins, and then the system stops production. After that, there are no rewards for miners–as there is nothing more to mine–and they should rely on charging fees for handling transactions. The date seems far enough to assure miners that the show will go on. But it is not: up to now, more than 18 million Bitcoins are in circulation. Only something north of two million and six thousand Bitcoins have yet to be created.
How does that affect miners, you ask? Well, every four years after 210,000 blocks have been mined, the reward that Bitcoin miners receive as a reward for processing transactions gets cut in half. Bitcoin was launched in 2009. In the years leading to the first halving in 2012, mining each block in the chain gave miner a handsome reward of 50 Bitcoins. From that time on, the reward dwindled to 25, and then 12.5. That was four years ago. This week on the 11th of May 2020, the reward for making each block cuts in half to 6.25 Bitcoins.
With fewer Bitcoins around, given healthy demand, prices should go up. The first halving pushed the price of Bitcoin10 times higher from $11 to $1,150.
The second round was even more of a frenzy. As the price of each Bitcoin flew from $650 before the 16th of July 2016 to nearly $20,000 by the end of December 2017, finally settling at $3,200. A meager amount compared to the highs Bitcoin has reached, but still 400% more than the pre-halving prices. Because of both technical issues and its history, there is a psychological effect to halving; the idea that only “few” Bitcoins are left seems to tempt many to buy some.
The Good News
The much-anticipated halving is happening right after the blow the world economy received from the Covid-19 pandemic. Just a month before, businesses across the globe were halting and different equity markets tanking. Even the crypto market, which is perceived as a safe haven in the time of financial distress, was not an exemption. But since mid-March 2020, an expansionary monetary policy from the Fed and other Central Banks in the world, accompanied by stimulus packages worth more than thousands of billions of dollars, changed the game. Governments tried to show the markets that no matter what, enough money was printed to keep economies afloat. As a result, markets for almost every asset class turned bullish.
In addition to that, one other factor saved Bitcoin from the low of $3,867 in early March 2020 and helped Bitcoin make inroads to the five figures. That was the rising interest of institutional investors. The news about the new flow into Bitcoin came from a top Wall Street name–Paul Tudor Jones. After praising digital coins as a store of value, he said that one of his funds holds futures on cryptocurrency. The BTC then crossed $10,000 on Friday morning, only to settle at $9,900, as the markets closed in Singapore. It was a one-day 6.4% rise in the value of Bitcoin—a piece of Good news before the greater one that all investors were waiting for.
All Set for Profit?
All this may paint a rosy picture where Bitcoin is currently doing well, and its price is highly correlated with the halving. So, things should be wonderful in the weeks to come. But there are some contrary views: looking at the precedent shows that Bitcoin was doing quite well both inside and outside the digital currency market, before the second halving. Hence, attributing Bitcoin surge to its all-time-high prices can be spurious.
There are technical complications, as well. On the day of halving, miners trying to calculate the latest Bitcoin generation rate, see the Bitcoin network difficulty reaching its all-time high. As a result, Bitcoin hash rate—a metric that shows the security of the system and a sign of activity of miners—is likely to reach new highs by the day of halving. At the same time, the reward miners receive in return for forming the blockchain gets cut in half.
If the price of each Bitcoin doubles, thanks to halving, miners’ reward will remain the same. However, if Bitcoin’s value does not reach the threshold, then some of the miners will no longer afford the costs of production. That being the case, they may decide to shut down their computers, kicking a decline in the hash rate of the Bitcoin network. This would affect the earnings of the remaining miners, for they should mine with higher costs. Eventually, the remaining miners are likely to decide to keep the Bitcoins for a while. However, the costs of the operations may have them make up their minds. Upon the supply of their coins into the market, the previously high price due to the lack of supply would eventually decrease. This process would continue until the balance is maintained, and the hash rate of Bitcoin Network restores to normal. You can also see this trend in prior halvings.
There is another scenario, as well. Bitcoin miners use devices with SHA256 algorithm. On the day of halving, they might choose not to switch their systems off in case the price of Bitcoin does not duplicate. But they might instead shift to other minable digital coins like BCH, BSV, PPC that share the same encryption algorithm as Bitcoin does. Hence, in the short run, the difficulty and hash rate of these smaller coins are affected. In the midterm, however, the scenario mentioned earlier, holds.
More than Profit
With estimates of Bitcoin price hovering around $3,000 to $15,000 after halving, there are signs that an ongoing surge in the price of Bitcoin would be different from what we saw in 2017. The exclusiveness of the rally to the price of Bitcoin and the exclusion of the altcoin market from the current game is a signal that this situation is not retail speculation.
Aside from that, the presence of high-level institutional investors, wary of monetary easing policies, in the Bitcoin space will increase the financial maturity market, the missing part of the puzzle in 2017.
Some index funds are celebrating from now, the prospect of Bitcoin price appreciation by early 2021. But the bigger prize might be something else—something even more precious.