Key Takeaways

  • Bitcoin's halving is happening in the next 33 days
  • The halving increases Bitcoin's scarcity and stock-to-flow ratio which has the potential to increase demand
  • The halving could send Bitcoin's price higher over the next year if it follows the same trend as previous halvings

What Is the Bitcoin Halving?

We are fast approaching a Bitcoin reward halving set to take place in 33 days on May 13th. Before we can explain what the Bitcoin Halving is we must first explain a bit about how the Bitcoin network operates. This system can seem daunting at first but is relatively simple.

Nodes

Bitcoin and its blockchain are basically a collective of computers, or nodes, around the world that all have Bitcoin's code downloaded on them. Each of these computers has all of Bitcoin's blockchain stored on them. This means that each node has the entire history of Bitcoin transactions, making sure no one can cheat the system as every node would see this and not allow it. While anyone can participate in Bitcoin's network as a node, as long as they have enough storage to download the entire blockchain and its history of transactions, not all of them are miners. The more computers added to the blockchain increase its stability and power. There are currently over 10,000 nodes, or computers, running the Bitcoin code.

Mining

Bitcoin mining is the process where people use their computers to participate in Bitcoin's blockchain network as a transaction processor. Faster computers with certain types of hardware yield larger rewards and some companies have designed chips specifically built for mining. These computers are tasked with processing Bitcoin transactions and they are rewarded for doing so.

The term mining is not used in a literal sense but used in a reference to the way precious metals are gathered. Bitcoin miners solve mathematical problems and confirm transactions legitimacy and then add the transactions to the block and form chains of these blocks of transactions. Transactions of greater monetary value require more confirmations to ensure security. For doing all of this work they are rewarded Bitcoin. The name of mining has been given because the work done to get new Bitcoin out of the code is akin to the physical work done to pull gold out of the earth.

Halving

About every four years the reward given to Bitcoin miners for processing a transaction is cut in half. This cuts in half the rate at which new Bitcoin is released into circulation. This is Bitcoin’s way of using a, sort of, synthetic form of inflation that slowly dissipates until all Bitcoin is released and is in circulation. At that point, miners will be rewarded with fees for processing transactions that network users will pay. These fees ensure that miners still have the incentive to mine and keep the network going. The idea is that competition for these fees will cause them to remain low after halvings are finished.

The halving is significant because it marks another step in Bitcoin’s dwindling supply. There are only 21,000,000 Bitcoins in existence. At the time of writing, there are 18,301,475 Bitcoins in circulation, leaving just 2,697,213 left to be released. You will, of course, be able to obtain and purchase Bitcoin regardless, but Bitcoins low supply at 21 million has the potential to create demand and drive prices higher.

In 2009 the reward for each block in the chain mined was 50 Bitcoins. After the first halving it was 25, then 12.5, and now it will be 6.25 Bitcoins per block. To put this in another context, imagine if the amount of gold mined out of the earth was cut in half every four years.

Bitcoin’s reward halvings ensure that new Bitcoin will continue to be released until around 2140. It also means that the remaining Bitcoin given out as rewards will decrease. This drops the available supply and can cause some implications for investors as other assets with low supply, like gold, can have high demand and push prices higher. 

In the past, these Bitcoin halvings have correlated with massive surges in Bitcoin’s price. The first halving, which occurred in November of 2012, saw an increase of nearly $1,000. The price of Bitcoin started November at around $12 and then peaked at around $950 a year later on November 25th, 2013.

First Halving
First Halving.

The second Bitcoin halving occurred in July of 2016. The price at that halving was about $650. By December 16th, 2017 Bitcoin’s price had soared to nearly $20,000. The price then fell over the course of a year from this peak down to around $3,200, a price still higher than its pre-halving price.

Second Halving
Second Halving.

Of course, there have only been two halvings so far in Bitcoin’s history, and one could argue that it is not enough evidence to allege that Bitcoin’s price will increase following the event. That said, this is something that is on a good deal of people's radar.

Google trends searches for Bitcoin halving
Google trends searches for Bitcoin halving.

Over the course of the last year, Google has seen a significant increase in the number of searches for Bitcoin halving. The topic has also been very actively referenced and debated on Twitter among the crypto community. Between April 3rd and April 9th, the hashtag #Bitcoinhalving was used well over 1600 times.

Scarcity

Based on the past two halvings we can speculate that Bitcoin could go up, but why should it go up? Other assets that are typically very scarce, like gold and silver, can give us a window into why Bitcoin’s halving could push its price higher. As Bitcoin’s inflation decreases every four years, it moves closer and closer to the scarcity of assets like gold.

Elemental Scarcity vs. Commodity Value
Elemental Scarcity vs. Commodity Value.

Assets with little supply tend to have larger prices. The same can be said for Bitcoin, but Bitcoin has one crucial difference. While precious metals like gold and silver have limited supply, they do not have a pre-set cap on their quantity. We can assume there is only so much gold on the planet but its true quantity is unknown.

Bitcoin is completely capped at 21,000,000 coins making its supply extremely limited. The current inflation rate of Bitcoin, created by its mining reward mechanism, is higher than golds, making it less scarce than gold right now. As these halvings continue to happen this inflation rate will drop past that of gold until it is zero.

Bitcoin’s inflation rate right now is at 3.65%. After the halving, this will be cut in half to 1.8%. Currently, there are about 190,040 metric tonnes of gold in existence and the average annual production of gold over the last is 2,778. This gives gold an inflation rate of nearly 1.6%. While gold does have a lower rate of inflation right now, this will not be the case for too much longer.

Stock-to-Flow Ratio

Related to scarcity, is an assets stock-to-flow ratio. Stock-to-flow ratio is the amount of a commodity already out in circulation divided by the amount of the commodity produced annually. Annual production In the case of gold refers to the amount mined from the earth and in the case of Bitcoin it refers to the amount released as rewards to the “miners” who process the transactions. 

Stock-to-flow ratios can indicate a level of scarcity an asset has. If this number continues to grow it shows the asset becoming more rare and scarce. Each Bitcoin halving lowers Bitcoin’s rate of inflation and increases its stock-to-flow ratio. Bitcoin’s stock-to-flow ratio is set to fly past that of golds as halvings continue. 

Stock-to-flow ratio
ZPX, Satoshi&Co research.

What Does This Mean?

There is a massive amount of unhealthy speculation and volatility with Bitcoin and the cryptocurrency community as a whole. Some will hear about new internet money and simply buy or entirely denounce it with little understanding and research, but Bitcoin's basic characteristics are where the value lies. 

The theory of the halving and the chain reaction that it sets off is quite interesting. You have the reward halving → smaller mining reward → less inflation → lower supply → higher demand → higher price → miners incentive still remains regardless of smaller rewards as the value of Bitcoin is increased in the process.

Logarithmic Bitcoin chart showing previous halvings
Logarithmic Bitcoin chart showing previous halvings.

This theory has proven to work in the two previous halvings and if we assume that this success continues then we could be seeing a rise in Bitcoin’s price in the following year. Aside from scarcity driven price moves, these halvings always seem to be surrounded by extreme amounts of hype and speculation, which in itself can cause huge price movements, both up and down. If history were to repeat after this upcoming halving then the market reaction would be a steady increase in price in the following year.

Performance: Year-to-Date

YTD performance

Many have speculated that Bitcoin and some other cryptocurrencies were becoming safe-haven assets as they were showing some similar correlations to them. During the coronavirus sell-off and liquidity crisis, many assets that were considered safe-haven assets were being sold. Since the lows that cryptocurrencies have hit there has been a sharp rebound. Many were showing negative returns year-to-date just weeks ago. Some, like Ethereum, are now up over 30%.

The entire cryptocurrency market has shown a tendency to follow in the direction that Bitcoin does. With Bitcoin's upcoming halving, the market's reaction will be interesting to follow.

  • Bitcoin (BTC) YTD: 1.43%
  • Bitcoin Cash (BCH) YTD: 27.17%
  • Ripple (XRP) YTD: 3.57%
  • Ethereum (ETH) YTD: 30.75%
  • S&P 500 YTD: -13.26%

Current Market Capitalizations

Investing in cryptocurrencies and Initial Coin Offerings ("ICOs") can be highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.