What is Bitcoin Halving? A Detailed Guide
The emergence of Bitcoin approximately nine years ago has had a tremendous impact on how we view money. The creation and continued existence of Bitcoin proved that the digital and trustless transfer of money was possible. In order for Bitcoin to truly serve as a transfer of value, certain features have been incorporated into the Bitcoin protocol in order for it to facilitate value transfer. For example, the entire concept of proof-of-work (PoW) is a feature that is intended as a solution to the double-spend problem. Bitcoin also houses an interesting encoded feature to allow for what has now become known as Bitcoin halving events. This guide is intended to serve as a comprehensive introduction into this unique aspect of Bitcoin.
With Bitcoin being an open-source project, the lines of code that allow for Bitcoin halving events to take place are freely and readily accessible to everyone. Within the code itself, there is a particular line that reads:
“Consensus.nSubsidyHalvingInterval = 210,000”
This line of code signifies that the number of bitcoins generated per block is set to decrease, with a 50% reduction of bitcoins generated every 210,000 blocks, which can otherwise be interpreted as being approximately every 4 years.
Referencing the image above, line 1574 indicates how the maximum number of bitcoins, which is calculated as being approximately 21 million, will be reached:
If (halvings >= 64)
What this means is that, once there has been 64 Bitcoin halving events, there should no longer be any more bitcoins released from a block on the blockchain.
What Happens When All Bitcoins are Mined?
Before answering this question, it would first be useful to explore the process by which bitcoins are introduced into the ecosystem, this process of course being known as bitcoin mining. In countries such as the USA, there is the existence of a central bank that effectively controls the money supply of the US Dollar flowing through the US economy. However, because Bitcoin is decentralized, no central authority exists to disseminate more bitcoins into the ecosystem. Bitcoin mining serves as the function by which more bitcoins can be released. At a high-level overview, mining involves the process of solving mathematical puzzles on the network, and in-exchange for solving those puzzles, miners are rewarded with bitcoin. This serves as an incentive for miners to continue mining more coins, which subsequently introduces more bitcoins into circulation. The network will also adjust the mining difficulty, depending on the rate at which bitcoins are being mined. If the rate of bitcoins being mined increases, then the complexity of the mathematical puzzle will also increase, and vice versa. Currently, the difficulty of mining bitcoin is extremely high, this has encouraged miners to pool their computing resources together to form what are known as mining pools, so that the chances of successfully solving these mathematical puzzles are higher.
A more complex explanation of Bitcoin mining is the following:
The process of solving a mathematical puzzle in exchange for receiving bitcoin, can really be thought of as PoW, which is the consensus algorithm for Bitcoin. The answers to these mathematical puzzles are known as generating the correct hash value. A hash value can be described as a unique number that is of a fixed length, that represents a large amount of data as a smaller value. The large amounts of data form an input in what is called a cryptographic hash function, which produces the much smaller output of the hash value. The cryptographic hash function for Bitcoin, is well known to be the Secure Hash Algorithm-256, or SHA-256 for short.
The mathematical puzzle is regarded as being solved when a hash value is smaller than the target hash value that has been set by the network. Any generated hash values that are above the target hash value will be invalid. The concept of difficulty can best be understood as increasing or decreasing the target hash value. If the rate of mathematical puzzles being solved increases, then the network will automatically increase the difficulty. It does this by lowering the network target hash value, so that the number of valid hash values that are capable of being produced also decrease. Solving these mathematical puzzles often require numerous guesses, or the generation of multiple hash values. As a result, this can make PoW mining a very expensive process for miners, given the financial cost associated with the hardware and electricity that is required for mining. That is why one will often find miners sharing their resources to form mining pools.
Back to the question, what actually happens when all bitcoins are mined?
As alluded to earlier in this article, Bitcoin is a deflationary asset, which means that the number of coins capable of being mined on the network is limited to 21 million coins. However, due to bitcoins being lost in old hard drives and individuals just not being able to access their bitcoins, the amount of active bitcoins in circulation is likely much lower than that. According to research carried out by Chainalysis, the number of permanently lost bitcoins are estimated to be 3.79 million.
It is estimated that the last bitcoin will be mined sometime in the year 2140, at which point bitcoin miners will begin to rely on transaction fees as a source of revenue instead of a block reward. This is possible because the nature of the Bitcoin network is such that the space within a block can essentially be commodified. Individuals that want to make a transaction on the network effectively pay for a portion of the block space so that a miner can process it. Transaction fees as a viable source of income for miners was demonstrated between December of 2017 to January of 2018, where increased transaction volumes drove the average transaction fee on the Bitcoin network upward. At its highest point, the average transaction fee on the network was approximately $54. The reason behind this increased transaction fee was attributable to Bitcoin’s 1MB block size. The increase in demand of transactions to be processed could not adequately be met given the restricted supply of a 1MB block space. This resulted in a lot of unprocessed transactions being left in the Mempool. Thus, in order for an individual to have their transactions processed in a timely fashion, setting a high transaction fee was necessary, so that a miner would be incentivized to include that transaction in the block and process it.
Aside from high transaction fees, at a more fundamental level, miners must rely on the value of Bitcoin itself appreciating in value. The deflationary nature of Bitcoin suggests that this may happen, as an increasing demand for Bitcoin is expected to outstrip its supply.
As the image above shows, there has thus far been two Bitcoin halving events. The next halving event is estimated to occur sometime in 2020, and will reduce block rewards from the current level of 12.5 bitcoins per block to 6.25 bitcoins per block. Thus, when the time that all bitcoins in existence are mined eventually occurs, miners can rely on transaction fees and any appreciation in the value of Bitcoin to earn some income.
Halving and Miners
The reason behind the implementation of Bitcoin halving events can seemingly be found within the original Bitcoin whitepaper itself. It appears that Satoshi Nakamoto, the creator responsible for Bitcoin, intended to create a self-sustaining system that, to some degree, emulated gold-mining:
“The steady addition of a constant of amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended”
The halving events of Bitcoin are intended to mimic the scarcity features that can be attributed to the precious metal gold. As more gold is mined by gold-miners, gold becomes increasingly scarce, which in turn makes it all the more difficult for these miners to extract gold from the earth. The scarcity feature that is implemented into the protocol via halving events, coupled with the PoW mining process is intended to mimic the relationship that exists between gold and gold-miners. Satoshi correctly establishes the incentive to encourage individuals to mine by promising a reward of bitcoins. This incentive needed to have sufficient pull that individuals are strongly incentivized enough to commit financial capital. However, the reward cannot be too much that it causes an oversupply, and the subsequent devaluation of bitcoin.
Historical Bitcoin Halving Events
There have so far been two halving events, the first one occurred on the 28th of November 2012, where the mining reward was reduced from 50 bitcoins per block, to 25 per block. Following the subsidy reduction, there was no real impact on the price of Bitcoin. The second Bitcoin halving event occurred on the 9th of July 2016, and this time the reward per block was reduced from 25 bitcoins per block to 12.5. Again, the price action following the halving was minimal, Bitcoin saw an increase from $650 to $675.
There is considerable speculation as to what will happen when the third halving event occurs in 2020, and if the effects of the 2016 halving event is anything to go by, it may be the case that nothing will happen.
Effects of the 2016 Bitcoin Halving Event:
Perhaps at this time the most talked about issue was the effect that the halving event would have on the price of Bitcoin. Some speculated that, because Bitcoin’s price is heavily influenced by supply and demand, then a cut in supply would lead to a subsequent increase in the price of Bitcoin. As mentioned earlier, Bitcoin did see an increase in price, but it was not substantial. Some individuals attributed this to the fact that the halving event was highly anticipated, so the market likely already priced in the supply cut and any expected price action that could result from the halving event.
Thus, it would not be completely unreasonable that the next halving event will also produce a tame movement in the price of Bitcoin. As the 2020 Bitcoin halving approaches, news coverage of the event will increase, which in turn will likely cause the market to again price in any expectations of what should occur following the event.
Considering that miners on the Bitcoin network rely on block rewards as a source of income, many expected to see a drop in the hash rate following the halving event. However, Bitcoin’s hash rate hardly dropped, nor did we see any significant shift in the mining landscape following the event. This is likely to be the case in the 2020 Bitcoin halving event.
Due to concerns that Bitcoin’s hash rate would fall, there was speculation of increased instability of the network as a whole. They believed that a drop in the block reward from 25 bitcoins per block to 12.5 per block would prompt miners to turn off their hardware and cease mining. This would have resulted in the network clogging up due to transactions not being processed. It would have even made the network more susceptible to attacks such as a 51% attack. However, because there was no significant fall in the hash rate of Bitcoin, none of these scenarios played out. Thus, network stability of Bitcoin following the halving in 2020 should also remain more or less constant.
The Deflation Debate
As the monetary base of bitcoin cannot be expanded by mining after a certain point, it is likely to face considerable deflationary pressures if the currency becomes widely used. There is some debate as to the expected ramifications that this will have on actors within the ecosystem, of which can be explored through the lens of Keynesian economics and The Austrian School of Thought.
Economists that are aligned with Keynesian thinking perceive deflation as being detrimental to an economy. The argument is that in a deflationary economy, individuals are encouraged to hoard rather than to spend, which in turn has negative ramifications for job creation. If individuals are not spending and demanding more goods and services, then businesses have no need to hire extra staff to cope with a growing demand. This is a critique that can somewhat be applied to Bitcoin, because the primary use-case of Bitcoin currently is more of a speculative asset than digital money. Holders of Bitcoin likely do not want to sell their bitcoins, when the value of bitcoin might be higher the very next day.
Economists that are proponents of the Austrian perspective counter the Keynesian critique of deflation by arguing that, in a deflationary environment, goods and services do decrease in price, but at the same time the cost of producing those goods and services tend to decrease proportionally. Which in turn does not effectively affect profits. Furthermore, these economists assert that price deflation encourages hoarding, thus savings, which leads to reduced interest rates and an increased incentive for businesses and entrepreneurs to invest in projects for the longer term. The Bitcoin ecosystem is still too immature for this counter argument to have much applicability, but it does serve as food for thought as to the future development of this young ecosystem.
Currently, the prevailing narrative is that Bitcoin has transitioned from being a digital asset that serves as a digital currency, to an asset that now functions as a store of value. This change in narrative is more suited to the characteristics that are demonstrated by Bitcoin. Bitcoin’s hashing power is incredibly high, the highest of all the crypto-assets that currently exist in the market. This makes storing value in Bitcoin extremely secure and virtually untouchable by anyone apart from yourself. This is because it would require a tremendous amount of financial cost to attack the Bitcoin Network, which serves as a deterrent for bad actors.
To conclude, Bitcoin halving events play a very technological and economic role in ensuring the continuing viability of Bitcoin as a digital currency. Halving events ensure that Bitcoin retains its deflationary quality, which serves as ideological opposition to the monetary policies that we see being pursued by central banks today. These centralized entities such as the American Federal Reserve engage in policies that are designed to expand the money supply, which often results in inflation, meaning that the value of one’s money becomes reduced. Satoshi Nakamoto clearly did not want an expanding money supply for Bitcoin, which gives reasoning as to why the scarcity function that is Bitcoin halving events was implemented into the protocol in the first place. Despite the fact that there will be a point in which no more bitcoins will be released into the ecosystem, there still exists sufficient functionality to ensure that Bitcoin continues to operate. Miners that are responsible for processing transactions, and receiving bitcoins as a reward, can still play their role. This is possible because block space on the Bitcoin network can essentially be commodified, meaning that miners can generate an income based on transaction fees. However, it is important to note that this is dependent on Bitcoin as a digital asset maintaining or appreciating in value.
The upcoming Bitcoin halving event can be tracked using online tools such as this one. It provides a countdown to the event, as well as relevant information such as:
- Total bitcoins in circulation
- Percentage of total bitcoins mined
- Total bitcoins left to mine until next block half