Bitcoin is about to undergo a halving event. What exactly does this mean?
Bitcoin is set to undergo its third halving in May 2020. Bitcoin Cash, a fork of Bitcoin, also recently underwent the same process. What does this mean and what are the implications?
What is mining?
Halving is all to do with mining.
Bitcoin mining is like prospecting for digital gold. High powered computers (or miners) crunch complex mathematical problems. This action verifies transactions that are added to the blockchain network as ‘blocks’. These blocks contain the entire history of transactional data of Bitcoin.
New blocks are mined roughly every 10 minutes.
Miners can earn Bitcoin as a reward for lending their computing power. Anyone can mine Bitcoin as the network is open source. However, mining has become a lucrative business. Consequently, companies have established large groups of computers, known as ‘farms’, to reap these rewards.
Mining is resource-intensive, requiring large amounts of electricity.
What is halving?
Halving is when the mining reward is reduced by half. This happens every 210,000 blocks mined, roughly every four years. The process is built into Bitcoin’s code and cannot be changed.
Satoshi Nakamoto, the anonymous creator of Bitcoin, designed it to be a deflationary asset. Only 21,000,000 Bitcoin tokens will ever exist, with the last estimated to be mined in 2140.
It gives a predictable nature to supply.
Over time, supply of newly mined Bitcoin is reduced. As accessibility of the asset becomes sparser; demand and therefore value should increase over time.
A brief history of Bitcoin halving.
Bitcoin was created in 2009 and underwent its first halving in November 2012. The mining reward was cut from 50 Bitcoin to 25 per block mined. At the time, one Bitcoin was worth US$12.
The second halving occurred in September 2016 when it was valued at US$657. The mining reward was once again halved from 25 Bitcoin to 12.5 for every block mined.
The next halving will see the mining reward of 12.5 Bitcoin halve to 6.25. The current price of Bitcoin is US$6855. This process will continue until all 21,000,000 tokens have been mined.
What is the purpose of the halving?
Halving is a common practice across many digital assets. Its function is to decrease supply and thus impact the rate of inflation.
Fiat currencies such as the Australian Dollar have no limit on new supply. Their issuance is controlled by a central bank who have power to increase or remove funds from circulation. This occurs through political processes.
The value and buying power of a dollar generally will decrease over time as inflation increases.
Bitcoin is different. It’s supply is predetermined by its code and cannot be changed. Only a finite amount of Bitcoin will ever exist.
How halving affects miners?
The effect halving will have on miners depends upon the price action of Bitcoin.
Ideally, miners would want to see higher prices for Bitcoin. This would allow profits from mining rewards to continue and to cover operational costs.
If prices decrease, it could become unsustainable for some miners to operate. Overheads such as electricity bills and equipment maintenance could outweigh mining profits. This could lead to some farms either reducing their operational equipment or close completely.
Fewer miners on the Bitcoin network works against its decentralised nature. By design, the asset relies on a diverse number of connections to ensure its network strength.
Ultimately, we will need to wait and see what happens after the halving takes place.