The Halvening, What You NEED to Know
If you have been following our previous DAD issues or just regularly follow the crypto market, you’ve probably heard of “the halvening” and its supposed impact on the price of Bitcoin starting in May. This is a unique event that happens every four years, and barring extreme circumstances, Bitcoin’s halvening is scheduled to occur on May 11th-12th of this year. Today, we want to give an overview of the halvening and offer an evidence-based view of its impact on Bitcoin’s trading economics.
An unfortunate amount of online commentary centered around the halvening borders on lies, speculation and pure myth. Our goal in this edition of The Digital Asset Digest is to separate the facts from fiction, so you can make an educated decision in your own portfolio.
Before we jump into the halvening, we need to talk about mining. Mining is the process by which cryptocurrency transactions are anonymously verified, and new cryptocurrency enters circulation. Mining follows the verification protocol known as Proof-of-Work (POW).
Every day, hundreds of thousands of Bitcoin transactions are performed and broadcasted to the Bitcoin Network. These transactions are bundled together into what we call blocks. Bitcoin is effectively thousands of blocks linked together in a chain, which is where the term blockchain comes from.
For a block to be accepted by the rest of the network, each miner must submit a proof-of-work along with the block. To generate a proof-of-work, a miner must input the block’s contents into a hash function and generate a hash that is smaller than a target set by the network. Miners do this by adding a number to the block (called a nonce) that changes the block’s hash. Since miners are competing against each other to submit a proof-of-work and earn the block reward, they will spend substantial amounts of capital on equipment and electricity, so they can have a faster throughput and be the first to submit the proof-of-work. If/when a miner successfully accomplishes this, the miner announces it to the network, who verifies this by trying the nonce themselves. If the nonce is valid, the miner is rewarded with Bitcoin, which is how new Bitcoin is put into circulation.
The elegance of the proof-of-work protocol speaks to the elegance of bitcoin and decentralization. Proof-of-work creates a dollar value on the securitization of the network. To compromise a blockchain you need to control 51% of the miners hashing power. So, based on how much each miner spends on electricity and equipment to mine, you can determine what the dollar cost attached to their hashing power is. From this, you can calculate how much it would cost to control 51% of the network’s hashing power. For advanced networks such as Bitcoin though, this is a near-unimaginable sum.
An important figure with respect to mining is Bitcoin’s hash rate. In short, the hash rate measures how many hashes are being performed over a set period. The higher the hash rate, the higher the mining activity across the Bitcoin network. Currently, the standard unit for measuring hash rate is terahash per second, or TH/s. One terahash is equal to a billion hashes, so if the hash rate on a certain date is 20 TH/s, there are 20 billion hashes being performed on the Bitcoin network every second. As expected, given the lower reward for mining, the hash rate tumbles as miners’ incentives drop. As such, there is a direct correlation between the hash rate and price and the hash rate is often used as a key indicator for market performance.
What does any of this have to do with the halvening? When we talk about the halvening, we really mean that the number of Bitcoins a miner receives for submitting a proof-of-work is going to be halved. Bitcoin was designed so that a halvening would occur every 210,000 blocks. Since a block is mined approximately every 10 minutes, a halvening should occur every four years. The halvening this May will be the third halvening in Bitcoin’s history. Currently, miners are rewarded 12.5 BTC for successfully mining a block. Post-halvening, this reward will drop to 6.25 BTC.
The reason for instituting a halvening mechanism is to limit the total number of circulating Bitcoins, creating artificial limits on supply, and preventing miners from owning a disproportionate percentage of all Bitcoins. As you may be aware, Bitcoin’s supply is capped at 21 million, and as of today, over 18.3 million Bitcoins have already been mined. This means more than 87% of all Bitcoins have been mined into existence. With over 620,000 blocks mined, had there been no halvening mechanism in place, we would have surpassed Bitcoin’s supply cap by 10 million.
The impact of Bitcoin’s halvening this May is highly contentious. We have two prior halvening’s to analyze, but the crypto landscape has changed significantly over the last four years and it’s debatable whether we should expect the same to occur this time around.
The traditional argument is that Bitcoin’s price should rise as the halvening approaches. Proponents of this argue that while the demand for Bitcoin remains the same, the incoming supply will shrink, boosting Bitcoin’s price. They point to rallies before previous halvening’s as evidence of this.
“Imperium Investments is a Private equity fund focused on monetizing energy. We use Bitcoin, via one of the largest mining operations in North America, as the arbitrage vehicle to convert energy to cash. We maximize results by being the lowest cost Bitcoin producer. We achieve this through our expertise in international capital markets, financial products, and large scale industrial operational excellence.
Imperium Investments believes Bitcoin miner capitulation is likely to occur given the current macroeconomic backdrop (COVID-19). We believe it is unlikely that retail investors prop up Bitcoin’s price, in the form of speculation, as free cash flow is contracting for the global consumer. The majority of the middle class no longer has the ability to put more money to work in the form of financial investments and this free cash flow is being used to pay monthly expenses. Instead, the driver for future Bitcoin price increases will be from real supply-side shock both from the guaranteed 50% decrease in block rewards as a result of the halvening (12.5 to 6.25 Bitcoin per block), as well as the intentional decision of industrial-scale miners with strong cash balance sheet positions not to sell.
Imperium Investments believes there will be a multi-month capitulation effect that will come into play post-halving as the majority of Bitcoin mining businesses are forced to liquidate their holdings to weather the storm of depressed prices. Therefore It is the opinion of Imperium Investments that there is a high likelihood of bankruptcies and consolidation to occur across the global landscape of Bitcoin mining. However, after this large consolidation event occurs our team believes that we will be seeing Bitcoin reach all-time highs 6-18 months after the end of the capitulation event. This will result in significant opportunities for well-positioned mining firms to capitalize on in the form of distressed asset purchases.”
The sheer existence of the halvening will undoubtedly have a psychological impact on the market. The irreversible decrease in block-rewards has attracted corporate and retail entities to Bitcoin, and we expect those adoption trends to continue in the wake of the third halvening.
Moreover, the halvening is an event that creates a lot of attention around bitcoin. No matter the spin, this is a positive for the asset. Like in any industry, promotional/marketing activities are key for growth so the more focus the news-cycle puts on the halvening, the larger the audience and the greater the chance someone will hear about bitcoin and decentralization for the first time, so we view the upcoming halvening as an excellent growth opportunity for Bitcoin.
We expect this year to be no different, forecasting that hash rates will tumble post-halvening. However, we expect the 2020 halvening to be notable as the mining landscape has become increasingly competitive. Hobbyist miners have long been pushed out and large-scale operations have had mixed results due to Bitcoin’s volatile performance over the last year. At current levels, transaction fees make it difficult for miners to scale their operations and compete with the larger firms, so post halvening we expect the consolidation of the mining industry to continue.
There are some experts that think the market has already accounted for retail excitement and that this anticipated influx in trading volume is already priced into current figures.
All this being said, we are still bullish on Bitcoin as the halvening approaches, albeit cautiously and with a skeptical eye. We expect increased volatility similar to prior halvening’s and warn against letting fear dictate trading decisions. Since the halvening is a catalyst for Bitcoin alone as opposed to the broader cryptocurrency market, we expect Bitcoin’s dominance in the market to improve (as of today, BTC accounts for 64% according to CoinMarketCap).
For investors with a higher tolerance for volatility, increasing exposure to Bitcoin over the next few weeks is a sensible manoeuvre in our view. However, with the crypto markets ubiquity and accessibility, bull & bear runs happen quickly. Therefore, we encourage readers to find a reliable liquidity on-ramp ahead of the halvening.
With just under 2-weeks left until the halvening, GDA will be focusing its resources on analyzing the market to make sure our readers are as well-positioned as they can be. Make sure to tune in next week and to follow our twitter to stay updated on all halvening news and analysis!