What is Bitcoin’s Halving and Why does it Affect the Price of Bitcoin?

Just after 01:00 on May 22, 2020, Bitcoin will undergo its third block reward halving.

 

But what does the term ‘Bitcoin halving’ actually mean? How does it affect the price of bitcoin? And how you can prepare for it? How does it apply to other cryptocurrencies? We explain the answers.

 

What is the Bitcoin block reward halving?

 

Bitcoin is decentralized, meaning there is no central authority issuing the cryptocurrency, unlike fiat currencies such as the US Dollar or the British Pound, which have central banks for the purposes of issuing and stabilising a currency.

 

Instead, computing power is devoted to the Bitcoin network to ‘mine’ bitcoins, i.e., to solve computation problems and confirm the transactions on the network. To incentivise and bootstrap the Bitcoin network, miners are rewarded for each block they mine, with what’s known as a ‘block reward.’ So that means every ten minutes, a block of bitcoin transactions is added to the blockchain by miners and a block reward is earned.

 

 

In the first four years of Bitcoin, the block reward was 50 bitcoin, meaning that if a single miner mined a block, he would have received 50 bitcoins to his wallet once the block was confirmed.  However, at the time of writing, the block reward is 12.5 bitcoin. Once the third block reward halving happens, it is cut in half again to 6.25. And every 210,000 blocks (or roughly 4 years) the block reward halves and continues to do so until the predetermined, capped supply of 21 million is reached. This process ensures over time that bitcoin is harder to mine and it is like digging deeper for gold until you have extracted and depleted all of the gold ore.

 

The process of the block reward halving and decreasing rate of supply of bitcoin is known as ‘asymptotic money supply targeting’ where bitcoin targets a fixed limit of 21 million and will slowly reach this limit over time. By 2024, almost 94 percent of all bitcoin will be mined and we will be at block number 787,500. It will not be until block number 6,930,000 – in the year 2140 – until the bitcoin block rewards will be exhausted completely and 100 percent of all bitcoins will be in circulation; this is demonstrated in the chart below.

 

Source: Nakamoto Institute

 

How does the Halving Affect the Bitcoin Price and Ecosystem?

 

Over time, as the rate of supply is decreasing, the inflation in the system is decreasing and makes bitcoin more attractive to fiat currencies where inflation is higher. After the next halving in 2020, the inflation in the Bitcoin economy will be lower than that of most developed economies, i.e., less than 2 percent. As the money supply growth rate falls over time, we also expect inflation to fall proportionately.

 

For this reason, we expect bitcoin to appreciate in value against fiat currencies running up to the halving and/or following the halving, as well as in general over the long term. In practice, we have seen an increase in price volatility following the previous bitcoin block reward halving events and an increase in price following each halving.

 

 

Using halvings to buy and sell cryptocurrencies is a type of carry trade, which is traditionally done by taking advantage of interest rates in higher countries to save money and earn interest, and borrowing in lower interest rate countries. Instead, we are buying (crypto-)currencies that have a lower inflation rate using (fiat) currencies with a higher inflation rate.

 

For instance, the chart below shows that bitcoin’s price has historically jumped higher following a halving. The red dots represent the time period immediately after a halving, displaying that in these periods, price has jumped sharply. For two of bitcoin’s previous halvings, the immediate price reaction was to rise from $10 to $100 in 2013 and from $700 to $1,000 in 2016.

 

The price appreciation seems to last around 10 months after each halving, as indicated by the chart where the orange dots align with each peak. The light blue dots also shows a steady rise in the price of bitcoin as the halving approaches, suggesting you want to starting buying into bitcoin regularly 5-10 months before the halving.

 

Source: @100trillionUSD

 

So as the halving occurs on May 22, 2020, the best way to prepare is to buy a fixed amount of bitcoin every week up until the halving – starting in August 22, 2019 – as well as accumulate after the halving until 10 months after the event – around March 22, 2021, at which point the market should have reached its peak.

 

Historically, the market reaches a peak around 10 months after a halving, so this is a good time to sell some of your bitcoin holdings. Of course, this time might be different and precipitate a longer bull market, especially as awareness of bitcoin is a lot higher and the infrastructure has improved. You could also take the price target from the chart, which estimates a price of approximately $60,000 by the time of the third halving.

 

Another effect of the halving is on the ecosystem, specifically the miners. While miners currently get 12.5 bitcoin for every block they find – which is on average every ten minutes, they will only get 6.25 per block every ten minutes, reducing their collective revenue and cutting their profitability in half. As a result, either miners will give up and stop mining on the bitcoin network, or they will refuse to sell bitcoins generated at a price below $20,000 and become holders.

 

If enough miners give up and their combined hashrate is significant, the halving can also lead to reduced hashrate, increased miner concentration and increased exposure to 51 percent attack. This problem becomes more apparent as rewards are reduced over time to subsidize miners. No one knows if a market for transaction fees will be enough to keep miners on the Bitcoin network and keep it secure in the long term, which is why other cryptocurrencies use different supply schedules, such as Monero and Dogecoin.

 

Halvings may also serve to strengthen the perception of credibility of the bitcoin system, as each passing halving shows the network is working as planned and that the rules are not being bent. Central bankers will regularly meet and make decisions on money and interest rates, while halving events serve as pre-determined changes in the cryptocurrency’s monetary policy.

 

Policymakers, or anyone for that matter, cannot interfere in the monetary policy of bitcoin and stands in stark contrasts to the monetary policy of the US central bank, which has recently suggested a return to quantitative easing, an ultra-loose monetary policy that aggressively expands the money supply and really displays the falseness and inequity of the current financial system.

 

Altcoin Halvings

 

Many of the leading altcoins are based on Bitcoin’s code, like Litecoin, Vertcoin and Zcash to new a few. Since they share the same codebase as bitcoin, they also have the feature of block reward halvings, and investors can use this to make money on the volatility that comes with these block reward halvings.

 

 

First, we look at Litecoin’s block reward halving and how you can prepare for it. Then we will look at two other altcoins, vertcoin and zcash, and answer the same question. All three of these altcoins are the dominant cryptocurrency on their respective algorithms, which are Scrypt, Lyra2REv3, and Equihash.

 

Litecoin

 

Litecoin will undergo its second block reward halving on August 5, 2019, cutting the block reward from 25 to 12.5, and the price of is comfortably above $100 at the time of writing. Similar to Bitcoin, Litecoin will undergo a halving every four years, but as blocks are produced faster in the altcoin, they occur at every 840,000 blocks instead of every 210,000 blocks. The inflation rate in the Litecoin system will fall from around 8 percent to 4 percent after August 2019.

 

 

For the previous Litecoin halving, the cryptocurrency experienced a massive rally in the three months prior to the event, rising more than 500 percent. The fist halving occured on August 26, 2015 and the price increased in the months prior to the halving, going from $1.50 around the end of May 2015 to near $9 in mid-July 2015.

 

Following the halving, litecoin stabilised around $3. The price was then boosted by the implementation of Segregated Witness and breached $20 two years later in 2017.

 

 

The best strategy for the upcoming halving is to buy 3-6 months before the halving, so at this very moment, up until the halving occurs and then perhaps sell litecoin for bitcoin or fiat. If you believe that Litecoin will continue to serve as an important testbed for Bitcoin, then it may be worth holding litecoin as it implements more exclusive features such as Confidential Transactions, which is likely going to follow in six months after the August 2019 halving.

 

Litecoin’s second halving may not mirror exactly what has happened with bitcoin. Litecoin’s transaction fees have never exceeded six percent of the block rewards received by miners, suggesting that many miners could rush in to mine litecoin before the halving and contribute to a rally in its price and/or exit the market after the halving and mine more profitable coins.

 

In the worst case, if the price does not increase up to the halving, mining profitability could drop excessively and the reduction in the block reward may be enough for enough miners to quit, making Litecoin more insecure. However, as the cryptocurrency with the highest hashpower on the Scrypt mining algorithm, it’s an unlikely possibility.

 

Vertcoin

 

In December 2017, the bitcoin-derived cryptocurrency Vertcoin experienced its first halving. Similar to litecoin, the price appreciated rapidly in the run up to the event, but as the halving occured, the price started to dwindle and fall to previous levels.

 

As the chart below shows, the rise in vertcoin started in July 2017 when it was valued less than $1, about six months before the halving. Then, in the run up to the halving, the price quickly appreciated from $1 to $7 over the months of of October, November and December, at which point the price preaked near $12 in the same week as the block reward halving. Following the halving, the price started to fall and reached a low near $2 by February 2018.

 

 

The next halving for vertcoin will occur in late 2021 and the best way to prepare is to buy around 6-8 months prior to the halving – May/July 2021 – and sell just as the halving is occuring or in a very short timeframe before, or after, the event.

 

Litecoin’s second halving will provide a precedent for an altcoin’s second halving, and therefore Vertcoin’s halving in 2021. If price and mining profitability turn unfavourable for litecoin in its second halving, then it may be safe to assume that vertcoin will not get past its second halving either. However, if litecoin shows positive price appreciation and favourable mining profitability after its second halving, then it would be worth taking the trade on Vertcoin’s second halving.

 

Zcash

 

Privacy-focused altcoin Zcash will undergo its first halving in late 2020, as the first block was mined in late 2016. While sharing Bitcoin’s codebase, the altcoin alters it slightly to allow optional private transactions using zero knowledge proofs to hide the amount sent, the receivers address, and the senders address.

 

 

Just like with Bitcoin’s first halving in 2012, the block reward will fall from 50 to 25 in late 2020 for Zcash. Zcash’s founders reward will also be stopped after late 2020, which is not a feature of Bitcoin.

 

At present, 20 percent of the block reward goes to the Zcash Electric Coin company, i.e., the founders of Zcash, while after the halving miners will get to keep the entire block reward from that point onwards. This could induce more miners to secure the Zcash blockchain, as the decision will not be distorted by the founder’s reward, which has been a controversial topic in the cryptocurrency scene.

 

The strategy here would be to buy around 6-8 months before the halving, going off of what other bitcoin-derived altcoins have done in the run up to their halvings, with a view to sell just before/after the halving in late 2020.

 

Use Halvings for Time-based Investment Strategies

 

In summary, you can use the timings and precedents – if possible – of the halvings of bitcoin and bitcoin-derived cryptocurrencies to formulate simple investment strategies.

 

 

By dollar-cost averaging into ‘cryptocurrency X’ at a predetermined date and for a predetermined duration, you can make trades based purely off of time rather than price.

 

For example, you could buy vertcoin 6-8 months before its halving, every week until it’s halving and then start converting the profits into bitcoin or the currency of your choice; it’s really that simple!