Bitcoin Halving and the Scarcity Effect

What will happen to the value of Bitcoin once its final stage of halving has occurred? This is a question on many investors minds as we get closer and closer to the actual date.

Bitcoin has recently returned with a serious Bull Market, which is great news for current holders and means that new investors are trying to break into the market.

There are a few theories about why Bitcoin is in full bull-mode. It could be because we are entering the third halving on May 12, 2020, at which point miners’ rewards will be cut from 12.5 to 6.25 BTC. What’s more, it means we are getting closer to the end of Bitcoin mining, at which point miners will only be rewarded through transaction fees and no more block rewards.

But maybe I am getting ahead of myself. Let’s have a quick look at what halving means for Bitcoin, and how it might effect Bitcoin scarcity.

What is Halving

Bitcoin halving is a process that was built into the hard-code of the original Bitcoin script. Satoshi Nakamoto designed the halving system with two main reasons in mind:

  • Halving controls the mining rate by maintaining a difficulty for solving the target hash.
  • Second, maintaining a level of difficulty to mine coins and respond to increased hash power mitigates the potential for coin inflation.

An aspect of the hard-code, which without a fork makes the code immutable, is the deterministic supply of Bitcoins. Bitcoin’s supply is set to stop after 21 million Bitcoins have been mined.

bitcoin halving bitcoin supply

As you can see in this above chart, the supply of Bitcoin took a major increase between 2009 and 2016, when the difficulty rate increased and since then mining has slowed.

Difficulty Rate

When it comes to Bitcoin, the hash power required to solve for the target hash is referred to as the difficulty rate. Difficulty needs to be increased as mining increases so that 1 Bitcoin is mined only about every 10 minutes. This procedure was built into the original script in order to mitigate the inevitability of greater hashing power.

To get a better idea of how difficulty fluctuates and adjusts to hash power, check out the resources available on Blockchain.com.

Here is a snapshot of the life of Bitcoin’s difficulty rate courtesy of Blockchain.com:

bitcoin halving difficulty rate

Halves and How Supply Works

Halving works in part by setting a maximum number of Bitcoins that can be mined ans essentially setting up how the supply works. As Bitcoins are continually mined the Bitcoin reward for miners are gradually and steadily reduced by half; hence the term halving.

If you are interested in a close estimation when the next halve will be, then check out this Bitcoin mining clock. The clock counts down until the next halving occurs, by watching the contributing variables, which includes hash power and difficulty.

The following image demonstrates how halving, mining rewards, and difficulty are related.

bitcoin halving rewards
Image from Investopedia

As defined by the protocol, and based on the above estimation, we are moving into the final halving of block rewards at 6.5 BTC. Once the final halving occurs, and the supply capacity is reached, the only rewards miners will receive is from confirming transactions.

Inflation and Scarcity with the Bitcoin Halving

The importance of halving is supply control and therefore, inflation control. Bitcoin is designed to artificially produce scarcity with a deterministic supply. I say “artificially,” because, much like burning coins, it is not an organic response to the market; it is there by design.  

But regardless of its artificial initiation, it appears that, at least for now, halving is an effective way of maintaining Bitcoin’s value.

According to Kyle Samani of hedge fund Multicoin Capital:

“The first halvening brought inflation from 40% to 20%. The second from 20% to 10%. The next halvening is going to reduce it from about 3.8% to 1.9%. On an absolute basis, each halvening is becoming increasingly less relevant.”

Interestingly, 1.9% is below that of the most recent 2.1% of USD inflation.

Controlling Bitcoin’s Supply: Coin Burns

Burning coins is a deflationary tactic for cryptocurrency. When coins are burnt they are typically sent to an inaccessible address. They are not literally burned, rather the coins are taken out of use.

While Satoshi Nakamoto set a limit on Bitcoin, there have been several very successful forks; like Bitcoin Cash and Bitcoin Gold. Although Bitcoin is capped at 21 million, we do not know the exact effect these forked currencies will have on the market in the long term.

Basically, we are dealing with the ever-present problem of manufacturing market value, versus organic growth and value.

A common method for burning is to send coins to an address that has no known private key. Another way to take coins out of use is to send Bitcoin in a transaction where the conditions cannot possibly be met.

This can be done with a transaction that is made unspendable. It uses OP_RETURN or script operations that require the user to prove that 1+1 equals 3 (not possible). This transaction won’t be confirmed and therefore the coin is virtually gone.

Whale’s Making Moves and News

Returning to my original point, Bitcoin’s bull market could be due to impending scarcity, however, there are other reasons that may be contributing to the upswing.

In October 2018 Binance, an infamous Bitcoin whale, made two major moves. The move was of 77,410.477 BTC; and as an aside, all this transaction cost was $19.22. The second shifted 68,569.60 BTC for a slightly higher fee of $105.38.

What exactly @cz_binance was doing with his funds is beside the point. But it may have something to do with an effort to control the supply and circulation of Bitcoin, as whales like to do.

Supply and Demand

Finally, while Bitcoin is entering the final stage of halving, it has also increased its presence and institutional adoption. That is to say, the original design idealized in Satoshi’s white paper has been realized. Bitcoin continues to hold its value, despite its volatility, and major players like JPMorgan are even using Bitcoin for their own services.

The bottom line is that it is hard to pin down exactly why Bitcoin is in such a bull-market. Bitcoin has traditionally rallied around the time of a halving, and that is more or less a response to supply and demand.

But from 2009 to the present Bitcoin has undergone major advances. It is more than likely that all of the factors I discussed (bitcoin halving, scarcity, institutional adoption) have contributed to its success.

That said, Bitcoin has not had a long lifespan, which makes it difficult to measure by any substantive metrics. The sample size of data is simply too small to come up with any quality estimations.

  • It is a desirable asset on the market and it has recovered from several bear markets, just as many valuable assets have.
  • Scarcity is an important principle when it comes to value and investing. With the next Bitcoin halving approaching, Bitcoin’s demand with only increase.
  • Bitcoin has shown a healthy inflation rate from the start. The next halving should only contribute to that consistency and its staying power on the market and circulation.
  • While Bitcoin’s scarcity increases, its adoption rate also increases. That means more demand for the non-fiat currency.
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