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Bitcoin Halving happens every four years. But what is it and why is it so important? Here's what you need to know in order to prepare for the next halving event.
As tempting as it is to think of cryptocurrencies as digital cash, they do function quite differently than normal fiat currencies. Take Bitcoin halving, an event that plays out every few years and may affect Bitcoin’s value.
But what is Bitcoin halving? And why does it matter?
This article will help you understand the concept of Bitcoin halving, why it exists, and what it means for traders.
Defining Bitcoin halving is the easy part. Bitcoin halving is a process built into Bitcoin’s code that automatically halves the reward paid for verifying, validating, and adding a new transaction block to Bitcoin’s blockchain.
There have been three events so far, with the most recent event taking place on May 11, 2020. The next is estimated to occur on April 19, 2024.
Now for the more complicated part: What’s a block and what’s a blockchain? Who exactly is being rewarded and then having their rewards halved, and what does that have to do with the price of Bitcoin?
To better understand these questions, let’s take a look at some basics of how cryptocurrencies, like Bitcoin, work.
Bitcoin is a type of digital money (or cryptocurrency) that users may store in a digital wallet.
But it’s also a peer-to-peer network of computers running Bitcoin’s unique code. This network relies on a blockchain to create a distributed ledger that records immutable and verifiable transactions.
A blockchain comprises many individual blocks. Each contains a complete record of a series of transactions. To make sure the transactions are accurate, each block must be validated before it can be added to the chain. The validation method must also make it tamper-proof.
A key advantage of Bitcoin and other cryptocurrencies is their lack of any governing authority, such as a government or third-party intervention.
So who, in a peer-to-peer network, validates the block as trusted? Bitcoin miners.
Bitcoin relies on a cryptographic technique called proof-of-work (PoW) to ensure consensus across its network for each block added. In a nutshell, the network requires participants to solve an arbitrary, complex mathematical puzzle before adding a block.
Solving the problem requires energy-intense computing power. So it sets a high threshold for participants who are also competing to be the first to solve the puzzle. This is designed to weed out nefarious actors and make it almost impossible for a bad actor to gain control of the network.
But where’s the “mining” in all this? Bitcoin offers a reward for performing this proof-of-work validation. It pays a set amount of new Bitcoins (BTC) for each block added to the network. The current reward for solving the math problem is 6.25 BTC.
Here is where we circle back to halving. That block reward is automatically halved each time 210,000 new Bitcoins have been mined. Halving will continue until Bitcoin eventually reaches its upper limit of 21 million coins.
You may rightly wonder why there is an upper limit and why halving exists. Won’t halving the reward discourage miners from doing their validation work, which is essential to the health and growth of Bitcoin’s blockchain?
Let’s look at two fundamental challenges faced by cryptocurrencies and the specific decisions Bitcoin has made to address them.
First, it’s important to discuss inflation’s role in all of this.
Cryptocurrencies share a challenge faced by all currencies: inflation. If a central authority prints too much money, the currency can quickly lose value, driving prices up to compensate. This is especially problematic for currencies with no limit on how much money can be in circulation.
Bitcoin has elected to set a limit on how much of it can ever be produced — the previously mentioned 21 million coins. In theory, this means that, over time, it should be able to hold onto its value, perhaps even increase.
Bitcoin halving is another way of warding off inflation and the resulting devaluation of Bitcoin. If too many Bitcoins are mined too quickly, this could undermine its value. By halving the reward, Bitcoin taps the brakes lightly on mining new Bitcoin.
Bitcoin also has a gas pedal in its arsenal, in case mining were to slow down too quickly. Just as reducing the Bitcoin reward lowers the incentive to mine, reducing the difficulty of the math problem — and therefore the energy required to solve it — can raise the incentive.
That’s the theory, at least. Let’s take a look at some of the effects Bitcoin halving has had in the real world.
Since there were three previous halving events, let's take a look at historical trends. In the year following the 2012 halving, Bitcoin’s price soared from roughly $12 to over $1,200. After the 2016 halving, it went on a wild ride from $647, almost hitting $20,000, before settling down to over $3,000.
The 2020 halving saw a subsequent increase from just under $9,000 to over $40,000, after flirting with the $70,000 mark for a bit. No wonder halving events generate so much excitement and speculation — at least for traders!
But what about miners? Anything that drives up the value of Bitcoin will benefit miners that are paid in Bitcoin and may be holding on to it. However, having your compensation slashed in half is obviously not all good news.
Some individual or small group miners might find it harder to stay in the game after a halving. But Bitcoin is counting on a potential silver lining to help: The more the network grows and is used, the more transaction fees — another source of income for miners — will increase.
It’s important, though, to remember that there are factors at play influencing the value of Bitcoin besides the number of coins being produced. Other crypto market forces, the general economic climate, and even geopolitical events can all push and pull on Bitcoin pricing.
Another factor to consider is the maturing of the crypto universe. There are many more cryptocurrencies available now. Traders may be getting better at anticipating the effects of future halving events and price them into their trading in advance.
If you are considering buying Bitcoin or already have, you will want to pay close attention to halving events, as they can spur remarkable volatility and dynamic price changes.
Halving functions can, in theory, go on forever. So, even though there are already roughly 19 million Bitcoin created, getting to the final 21 million will take a while as the production of them is continually slowed. Current estimates place hitting 21 million as a year 2140 event.
When this limit is reached, there’ll be no more need for halving. And, in theory, a block reward for validating transactions and adding blocks will cease. The incentive will have to rest totally on the profitability of transaction fees.
Will miners still mine for the reward of transaction fees alone? There’s no way to tell. But none of us will be around in 2140 to find out.
Buying or trading Bitcoin can be a valid part of a crypto strategy. But, as with all strategies, turning it into action requires regularly monitoring changing circumstances. For example, halving events have a high likelihood of driving significant change.
So once you’ve worked out your overall crypto strategy and how Bitcoin fits into it, you’ll want to keep abreast of potential impacts from these events.
With a deeper understanding of what they are, you’ll be in a better position to decide how you’ll want to plan for them.
