Bitcoin’s fixed supply and decreasing issuance schedule is at a new landmark. As Vitalik Buterin once put it:
“One of the major faults of traditional, “fiat”, currencies controlled by central banks is that the banks can print as much of the currency as they want, and if they print too much, the laws of supply and demand ensure that the value of the currency starts dropping quickly.
Bitcoin, on the other hand, is intended to simulate a commodity, like gold. There is only a limited amount of gold in the world, and with every gram of gold that is mined, the gold that still remains becomes harder and harder to extract. As a result of this limited supply, gold has maintained its value as an international medium of exchange and store of value for over six thousand years, and the hope is that Bitcoin will do the same”. In order to reproduce the natural scarcity of an asset like gold, Bitcoin employs a predefined issuance schedule, periodically reducing the amount of coins issued to ensure they become harder to “extract” over time. This change in new supply has become known as the halving.
Every 210,000 blocks the amount of newly issued bitcoin is cut in half. Typically this “halving” will come every four years, but the exact dates are hard to predict due to variability in the rate at which new blocks are added.
On average, a new block is added to the Bitcoin blockchain every 10 minutes through a process known as mining. Mining involves specialized computers that perform computationally expensive work in order to validate transactions. This work amounts to finding a needle in a haystack where the needle is a random number (nonce) that satisfies a given condition. The total amount of work being done is referred to as the hash power of the network.
As more hardware comes online, hash power increases and nonces are found faster. In order to retain the targeted 10 minute block time, the protocol has a difficulty adjustment to make it harder to find the nonce. This occurs every 2,016 blocks (approximately every two weeks), however, the actual time depends on how hash power changes over that period. For the majority of Bitcoin’s existence, the hash rate has been increasing, meaning block times have averaged less than 10 minutes. This is why previous halvings occurred more quickly than the expected four-year time interval.
The halving has become a focal point of the Bitcoin community primarily due to the historically positive relationship with bitcoin’s price. Each of the past two halvings were followed by bull runs that saw price rise thousands of percentage points. Although the data to support this relationship is limited given Bitcoin has only undergone two halvings, it has been enough to convince some people that halvings are a leading cause of bitcoin bull runs. Interest around Bitcoin’s upcoming third halving is driven by the expectation that it will produce similar results.
The Bitcoin halving is a multifaceted event that will affect all stakeholders in Bitcoin’s ecosystem but it’s miners who will be the most impacted. Holding price constant, Bitcoin miners face a 50% overnight drop in revenue, as their BTC earned every block is cut in half.
While this overnight drop may not be a shock, given that the halving is known in advance, it doesn’t mean that planning for the halving is straightforward. The amount of new BTC issued every block is only one side of the equation. The other side is bitcoin’s price.
Without a 100% price increase to counteract the reduction in new issuance, every miner’s revenue will be impacted significantly. Those with the most efficient cost structures will ultimately stay in business. Those with inefficient structures will likely be forced to shut off their machines once profitability dips below break-even levels. While most miners cannot immediately shut off their machines due to contractual obligations with colocation facilitates and utilities, those with the highest costs to produce new BTC will eventually capitulate and go bankrupt.