Halving is one of the most important events for Bitcoin. This operation is performed on the Bitcoin network every four years or so. The next Bitcoin halving will take place in May 2024. What is Bitcoin halving? Why is it such an important event? This article is a beginner’s guide to Bitcoin halving. We’ll also analyze the famous Stock-To-Flow model.
Bitcoin mining and the block rewards
In order to understand the halving, we need to outline the basics of Bitcoin mining. A more comprehensive guide is also available for those interested.
Halving is the cornerstone of Bitcoin’s monetary policy. It refers to the halving of Bitcoin block rewards (sometimes referred to as mining rewards). What are block rewards all about?
The Bitcoin blockchain is maintained by miners. They are essentially custom-built computers (ASICs) designed only for this very purpose. Miners are nowadays concentrated on massive farms. After the Chinese mining ban (summer 2021), the United States became the leading country in Bitcoin mining. The video below shows a large mining farm in Texas.
New blocks are created on the Bitcoin network every 10 minutes (on average). Miners are constantly competing to mine a new block. Whoever mines a block receives the block reward and transaction fees that come with it. The block rewards (mining rewards) are therefore the incentive for the miners to maintain the Bitcoin blockchain.
The hash rate of the Bitcoin network is growing over time. New mining farms are being built, and the efficiency of the mining equipment is improving. How is it possible that blocks are still created only every 10 minutes? This is where the mining difficulty comes in.
Satoshi Nakamoto designed this mechanism for Bitcoin to adjust the difficulty automatically when the hash rate changes. The more the mining capacity increases, the more difficult the mining becomes. This adjustment is made automatically every two weeks.
The halving of block rewards
The aforementioned difficulty adjustment is one of the cornerstones of Bitcoin. The halving of the block rewards is another crucial building block. It is what makes Bitcoin’s monetary policy.
Satoshi Nakamoto wanted to create a counterforce to fiat currencies. They are characterized by continuous inflation, which tends to evolve into hyperinflation at regular intervals. Fiat currencies are therefore designed to lose value. At the beginning of the millennium, for example, the euro still had 40% more purchasing power. The U.S. dollar has lost about 99% of its purchasing power in the past 100 years.
Bitcoin works exactly the opposite way. Its inflation rate decreases over time and eventually reaches zero. At current development, this will happen around the year 2140. At that time, all 21 million bitcoins will have been mined. Currently (6/2022), just over 90% of all bitcoins have been mined.
Bitcoin’s inflation comes from the previously mentioned block rewards. Over time, the rewards get smaller and smaller. This is what halving is all about. The graphic below illustrates it very well. (source: Bitcoin Magazine).
Block rewards are halved exactly at every 210.000 blocks. This translates to about four years. The previous halving took place in May 2020. The next halving will take place in May 2024, when block number 840.000 will be mined.
In the early days of Bitcoin, the block reward was 50 bitcoins. It has since been halved three times: 50 -> 25 (halving 1), 25 -> 12.5 (halving 2) and 12.5 -> 6.25 (halving 3). After May 2024, the block reward will be 3.125 bitcoins.
Bitcoin inflation vs. deflation
Is Bitcoin ultimately a deflationary or inflationary asset? There is a debate going on regarding this matter.
It is commonly acknowledged that Bitcoin is inflationary, as the number of coins in circulation increases because of annual inflation. This is also the Austrian school’s definition of inflation, and many Bitcoin supporters believe in this economic doctrine. Inflation = increase in the money supply. In this case, of course, the coin supply.
Bitcoin’s inflation is decreasing, but it will never fall below zero. In other words, the number of bitcoins in circulation does not decrease. This is not entirely true, however, as up to three million bitcoins have left circulation. Thousands of wallets have been lost over the years and are no longer accessible.
On top of all this, Satoshi Nakamoto is estimated to hold one million bitcoins. Satoshi has never touched these coins and is unlikely to do so. But these factors are independent of monetary policy.
There are actually deflationary cryptocurrencies on the market today, like BNB. The number of coins in circulation is decreased through monetary policy. So-called “burning mechanisms” are used to destroy the coins. The aim is to increase the value of the token by reducing its supply.
The second aspect comes through purchasing power. The Austrian definition of inflation is not widely used. When economists and the mainstream media write about inflation, they mean the rising of consumer prices (CPI). Deflation refers to falling prices.
Inflation happens due to the depreciation of fiat currencies. As they don’t have a max supply, like Bitcoin, there is no limit to the number of fiat unts that can be created. Consequently, the value of fiat decreases over time and goes eventually to zero. Unlike Bitcoin, whose inflation rate falls, leading to a strengthening of purchasing power.
More importantly, the monetary policy of Bitcoin is set in stone. No single entity can change the inflation rate of Bitcoin. The predictability of monetary policy is really important for Bitcoin investors.
So, which is better: inflationary or deflationary? The best definition would actually be a disinflationary currency. Disinflation means slowing down inflation.
Bitcoin halving and the Stock-To-Flow model
Do halvings have an effect on the price of Bitcoin? They certainly do if you believe in the Stock-To-Flow (S2F). This is a model published by the pseudonym Plan B. It was launched in spring 2019 and gained great popularity. According to Plan B, the Bitcoin price rises and falls in four-year cycles with peaks and bottoms set by the halvings.
The S2F has been the guide for Bitcoin investors over the past years. The bitcoin price has also followed this model very nicely until the Q4 of 2021. At that time, the price turned bearish just at the time when everyone was expecting the parabolic rally to take place.
Below is an image of the model’s forecast and the Bitcoin price (as of 6/2022).
As you can see, the model held very well until late 2021. The collapse seen in the summer was the first alarm, but Bitcoin rose to almost $70,000 in early November. Many believed a parabolic bull market would follow the S2F forecast.
However, this development came to a rude end. When the U.S. Federal Reserve announced monetary tightening and stopped the easy money party, markets turned down. It became clear to investors that the general market trend is a stronger driver of Bitcoin’s price than halving cycles.
Is the Stock-To-Flow model broken for good? Do new halvings have any meaning anymore?
The future of the Stock-To-Flow model
The S2F model has still lots of supporters. Even if Plan B hasn’t been exactly a frequent guest on investment podcasts in 2022, the man has still 1.8 million Twitter followers. There are few influencers in the crypto industry with a larger follower base. However, we feel that it’s time for the S2F to go.
Halving cycles made a lot of sense in the early years when most bitcoins were still to be mined. Now, more than 90% of all bitcoins are on the market. Miners have also become large companies that do not need to immediately sell the bitcoins they mine to cover the energy costs. This means the miners’ activities have changed.
Bitcoin has also come of age as an asset class since 2018. It is increasingly owned by investment professionals, hedge funds, and other institutions. The actions of these entities are driven by the monetary policy of central banks.
The chart below shows the technology-heavy Nasdaq index.
Since 2018, we have seen three crashes and two big rallies in the stock markets. Bitcoin has risen and fallen in the same direction each time. Perhaps the correlation with equities has been stronger for much longer than generally understood?
Bitcoin’s ownership base was very different at the time of the first halvings. Today, institutions have access to custody services, Bitcoin futures, ETF products and so on. The market has changed enormously in the past years.
Most investors still see Bitcoin as a high-risk asset. At some point it will reach the status of digital gold on a wider scale – at least we believe so. However, this will take years. Until then, Bitcoin’s price is probably driven more by the stock market than the halving cycles.
The problem with this analysis is, of course, the lack of data points. There have only been three halvings so far, which means the chance can play a big part. In addition, the Bitcoin market is constantly growing and evolving. All we have is good guesses.
The ending of mining rewards
There is a common concern related to halvings. If block rewards will eventually drop to zero, what incentives will miners have to continue to maintain the blockchain? This concern is completely misplaced for at least three reasons.
- In addition to block rewards, miners also receive network transaction fees.
- With block rewards dropping to zero in around 120 years, this event is unlikely to make a difference to the lives of any current Bitcoin holders.
- Technology will evolve so much we have no idea what the whole crypto space will look like.
Think about how much the internet and mobile technology have evolved over the last 20 years. What could happen in the next 20 years, let alone 120 years? It is simply impossible to predict.
There is also the possibility that future generations will change the monetary policy of Bitcoin. Perhaps in a hundred years’ time, the Bitcoin maximalists will decide to take Satoshi Nakamoto’s bitcoins and distribute them as block rewards until the year 3000? This is one fun theory.
So, for the moment, it’s mainly a philosophical problem that is unlikely to affect any current Bitcoin holders. It is impossible to predict the evolution of technology and regulation even 20 years from now. Let alone 120 years. Let’s just take one year at a time and see what happens.
The Bitcoin halving of 2024
So the next halving will take place in May 2024. There are calculators online that predict the exact date. For example, bitcoinblockhalf.com predicts that the halving will take place on the 4th of May. At the time of writing, this is 698 days away. We are almost exactly at the halfway point between the 3rd and 4th halvings.
Even if the halving doesn’t drive the price of Bitcoin as it did in previous years, its importance cannot be underrated. It is the halving that differentiates Bitcoin from fiat currencies and creates digital scarcity. It also brings predictability and reliability to Bitcoin as an investment.
Bitcoin has received increasing support from institutional investors in recent years. It has also become legal tender in two different countries. Two major steps remain; mining becomes a nation-state race and Bitcoin will be held by the central banks.
Currently, Bitcoin is still growing and developing as an asset class. Around 300 million people invest in cryptocurrencies globally. The one billion mark will be broken during the next bull market. The majority of investors are still price speculators.
The bigger Bitcoin grows as an asset, the more people will treat it as digital gold. This is at least our theory. If this is the case, perhaps S2F will one day guide Bitcoin’s price development again, as it did in its early years? Time will tell!