Understanding Bitcoin Halving: Impact and Implications

Disclaimer: This article is informational and not intended as investment advice. It does not predict price movements during the Bitcoin halving.

What is Bitcoin Halving?

A blockchain is composed of a series of blocks, each containing multiple transactions. Bitcoin miners select transactions for inclusion in a block and then attempt to find a specific numeric solution that meets a predefined condition, allowing their block to be added to the chain. This process, known as mining, is akin to solving a cryptographic puzzle where the difficulty level adjusts every cycle to ensure that it takes approximately ten minutes for a miner to successfully guess the answer. Essentially, mining operates like a lottery where statistically, one participant is expected to find the solution every ten minutes, thereby securing the block reward and adding to the blockchain's continuity and security.

When miners successfully add a block, they receive a mining reward composed of transaction fees and a block reward. Transaction fees are paid by users for faster transaction processing, while the block reward comprises newly minted Bitcoins awarded to the miner through acoinbase transaction.

The block reward halves during a Bitcoin halving event. This mechanism ensures that the total supply of Bitcoin caps at 21 million, providing a deflationary model as opposed to fiat currencies which can be printed indefinitely.

Historical Halvings

Halving happens approximately every 4 years.

1. 1st Halving: November 28, 2012 - Reward decreased to 25 BTC.
2. 2nd Halving: July 9, 2016 - Reward decreased to 12.5 BTC.
3. 3rd Halving: May 11, 2020 - Reward decreased to 6.25 BTC.
4. 4th Halving: April 2024 - Reward will decrease to 3.125 BTC.

Reduced BTC Circulation

A significant consequence of halving is the reduced rate at which new Bitcoins enter circulation, potentially influencing market dynamics under classic supply and demand principles. Miners, who bear costs infiat currency for electricity and hardware, can be expected to convert their rewards to fiat to cover these expenses. A decrease in block rewards implies fewer Bitcoins being sold, possibly exerting upward pressure on Bitcoin prices.

However, the simple equation of “reduced supply equals price increase” does not always hold. Speculative behavior and external market forces also play crucial roles.

Daily volume of BTC transactions (Source: Blockchain.com)

The chart above illustrates the daily volume of Bitcoin transactions. On average, over the past year, slightly more than 400,000 BTC have been transferred each day.

Currently, the block reward for Bitcoin mining stands at 6.25 BTC. Given that a block is mined approximately every 10 minutes, this translates to a daily creation of 21,600 BTC. After the upcoming halving event, the block reward will decrease to 3.125 BTC, reducing the daily mining output to 10,800 BTC. If we assume that all mined Bitcoins are circulated on the same day they are created, the current block reward represents 5.4% of the total daily transactions. This percentage will drop to 2.7% following the halving.

The following graphs display the seven-day average of transaction fees per block, measured in BTC.

First halving (the block reward dropped to 25 BTC) (Source: Blockchain.com)

Second halving (the block reward dropped to 12.5 BTC) (Source: Blockchain.com)

Third halving (the block reward dropped to 6.25 BTC) (Source: Blockchain.com)

Transaction cost has incrementally increased over time, though the rise has not followed a linear pattern. For instance, the chart below illustrates how transaction fees were notably lower at the end of 2021 and throughout most of 2022.

Transaction fees were notably lower at the end of 2021 and throughout most of 2022 (Source: Blockchain.com)

Despite the reduction in mining rewards during halving events, the transaction fees per block have not doubled, underscoring that the decrease in rewards does not necessarily lead to a proportional increase in transaction costs.

Hashrate over time from 2017 (Source: Blockchain.com)

Hashrate measures the total computational power used to process transactions and mine new blocks on a blockchain, effectively indicating the number of attempts made to solve a block. The graph above demonstrates that although the hashrate has increased—implying greater computational effort—miners are receiving fewer bitcoins due to the reduction in mining rewards, measured in BTC.

Bitcoin price in USD over time from 2017 (Source: Blockchain.com)

Miners incur operational costs in fiat currencies, such as USD, but the price graph illustrates that their earnings in USD are not consistent. This variability reflects the fluctuating value of the rewards they receive for mining activities.

Transaction Fees and Mining Profitability

Each halving has historically led to a slight increase in transaction fees, though not proportionally to the decrease in block reward. This pattern suggests miners are not fully compensating their revenue losses from block rewards with higher transaction fees.

Moreover, the profitability for miners becomes squeezed, particularly for those operating on thin margins. This economic pressure could lead to a consolidation in the mining industry, where only larger, more efficient miners remain competitive.

Long-Term Implications

As block rewards continue to diminish, the reliance on transaction fees will increase. This raises questions about the economic viability for miners and the possible effects on the network's security. High transaction fees could deter users, while too low fees might not sustain mining operations, potentially making the network vulnerable to attacks.

Market Speculation and Sentiment

The speculative nature of Bitcoin markets plays a significant role in its price dynamics. Market sentiment can be heavily influenced by media coverage, investor behavior, and broader economic conditions, making it challenging to predict how halving events will impact Bitcoin in both short and long terms.

Conclusion

Bitcoin halving is a critical event that reduces the rate at which new coins are generated, influencing both the supply side of Bitcoin and the broader cryptocurrency market. While historical data suggests a potential price increase post-halving, the complex interplay of market forces makes it difficult to forecast future outcomes reliably. Investors and participants in the Bitcoin ecosystem should therefore approach halving events with a balanced perspective, considering both the opportunities and risks involved.