Long reads

Bitcoin halving: What does this mean and what will its effect be?

Jamie Crawley

Jamie Crawley

Reporter , Finextra

Bitcoin’s 2020 halving took place today. This happens around once every four years and is of much interest to cryptocurrency investors due to the profound effect halving has had on the cryptocurrency in previous occurrences.

Halving refers to the number of coins that miners receive for adding new transactions to the blockchain being cut in half.

This will now diminish from 12.5 bitcoin to 6.25 and will halve again every 210,000 blocks until the last bitcoin is mined in 2140.

Previous halvings have been followed by bull runs that saw the meteoric increases in bitcoin’s value, most notably in 2017, following the reward decreasing from 25 coins to 12.5 in 2016.

“Based on what we’ve seen historically, the expectation is for the next bull market to form following this halving event,” Simon Peters, analyst at eToro, says.

The theory around this is simple supply and demand: the fewer bitcoins that are being created, the more valuable those in existence are.

What’s new?

Where this halving may differ from its predecessors is the volatile economic environment that it takes place amidst.

The unprecedented levels of financial stimulus being injected into economies by central banks may see an increased demand for bitcoin and other cryptocurrencies as a hedge against inflation.

The short-term expectation however is towards a high degree of volatility as traders who have accumulated aggressively ahead of the halving may sell to cash in on immediate gains and take profits.

Global markets have rebounded since suffering a steep decline in March, with bitcoin following suit, recovering its Covid 19-induced losses to hit $10,000 over the weekend.

There does however remain the possibility of countries experiencing second waves of the virus, which could trigger another market sell-off as investors fly to liquidity. This would of course affect bitcoin just as it would equities and funds.

However, there are many who believe the current economic conditions are a net positive for the value of bitcoin.

Recent research by SEBA highlighted this by comparing bitcoin to gold, which has also seen substantial increases in its value in previous economic crises.

“In the last halving, we weren’t in a health or financial crisis and we didn’t have central banks creating ludicrous amounts of new money,” Peters says.

“The fact that we do have this now, combined with the halving, does make a significant difference and more reason to investigate the potential of crypto assets as a hedge against inflation, in my opinion.”

This could see more institutional investment enter the space, as professional investors seek exposure to alternative assets. This may not necessarily involve buying bitcoin itself, but rather buying shares in trust companies that do.

Peters believes this combination of diminished supply and increased demand could see the price of Bitcoin comfortably exceed its all-time-high of December 2017 and reach between $20,000 and $50,000.

Mining inefficiencies

Turning to the wider impact of the halving, a diminished reward for mining bitcoin will reduce the revenue that miners can generate from adding new transactions to the blockchain.

The cost of electricity required to power the computers that solve the mathematical problems is such that the price of bitcoin would need to increase substantially for miners to offset receiving half the number of coins.

“If the price doesn’t really increase in line with the decrease in reward then miners would find it difficult to remain competitive and stay in business,” Peters says. 

Miners will need to operate as efficiently as possible and there will therefore be a demand for new equipment that can deliver more hashes per second, while consuming less energy and reducing overheads.

An alternative outcome is that miners will switch to mining similar crypto assets, such as bitcoin cash or bitcoin SV.

These two cryptocurrencies were spawned from forks on the blockchain and use the same hashing algorithm as bitcoin, making them very easy to switch to.

Beyond the bull run

What will determine the positive effect on bitcoin and other cryptocurrencies from the halving effect however will be the extent to which it helps remove some of the barriers that have made previous bull runs unsustainable.

For example, bitcoin is still hampered by a lack of scalability given the amount of time it takes for the blockchain to settle transactions preventing it from being adopted widely as a means of payment.

Another area of some uncertainty is in regulation. While there has been some progress in this area since 2017, there is still no robust regulatory framework with the international recognition that would be required to legislate for the trading and settlement of crypto assets.

Without this, institutional investors and their deep pockets remain largely on the sidelines, which means crypto remains thinly traded and therefore volatile.

Peters described regulation as the “tipping point” for IFAs, wealth managers and family offices to feel comfortable talking to their clients about crypto as an asset class.  This could stimulate further investment in the space and help address its other shortcomings.

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