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Tagus Bits 'n Bobs issue 3: Countdown to Bitcoin Halving

Feb 23

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Feb 23 2024

Deep Dive: Countdown to Bitcoin Halving

  • Key element of Bitcoin Halving: The systematic reduction in Bitcoin’s minting rate aims to control supply and sustain the finite nature of Bitcoin, contributing to controlling inflation

  • Timetable: The first periodic halving occurred in November 2012, followed by the most recent in May 2020, and the next is scheduled for April 2024

  • Halving impact: Historically, Bitcoin Halving events trigger price surges, characterised by pre-halving rallies, corrections, and then substantial post-halving bull runs lasting about 18 months. Price increases after each halving range from +284% to +8069% within a year.

  • Bitcoin's unique monetary characteristics: Bitcoin, with its fixed supply and decentralised nature, differs from traditional fiat currencies controlled by central banks. The upcoming halving, featuring reduced block rewards and disinflation mechanism, underscores Bitcoin's stability and intrinsic long-term value.

  • Miners adapting & integral to the system: Bitcoin Halving diminishes miner rewards, affecting profitability, compelling the need for adaptation and efficiency enhancements. Halving is anticipated to raise energy consumption, requiring more energy for the same Bitcoin production, yet the increasing use of renewable energy addresses certain criticisms.


Bitcoin Halving dynamics in brief: Bitcoin Halving, occurs approximately every four years, involves a 50% reduction in the block reward for Bitcoin mining, a process integral to the cryptocurrency's scarcity mechanism. The number of Bitcoins (BTC) entering circulation every 10 minutes, is known as block rewards. Originally set at 50 BTC per block in 2009, the halving has taken place in 2012, 2016, and 2020, with the next due in April 2024. This systematic reduction aims to control inflation and sustain the finite nature of Bitcoin, as there will never exist more than 21 million Bitcoins. When this hard cap for Bitcoin is achieved around the year 2140, the process of inflation halts, as no new coins will be introduced into circulation. Bitcoin Halving is also a disinflationary measure that reduces inflation over time. As nearly 89% of Bitcoin has already been mined, the forthcoming halving in April 2024 will further curtail the pace of supply. 


This event will progressively reduce the mining reward from 6.25 BTC to 3.125 BTC per block. Miners must adapt to increased competition for diminished rewards amid the evolving Bitcoin mining landscape. The scarcity of Bitcoin, driven by its halving mechanism, plays a crucial role in its value proposition, serving as a tool to control inflation and potentially introducing deflationary traits in the long-term. As the reward diminishes during halving events, the rate of new coin supply decreases, potentially leading to price increases through supply shocks. Nonetheless, ongoing debates question the direct correlation between halving events and historical price movements.


Scarcity mechanism: After the unveiling of the Bitcoin white paper, Satoshi Nakamoto, the mysterious figure or group behind Bitcoin's pseudonymous creation, considered the potential consequences of the selected monetary policy. The exploration involved contemplating scenarios that could lead to either deflation or inflation. In light of Satoshi’s considerations, it became evident that Bitcoin's scarcity mechanism plays a crucial role in shaping its monetary policy, aiming to establish a system that avoids the pitfalls of inflation, setting the stage for a unique and robust digital currency. 


At the core of this system is the process of Bitcoin mining, the consensus mechanism used for the verification and approval of each and every blockchain transaction. Due to the lack of a centralised entity to record the transactions, miners globally compete using computers to verify transactions, discover new blocks, and add them to the Bitcoin blockchain. The successful miner is rewarded with newly minted Bitcoins known as "block rewards" and transaction fees from the transactions in the newly added blocks. The rewards for miners, comprising both block rewards and transaction fees, serve as incentives for their efforts, critical in sustaining the network and encouraging miners to actively participate in the validation and addition of transactions to the blockchain.


A key element of Bitcoin's scarcity mechanism is the Bitcoin Halving. This is a process where the reward for miners, which are the new Bitcoins entering circulation every 10 minutes, is systematically reduced by half every 210,000 blocks, occurring approximately every four years. The purpose is to control the rate at which new Bitcoins are introduced into the system, contributing to the overall scarcity of the cryptocurrency. Bitcoin halvings have been a recurring event in the cryptocurrency's history, originally set at 50 BTC per block in 2009, with subsequent halvings taking place in 2012, 2016, and 2020. Each of these events marked a significant milestone in the evolution of Bitcoin's supply dynamics.


Looking forward, the next Bitcoin halving is scheduled for April 2024, approximately four years after the previous one in 2020. As of the current writing, this event is just under 60 days away. The anticipation surrounding this upcoming halving underscores its ongoing importance in maintaining the scarcity mechanism of Bitcoin and also potential impact on price.  


Reduced Mining Rewards After Bitcoin Halving

 Source: Tagus Capital.


Past precedents and potential variations: The key reasons behind Bitcoin Halving are scarcity, controlled supply, and inflation control. It therefore contributes to the long-term intrinsic asset value proposition of Bitcoin. The event also affects market forces, impacting miners, market competition, and overall network security. Bitcoin's price has historically shown positive reactions to halving events, with increased volatility and a rise in value due to decreased supply. The reduction in mining rewards affects the flow of new Bitcoin into circulation, contributing to changes in demand and supply economics. While halvings are predictable, fully anticipating their impact on prices is challenging. A current higher price attracts more miners, adding sell pressure and limiting price growth. Post-halving, weaker miners, often with outdated machines or high costs, are the first to exit, reducing overall sell pressure as they previously sold most of their Bitcoin to sustain operations. 


Historically, past halving cycles consistently show a pre-halving rally, followed by a correction and a substantial post-halving bull run lasting around 18 months. Notably, each of the three halvings experienced so far has resulted in significant percentage price increases for Bitcoin. For the second halving on July 9, 2016, there was a remarkable increase of 2,000%, with Bitcoin's value soaring from around $650 to a peak of $13,650 by December 2017. The third halving in May 2020 saw a substantial rise, with Bitcoin's price increasing by approximately 740%, from about $8,200 to a peak of $68,789 in November 2021. Examining the 365 days after each halving reveals an increase of 8069% for the first halving on November 28, 2012, and +284% and +559% for the second and third halvings, respectively. Similarly, for the 365 days before each halving, the increases have been +365%, +142%, and +17%, respectively.


It's worth noting that the impact of halvings can vary between cycles, and past bullish trends do not guarantee future outcomes. That said, the macro environment including a prospective Fed easing cycle, a more pragmatic stance on regulation including approving U.S. spot Bitcoin ETFs, and growing institutional demand suggest a favourable backdrop during this upcoming Bitcoin Halving period.  


Bitcoin Halving Precedent

Source: Tagus Capital, YahooFinance. 


Bitcoin’s distinctive monetary attributes:Bitcoin significantly differs from national fiat currencies controlled by central banks and governments, such as the U.S. dollar managed by the Federal Reserve. Its unalterable and decentralised monetary policy, written in code and shared across the network, sets it apart. Unlike traditional currencies, and in turn TradFi assets, influenced by political processes, Bitcoin's fixed supply of 21 million coins enhances scarcity, affecting market value. Additionally, Bitcoin's programmed block reward reduction contrasts with modern financial systems, where central banks control money supply, leading to an almost doubling in dollar supply since the Global Financial Crisis in 2008.


U.S. Currency and Total Bitcoin in Circulation


Source: Tagus Capital, Federal Reserve, Blockchain.


Amid lingering global inflation concerns, Bitcoin's upcoming halving emphasises its controlled inflation nature, reinforced by a regulated supply that enhances scarcity.This event, reducing block rewards, becomes a crucial tool for mitigating inflation within the Bitcoin ecosystem, ensuring long-term stability and value. The process concludes when circulating bitcoin reaches 21 million, expected around 2140. Bitcoin's slower creation rate than the rate of loss or hoarding distinguishes it from inflationary fiat currencies. Approximately 60% of the total Bitcoin is in the possession of entities, be it individuals or businesses, who have consistently retained at least 75% of the Bitcoin they initially received. This Bitcoin has been held for an extended period, signifying long-term investment. Another 20% has remained stationary in its current addresses for five years or more, and is classified as lost Bitcoin. In times of escalating financial risks and geopolitical tensions, these distinctive attributes and resilience of Bitcoin compared to traditional assets become more apparent.


These dynamics contribute to the increasing interest in Bitcoin in certain Latin American countries facing instability and heightened inflation. El Salvador, diverging from traditional digital payment routes, adopted Bitcoin as legal tender in 2021. Brazil, Argentina, and Mexico lead crypto adoption in Latin America, ranking among the top 20 in the  Global Cryptocurrency Adoption Index, predominantly led by the Central and South Asia and Oceania (CSAO) region. For instance, Argentina's average annual inflation rate from 1944 to 2024 was 189%, with the current rate at 254% year-on-year as of January 2024. The persistently high inflation rates underscore the potential relevance of adopting Bitcoin as an alternative store of value.


Impact on miners: Miners receive Bitcoin rewards to incentivise network integrity and security. Cryptography ensures ownership security, employing game theory principles where miners are encouraged to mine honest blocks or  face a cost for attempting dishonesty. In simple terms, this reflects the “mining difficulty”, a measure of how many mathematical calculations (hashes) are needed to generate the next block in the Bitcoin blockchain. The increased computations, or hashrate, directed at Bitcoin by miners therefore enhances network security, demanding substantial hashrate for potential attacks. Motivated by potential earnings through block rewards, miners contribute to reinforcing Bitcoin's overall stability and protection.


The implications of Bitcoin halving and reduction in Bitcoin's inflation rate therefore include a decrease in miner rewards, and potential long-term effects on mining profitability. It is crucial for miners to adapt to changing dynamics and invest in efficient technologies. A significant number of miners quitting could impact the hash rate and network security temporarily, but historical evidence suggests that the network recovers. In the run up to the next Bitcoin Halving there already has been improved consolidation and efficiency of miners. CleanSpark Inc.,for example,  in January announced plans to acquire 160,000 Bitcoin mining machines by the end of 2024, including 60,000 Bitmain S21 units already purchased for $193.2 million, with an option for 100,000 more machines, aiming for a 400% increase in hash rate. This strategic move is viewed as a hedge against potential price hikes during bullish markets and aligns with preparations for the BTC halving event in April. 


Bitcoin Supply and Block Rewards

Source: Tagus Capital, Blockchain. 


Halving is expected to initially increase energy consumption, requiring more energy to produce the same quantity of Bitcoins as before. However, the growing adoption of renewable energy helps mitigate some of these criticisms. An increasing share of Bitcoin mining comes from renewables, with the Bitcoin Mining Council claiming 63%, a figure 20 percentage points higher than the CCAF's 2020 estimate. Such a shift to renewable energy resources will also improve sustainable efficiencies as well as address some of the additional oversight such as in the U.S. The U.S. Energy Information Administration (EIA) plans to monitor electricity use by U.S. cryptocurrency miners, launching a survey for selected Bitcoin miners to disclose energy consumption details. This aims to track power demand shifts, identify regions with concentrated mining growth, and analyse electricity sources. The EIA recognizes the significance of cryptocurrency mining as a demand source, seeking improved data quantification for energy consumption. That said, Bitcoin Halving also increases concentrated energy efficiency in the long-term. Miners employing efficient machines and benefiting from lower energy costs experience lower Bitcoin breakeven prices. Conversely, those with high breakeven prices may face unprofitability and exit the network or need to sell a significant portion of their mined Bitcoin to cover operational costs.


Pre-halving spurs record mining difficulty: Bitcoin mining difficulty has achieved an unprecedented high above 81 trillion, signaling increased participation ahead of the upcoming April halving. An essential component of the Bitcoin system, mining difficulty, as mentioned earlier, assesses the computational work required for block creation. It adjusts every 2,016 blocks (about two weeks) to sustain a 10-minute block creation interval, with increased miner participation leading to higher difficulty and vice versa. This increase in difficulty, reaching above 81 trillion with a hash rate (combined computational capacity of miners) of around 562 TH/s, is indicative of heightened computational power for block discovery. As the halving event nears, with mining rewards set to reduce from 6.25 BTC to 3.125 BTC, there's anticipation that less efficient miners may go offline, potentially causing a 20% reduction in the hash rate and it has already declined around 10% since early Feb.


Bitcoin Mining difficulty*


Source: BitInfoCharts. *Note: Average mining difficulty per day, Feb. 22, 2024 (81.725T).  


Bitcoin Halving - Challenges and adaptation: Bitcoin Halving, occurring every four years, reduces mining rewards by 50%, controlling inflation and sustaining scarcity. Historically, Bitcoin halving events have resulted in substantial price increases, ranging from +284% to +8069% over a 365-day period after each halving. The cycles typically include a pre-halving rally, followed by a correction, and a significant post-halving bull run approximately 18 months later. The imminent April 2024 halving poses challenges for miners and energy consumption, affecting rewards and necessitating adaptation amid heightened competition. However, signs of consolidation and operational efficiencies have already emerged in anticipation of the event.

The periodic decrease in block rewards is unlikely to be an issue for the next decade or so, given miners' adaptability and efficiency improvements. However, long-term challenges may emerge as block rewards diminish, posing potential issues for miners reliant on incentives. Transaction fees become crucial as a revenue source, but concerns arise about their sufficiency, leading to heightened costs for network security. The uncertainty surrounding Bitcoin future security arises, with the appeal of mining rewards diminishing when supplemented solely by fees. Nevertheless, the Bitcoin ecosystem is inherently resilient, ensuring continuous mining incentives. It adapts by reallocating block rewards to active participants when some miners exit or shut down equipment.


Feb 23

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