What is the Bitcoin Halving? How Bitcoin’s Supply is Limited

Every four years, the amount of Bitcoin doled out to cryptocurrency miners halves, in a process imaginatively known as the Bitcoin halving (or halvening). Here’s why—and how—it works.

Bitcoin’s supply limit

To understand the Bitcoin halving, we must first understand the theory behind Bitcoin’s supply.

The inventor of Bitcoin, Satoshi Nakamoto, believed that scarcity could create value where there was none before. After all, there’s only one Mona Lisa, only so many Picassos, a limited supply of gold on Earth.

Bitcoin was revolutionary in that it could, for the first time, make a digital product scarce; there will only ever be 21 million Bitcoin.

The idea of limiting Bitcoin’s supply stands in marked opposition to how fiat currencies such as the U.S. dollar work. Fiat currencies such as the U.S. dollar were initially created with firm rules–to create one U.S. dollar, the U.S. government needed to have a certain amount of gold in their reserves. This was known as the gold standard.

Over time, these rules eroded as modernizing economies, during bouts of extreme financial certainty–like the Great Depression and World War II–printed more money to help stimulate struggling economies. Over time, these rules evolved into today’s system, in which governments can (broadly speaking) print money as often as they like.

Satoshi Nakamoto believed that this devaluation of fiat money could have disastrous effects, and so, with code, prevented any single party from being able to print more Bitcoin.

What is the Bitcoin halving?

Embedded in the Bitcoin code is a hard supply limit of 21 million coins. New Bitcoin is released through mining as block rewards. Miners do the work of maintaining and securing the Bitcoin ledger; as a reward, they receive newly minted Bitcoin.

However, about every four years, the reward for mining is halved–hence “the halving.” Each halving reduces the rate of new Bitcoin entering into the supply, until no more new Bitcoin is created at all in the year 2140.

A brief history

• 2009 – Bitcoin mining rewards start at 50 BTC per block
• 2012 – The first Bitcoin halving reduces mining rewards to 25 BTC
• 2016 – In the second halving, mining rewards go down to 12.5 BTC
• 2020 – In the third halving, mining rewards drop to 6.25 BTC
• 2140 – The 64th and last halving occurs and no new Bitcoin will ever be created

What’s so special about the halving?

If a person, group, or government is trusted to set up the money supply, they must also be trusted to not mess with it. Bitcoin is supposed to be decentralized and trustless–no one in control and no one to trust. Since Bitcoin is not controlled by any one person or group, there must be hard and set rules about how many Bitcoin gets created and how they are released.

By writing a total supply and halving event into the Bitcoin code, the monetary system of Bitcoin is essentially set in stone and practically impossible to change. This “hard cap” means Bitcoin is a kind of “hard money” like gold, which has a total supply that is also practically impossible to change.

What happens to Bitcoin miners?

Bitcoin miners invest money in specialized mining hardware as well as the electricity required to run their rigs. The cost of this is offset by their mining rewards—but what happens when their rewards are halved?

Since the halving reduces mining rewards, the incentive for miners to work on the Bitcoin network is also reduced over time, leading to fewer miners and less security for the network.

For this reason, once the last Bitcoin is mined, miners will (assuming there haven’t been any major changes to the Bitcoin protocol) receive rewards in the form of transaction fees for maintaining the Bitcoin network.

At present, transaction fees make up a small proportion of a miner’s revenues; miners currently mint around 900 BTC (~$33.5 million) a day, but earn between 60 and 100 BTC ($2.2 million to $3.7 million) in transaction fees each day. That means transaction fees currently make up as little as 6.5% of a miner’s revenue—but in 2140, that’ll shoot up to 100%.

“Transaction fees will likely grow in an inverse correlation to, and as a compensation for, the diminishing mining returns,” Ben Zhou, CEO of crypto exchange ByBit, told Decrypt.

It’s also possible that the reward mechanism for Bitcoin could change before the final block is mined. Bitcoin currently runs on a proof of work consensus mechanism, which has attracted criticism from the likes of Tesla CEO Elon Musk for its high energy consumption and carbon footprint.

Rival cryptocurrency Ethereum is in the process of switching from proof of work to the less energy-intensive proof of stake consensus mechanism, in which the network is secured by having validators lock up, or “stake,” their cryptocurrency.

It’s possible that Bitcoin could follow suit. In an interview originally shot for German TV show Galileo, Niklas Nikolajsen, the founder of Swiss crypto broker Bitcoin Suisse, was quoted as saying “I’m sure, once [proof of stake] technology is proven, that Bitcoin will adapt to it as well.”

The halving’s impact on the price of Bitcoin

The debate over whether Bitcoin halvings impact on the cryptocurrency’s price, or whether they’re already “priced in”, continues to rage.

According to the laws of supply and demand, the dwindling Bitcoin supply should increase demand for Bitcoin, and would presumably push up prices. One theory, known as the stock-to-flow model, calculates a ratio based on the current supply of Bitcoin and how much is entering circulation, with each halving (unsurprisingly) impacting on that ratio. However, others have disputed the underlying assumptions upon which the theory is based.

Historically, after previous halving events, the price of Bitcoin has increased—but not immediately, and other factors have played a part.

At the time of the June 2016 halving, the price of Bitcoin had was around $660; following the halving, Bitcoin continued to trade horizontally until the end of the month, before crashing to as low as $533 in August. But following the crash, Bitcoin’s price shot up to its then all-time high of over $20,000 by the end of the year, an increase of 2,916%.

Similarly, in the wake of the 2020 halving, Bitcoin’s price increased from just over $9,000 to over $27,000 by the end of the year—but in the two months following the halving the price failed to break $10,000. It’s also important to note that other factors also influenced Bitcoin’s 2020 bull run, most notably growing institutional investment from the likes of MicroStrategy, and PayPal’s decision to enable its users to buy and hold Bitcoin.

Source: https://decrypt.co/17757/what-is-the-bitcoin-halving