What is the Bitcoin Halving?

Ashley_Buckwell

Approximately every four years, something extraordinary happens within the bitcoin network—the bitcoin halving. The halving describes the recurring event whereby the bitcoin issuance rate is cut in half. Every 210,000 blocks, or roughly four years, the amount of new bitcoin issued to miners halves. Meanwhile, their mining costs stay the same. In addition to the effects on mining businesses, the bitcoin halving also has unique effects on bitcoin’s supply and demand dynamics. In this article, we explain what the halving entails, how it affects miners and the network’s block subsidy, and how halvings have historically affected bitcoin’s price.

Bitcoin mining basics: what are blocks and what is the block reward?

Blocks are a fundamental component of the bitcoin blockchain. Blocks are data structures in which blockchain transaction data are permanently recorded by miners. Each new block records some or all of the most recent transactions not yet validated by the network. After creating a block of transactions, a minor will broadcast that block to the network. If the network accepts the block as valid (i.e., not containing malicious or ineligible transactions), the block is added to the chain, and the miner receives a reward. This reward is known as the block reward, and it's what incentivizes miners to participate in the bitcoin network.

The block reward comprises transaction fee revenue plus the block subsidy.

• Transaction fees. Blocks are limited in size to approximately 1–2 MB (or 2000–4000 transactions, depending on average transaction size). When demand for block size exceeds supply, minors prioritize transactions that pay higher fees.
• Block subsidy. New bitcoin is issued in accordance with the inflation schedule defined in the bitcoin protocol. This issuance is referred to as a subsidy because it serves to subsidize miners, ensuring they are adequately rewarded for participating in the network.

Currently, most of the block reward (approximately 90%) is derived from the block subsidy; however, eventually, transaction fees will be the predominant component of the block reward. This is thanks to the halving—the block subsidy is programmed to decline over time, whereas transaction fee revenue is expected to increase.

What is the bitcoin halving? 

The bitcoin halving is a preprogrammed change in the amount of new bitcoin issued with each block (the block subsidy). 

New bitcoin is issued approximately every 10 minutes in accordance with bitcoin’s inflation schedule, which strictly limits the amount of bitcoin that will ever exist to slightly less than 21 million. According to the inflation schedule, the issuance rate halves every 210,000 blocks. Given that a new block is mined approximately every 10 minutes, it takes approximately four years to mine 210,000 blocks. Anyone running a bitcoin node can verify the current total bitcoin supply directly. According to Blockchain’s node, as of this writing, approximately 19.6 million bitcoin has already been mined. This means only 1.4 million or so are left to mine. When Satoshi Nakamoto launched bitcoin on January 3, 2009, the issuance rate was 50 bitcoin per block. Fifteen years on, bitcoin has undergone three halvings, and its issuance rate is now 6.25 bitcoin per block. The next halving is expected to occur sometime around April 2024, and by 2140, the bitcoin issuance rate is expected to have declined to zero, after which no further halvings will occur. 

Purposes of the halving

The halving was incorporated into bitcoin to account for the predicted increase in bitcoin’s value over time.

Gradually inflating the supply of bitcoin is a way of distributing bitcoin to both early and late network participants. Without an inflation schedule, the entire supply would have had to be issued at inception, meaning a single entity would have received or had access to the entire float, making subsequent distribution challenging. For this reason, a gradual inflation schedule was chosen. Additionally, given that the value of bitcoin was predicted to increase over time, its issuance rate was programmed to decline, ensuring that later network participants, although receiving less bitcoin per block, received similar value in bitcoin per block.

The schedule also helped bootstrap the network into what it is today. In bitcoin's early days, the number of transactions (and fees) was low. Bitcoin was also much cheaper then. For these reasons, a relatively large block subsidy was required to incentivize miners to participate in the network. Miners joining the network later needed less of a direct incentive (subsidy) to participate, given the increased value of block rewards resulting from a higher proportion of the reward being derived from transaction fees and the increased value of bitcoin in the market.

Effects of halving on bitcoin mining

Bitcoin mining is a highly competitive industry—only the most efficient operators survive. The costs of mining include investment in physical infrastructure and various operating expenses, primarily electricity. Block rewards are usually only just sufficient to cover these expenses. Whenever a miner finds itself operating at a loss, it becomes forced to shut down all or part of its operations, thereby becoming ineligible for earning block rewards. Subsequent block rewards are then spread out among fewer miners, making mining more profitable. As this profitability increases, miners are encouraged to join the network. This cycle repeats in perpetuity. 

The halving decreases the block subsidy. Given that the block subsidy currently comprises approximately 90% of the block reward, which comprises the majority of a miner’s income, the halving substantially decreases income for miners, practically overnight. Most miners will find themselves instantly operating at a loss, and only those with sufficient capitalization and planning will be able to continue operating for long. Eventually, several miners will capitulate and shut down, and as that happens, profitability will increase among the miners who remain.

Historical impact of halving on the price of bitcoin

Assuming miners sell all of the bitcoin they earn from the block subsidy, a reduction in the amount of bitcoin issued per day means less sell-side pressure on the market, which in theory should mean higher bitcoin prices. The next halving will reduce the daily issuance of bitcoin from 900 to 450. At $37,000 (November’s average price), sell-side pressure from miners can be estimated at $33.3 million. Assuming no change in this price, sell-side pressure from miners will halve to $16.7 million when the halving occurs. This means that less money ($16.7 vs. $33.3 million) will be required to absorb the bitcoin being sold by miners. However, the amount of bitcoin traded per day exceeds the amount of bitcoin issued to miners by 10 orders of magnitude, with trading volumes ranging in the tens of billions of dollars, meaning that the reduction in sell-side pressure will be barely noticed in the market.

Arguably, the publicity generated by the halving has a greater effect on bitcoin’s price than the phenomenon itself, because the halving serves to highlight several of the positive characteristics of bitcoin that benefit participants of the network:

• Scarcity. Bitcoin’s hard cap is central to its primary value proposition as a savings instrument. Bitcoin savings cannot be diluted with the arbitrary issuance of new bitcoin because the inflation schedule has been defined in advance and is immutable.
• Difficulty of mining bitcoin. In the same way that gold is difficult to find and real estate is difficult to create (two historical examples of savings instruments), bitcoin is difficult to mine. Furthermore, it’s becoming more difficult with each halving.
• Fair distribution model. An inflation model ensures that late participants don’t miss out on the opportunity to mine bitcoin, and a declining inflation schedule ensures that early participants—those who took the most risk in bitcoin’s early days—were sufficiently rewarded.

The buzz generated by people talking about the bitcoin halving—what it means and why it’s important—results in greater interest in the bitcoin network. As interest in and use of the network grows, so too does the value of the network for all participants.