The most recent Bitcoin halving took place on 11th May 2020. But, for readers to understand what “Bitcoin halving” means, they need to first understand how the Bitcoin network usually operates.
Bitcoin and the blockchain technology associated with it are a system of nodes or computers used globally that have the entire Bitcoin code built-in to them. Each of the nodes has the Bitcoin protocol installed and stored in them. This means that every computer has a set of Bitcoin transactions in them, making sure that the network isn’t exploited by any developer. The system would deny any transaction that is not verified and stored in the network. This makes the entire Bitcoin network transparent and visible as no one can initiate any transaction without escaping the scrutiny of the system.
As more computers and nodes are added to the Bitcoin system, the security of the network increases even more. Currently, as per various sources, more than 10,000 computers are running the protocol. Any developer can join the Bitcoin network if their computer allows them to download the entire system of transactions, but not all can be miners.
It must be known that Bitcoin miners receive a reward for every block that they mine by solving the mathematical problem provided. This reward is halved every four years or after 210,000 blocks are mined. As a result, the rate at which new Bitcoins are circulated in the network is cut by half. This synthetic method applied by the Bitcoin network ensures that every Bitcoin mined is in circulation. It keeps a check on inflation in the system.
The protocol is developed in a way that it will continue till 2140. At that stage, Bitcoin miners will be able to earn fees for initiating transactions, and the protocol users will pay for it. The fees awarded to miners act as an incentive for miners to continue to mine Bitcoin and keep the protocol running. Once halvings are done, the sheer competition amongst miners will keep the fees low.
The halving procedure is important as it leads to another drop in the already finite supply of Bitcoin. Readers should know that Bitcoin is in limited supply (21 million). Already over 18 million Bitcoins are in circulation, and only over 2 million are left to be mined.
When Bitcoin was initially launched, in 2009, the reward for processing each block was 50 Bitcoins. It was reduced to 25 Bitcoins after the first halving, 12.5 after the second halving, and 6.25 after 11th May 2020.
The halving process diminishes the rate at which new tokens are released in the network and hence reduces the overall supply. This can lead to several implications on investors as it’s with assets like gold, which is limited in supply.
Previously, the process of halving was correlated with a huge rise in the prices of Bitcoin. The first halving led to an increase in the price of Bitcoin from a mere $12 to $1,150 in only a year. After the second halving in July 2016, the price soared from $650 to $20,000 by the end of 2017. The value reduced to just $3,200 in over a year from its peak, which was still 4 times its pre-halving price.
If the process of halving doesn’t increase demand and price of Bitcoin, then Bitcoin miners will have zero incentive as the reward for processing transactions would be low, and the value wouldn’t be high enough for them to profit. Bitcoin has a process to change the difficulty of mining a transaction to prevent a situation like this. If such an event occurs that the reward is halved but the value of Bitcoin hasn’t increased as substantially as it should, the difficulty of processing a transaction is reduced. It gives incentive to miners as the difficulty is reduced even though the reward is smaller.
This procedure is a proven and tested technique. It has been successful twice. The result of every halving process done until now has resulted in the surging of Bitcoin price followed by a drop. But even the crashes in the price of Bitcoin have maintained a value more than the pre-halving value of Bitcoin. Even though the process has worked so far, it’s surrounded by huge hype, speculation, and fluctuations. It’s almost impossible to know how it will react in the future.