The Bitcoin Halving
The halving is approaching and has been the topic of conversation in Bitcoin-country for months. But what exactly is the halving and why is everyone so enthusiastic about it? We are going to explain all that to you in this article. The principle is actually very simple. Bitcoin has miners that contribute computing power and energy to the Bitcoin network to ensure its safety. In exchange for that security, miners receive a reward in the form of new bitcoin for every block they add to the blockchain. That reward halves every 210 thousand blocks. This is where the name halving comes from and this is ingrained in the Bitcoin protocol. In Bitcoin's rules. So far we have experienced a halving twice, in 2012 and 2016, after both of these halvings we have seen an explosive rise in the bitcoin price quite soon after. That seems quite logical, given that the supply of new bitcoin on the market will cut in half after each halving, but if everyone already knows that in advance, why does the price still respond? If you are sure that gold is going to be rarer tomorrow, why not buy all the gold you can find now?
Is there a relationship between the halving and the explosive rise in the bitcoin price, or was the previous two times just a coincidence? There are several theories about this and we will go through them in this article with you so that you are fully aware of this important event.
The halving in numbers
Let's start this article with a small quantification of the halving. For that, we go back to the core of Bitcoin, to the protocol. The emergence of new bitcoins. Every ten minutes, the miner who won the race against the other miners adds a new block to the Bitcoin blockchain. In exchange for his hard work, this miner gets new bitcoin. This is the only way new bitcoin comes into circulation.
The reward miners receive for building new blocks started at 50 bitcoin per block with the invention of bitcoin in 2009 and has halved twice since then. At the time of writing, the reward is therefore at 12.5 bitcoin and in early May 2020 that reward will half once more to 6.25 bitcoin. So how often do those halves take place? Let's list the numbers:
- Miners manufacture a new block every 10 minutes
- Every 210,000 blocks the bitcoin reward halves
- 210,000 x 10 minutes = 2,100,000 minutes
- 2,100,000 minutes / 60 minutes = 35,000 hours
- 35,000 hours / 24 hours = 1458.33 days
- 1458.33 days / 365 days = 3,995 years
So it takes miners about four years to produce 210,000 blocks and work towards a new halving. Every four years, the halving causes a shock in the supply of new bitcoin, which then suddenly cuts in half. Coincidence or not, but so far bitcoin's price has skyrocketed after every halving. It therefore seems no coincidence that the mysterious Satoshi Nakamoto has chosen this scheme for the creation of new bitcoin. Due to the price explosion, the previous two halves caused a huge influx of new Bitcoiners. The halving is a super interesting mechanism for bitcoin adoption. An increase in the price often causes media attention, new Bitcoiners buy bitcoin and therefore the price increases. While the supply of new bitcoin is decreasing.
Satoshi has thought out everything meticulously and the concept of halves has also been a brilliant move for the adoption of bitcoin. Before we continue, let's list the mechanics of the halving:
- Halves the supply to the market of new bitcoin
- If demand remains the same, this inevitably leads to an increase in the price
- The higher price creates new attention from media and investors
- New attention is generating new Bitcoiners
- And so we are in a positive feedback loop
The halving and the bitcoin price, a story of scarcity?
More and more people are starting to understand bitcoin and therefore see why the bitcoin price has gone through the roof after the past two halves. Bitcoin is the digital perception of scarcity. Bitcoin is the discovery of absolute scarcity. It is the only good in the universe that we know for sure has a maximum. 21 million bitcoin and after that it is ready.
Satoshi once beautifully expressed: “As a thought experiment, imagine that a precious metal exists that is as scarce as gold, but with the following properties:
- Gray in color
- Not a good conductor of electricity
- Not physically strong, but certainly not bendable or malleable
- Not usable for any practical or ornamental purposes
But with one magical feature:
- Can be sent over a communication channel
If it somehow got value, anyone who wants to send value over a long distance could buy a little bit, send it, where the recipient can sell it again."
He is of course talking about bitcoin here, in my opinion the purest form of money there is. It's the combination of absolute scarcity and the ability to send them through a communication channel that make bitcoin the best form of money we've ever had. The scarcity is guaranteed by mathematics, the power of large numbers that cannot be broken by any physical force.
The first thing to notice when we consider the price history of bitcoin is that there is a clear pattern that continues to repeat. The beginning and the end of that pattern can be roughly divided by the two halves that have already taken place. In the first months before the halving, the price shows a small increase, and then, about twelve months after the halving, starts a parabolic increase. After that, there has always been a correction so far, but those corrections have never continued to the pre-halving price level.
Another interesting point is that in the previous two halves we saw a significant increase in the hashing power of the network. This is the computing power that miners invest to mine the next block and get the reward of new bitcoin. We see the same pattern repeat again.
This basically means that miners have full confidence in bitcoin and continue to invest in equipment and set up mining farms to mine more bitcoin, despite the block per reward going down in half. Where mining was still relatively cheap and accessible in 2012 and 2016, hundreds of millions are pumped worldwide to set up new mining farms. In other words, people are investing big money in the future of bitcoin. Of course this does not offer any guarantees, but these kinds of amounts are not invested to take a gamble. People who put such bags of money on the table are generally well informed and know what they are doing. It is no coincidence that the adage follow the money has become a well-known statement.
In addition to these facts, it is also important to highlight the hype surrounding the event. While hype should never be the main reason for investing, at least that's my opinion, I think the hype that will re-emerge around bitcoin before / after halving offers an opportunity for sharky investors. My strategy is therefore to pay close attention to my environment during a subsequent parabolic rise to possibly sell part of my bitcoin around the top. If my friendly hairdresser suddenly starts talking about his successful investment in bitcoin, it may be time to sell a small chunk of my portfolio and pick it up again after correction for less money. The hype will undoubtedly have a huge impact on the course, but we will certainly respond to that by columns and news via news.satos.nl! This static page is mainly intended to provide you with general information about the halving. Speaking of which, let's take a look at the now famous stock-to-flow model of Dutchman PlanB.
The stock-to-flow model, scarcity and bitcoin
It is now time for the real thing and we cannot ignore the Dutch quant operating under the pseudonym PlanB! His article, Modeling Bitcoins Value With Scarcity, struck like a bomb and created a lot of new bitcoiners. Many seasoned investors have not taken bitcoin seriously until the appearance of its model, but see the stock-to-flow model as an explanation of bitcoin in their own language. The language of hard math.
The Dutchman starts his famous article with a consideration of the concept of scarcity. What is scarcity and why is it important that money is scarce? Dictionaries define scarcity as a situation in which a good is not easy to find or obtain. So there must be a deficiency or shortage. As soon as demand exceeds supply, a good increases in value. This definition is still fairly simplistic and short-cut. Well-known computer scientist and cryptographer Nick Szabo goes into this a bit further and, according to PlanB, gives a much better definition of scarcity. Szabo is the man who came up with the concept of unforgeable costliness.
Quite simply put, an object has the property of unforgeable costliness if it has a form of preciousness that cannot simply be copied. Think, for example, of a work of art by a deceased painter. Such works of art have a history that cannot be imitated and can in no way go back into production. They are often even unique works.
Antique objects, time and gold all have this in common. They have a form of Kostba for various reasons that cannot simply be imitated without incurring a lot of costs, putting a lot of time and effort into it or because there is a unique history behind it. A form of precious that cannot simply be copied, hence the term unforgeable costliness. The value of gold and other precious metals is largely based on this. So why can't we just use these precious metals as a means of payment? Why don't we use gold as money instead of bitcoin? The problem with gold is that you always have to rely on third parties for payments. It is difficult to check whether a nugget of gold is real and you cannot just chop off a piece to pay for your coffee at the Starbucks. In addition, it is extremely dangerous to always have a lump of gold in your pocket and so you must always transport your assets via secure transport. Not convenient.
What would be much more convenient is a protocol that allows you to make bits and bytes unforgeably costly, without relying on third parties and sending and storing them securely… doesn't that sound like bitcoin? Sure!
Bitcoin is unforgeably costly because miners have to invest electricity to produce new bitcoin. In that sense, bitcoin is a kind of battery in which you can store energy or work. It is literally energy in it, bitcoin out. You cannot fake, copy or otherwise imitate the production of bitcoin. Everyone must participate in the same lottery and hope that their computer is the first to find a solution to the new block to claim the reward.
But we were talking about scarcity and we promised to back everything up with numbers, so let's do that. The Dutchman PlanB's model is built around the stock-to-flow ratio, a way of expressing the scarcity of a good in a number. That way you can compare the scarcity of different goods. How does it work? The stock-to-flow ratio is the ratio between the amount of a good that is currently there, divided by the annual production.
If there is now 10 kilograms of gold and the annual production is 1 kilogram, the stock-to-flow ratio of gold would be 10. It would take 10 years at that rate of production to double the total amount of gold. In reality, gold has a stock-to-flow ratio of about 62, making it the most scarce commodity we know today.
There are currently around 18 million bitcoin, and at the current rate, about 700 thousand bitcoin are added annually. That means bitcoin has a stock-to-flow ratio of about 25 (18 / 0.7 = 25). After the halving, the production of new bitcoin will cut in half and the stock-to-flow of bitcoin will double to about 50. This brings the scarcity of bitcoin close to that of gold and after the next halving bitcoin is the most scarce good in human history. How cool is that? PlanB has calculated with its model that the probability is 95% that there is a relationship between the stock-to-flow ratio and the price of bitcoin. That is, according to his model, the probability is 95% that the price will rise after the halving towards values that approach the new stock-to-flow of bitcoin. The reason why the relationship is not 100% has to do with other factors that influence the price, according to PlanB. Think for example of unexpected regulation that is negative for bitcoin, hacks from exchanges that affect the price, the PlusToken scandal and other news that can depress the price.
The same relationship can be found with gold
What makes the PlanB model more interesting and adds extra strength is that the same relationship between scarcity and price can be found in gold. The value of gold also follows the stock-to-flow ratio. According to PlanB, only additional confirmation that the model is valuable and forms a good basis for the valuation of bitcoin. Based on his model, after the halving he predicts a minimum value of bitcoin of $ 55000 - 100000, depending on the values you use as input.
As a rule of thumb, you can take, based on the two previous halves, that after a halving the price increases by about 1000% and so the price goes x10. But remember that it is only a model and that reality can never be captured in a model. The current corona crisis is a firm confirmation of this. The whole world suddenly comes to a standstill, stock prices tumble down, the bitcoin price was unstoppable for a while and gold was not a safe haven either. All predictions and price gains of the past few months could be disposed of with bulky waste. It is often the unexpected events that have the greatest impact on the world and they simply cannot be predicted. You can draw lines on the graph or listen to so-called experts who predict where the price is going, but no prediction is raised against such events. That is why in my view it is always best to look purely at the properties of a project or object in which you decide to invest. Bitcoin is the ultimate savings for me because it is the first and only form of absolute scarcity in the history of humanity. It does not matter to me what rate the market is currently sticking to bitcoin, it is about the long term.
According to the Dutchman, the money for the increase that the PlanB model predicts must come mainly from gold and silver, but also from countries where negative interest rates are the norm and from wealthy investors who want to hedge the financial system with bitcoin. These reasons seem to be gaining momentum now. The US central bank has cut interest rates to 0% in the current corona crisis and the European Central Bank has already charged negative interest rates. Confidence in the financial system now seems to be rapidly crumbling and it remains to be seen where all the money will flow.
I personally think that people will only really invest in bitcoin if they understand what it is. The more people understand bitcoin on a fundamental level, the greater the chance that this knowledge will spread again. Education is therefore perhaps the most important catalyst for the next bull run of bitcoin and we are happy to contribute to this at SATOS.