Bitcoin Halving 101: Definition, How It Works, Why It Matters

Every Bitcoin user and miner is familiar with the term “Bitcoin halving” and what it entails for the cryptocurrency. The halving is the term used to refer to one of the most pivotal events on Bitcoin’s blockchain. This event regulates the amount of Bitcoin in circulation, preventing it from growing exponentially. Bitcoin halving has implications for all stakeholders in the Bitcoin ecosystem.

What is Bitcoin halving?

To put it simply, Bitcoin halving, sometimes referred to as “the halvening,” is the process by which the incentives for mining Bitcoin are cut in half when each set of 210,000 blocks is mined.

By reducing the rewards for mining Bitcoin as more blocks are mined, Bitcoin halving restricts the supply of new coins generated. This contrasts with fiat currencies such as the US dollar or the euro, which lose purchasing power when governments issue an excessive amount of them.

Previous halvings have been associated with strong boom-bust cycles that concluded with prices higher than they were before the halving event.

How does Bitcoin halving work?

To comprehend how Bitcoin halving works, it’s necessary to grasp the fundamentals of cryptocurrency creation.

Bitcoins are created via a decentralised system in which individuals known as miners join the network as transaction processors and validators. They utilise high-powered computer systems to solve complicated mathematical puzzles to validate transactions on the Bitcoin ledger. After validating transactions successfully, which typically takes 10 minutes, miners receive the newly generated bitcoins as rewards.

Bitcoin mining is a kind of competition. Bitcoin uses a consensus protocol called Proof-of-work (PoW), which requires miners to process and verify transactions to get rewards in return. Miners essentially compete to be the first to add new blocks to the blockchain. They are rewarded with a set amount of fresh bitcoins for each block mined.

For every 210,000 blocks added, the payout for mining a block is halved. Since it presently takes four years to add that many blocks, Bitcoin halving occurs at around four-year intervals. The third Bitcoin halving occurred in May 2020, and the next is expected in 2024.

Below are the Bitcoin halving dates, block number and block reward changes.

The first eight halving dates for Bitcoin (BTC) – This is not exhaustive.

Why does Bitcoin halving occur?

Satoshi Nakamoto (pseudonym), the founder of Bitcoin, set a limit on the total amount of Bitcoins that may ever be created. This limit is 21 million Bitcoins, with the last bitcoin expected to be generated in 2140. With halving taking place typically every four years, Bitcoin will become scarcer and more valuable, preventing extreme price inflation simultaneously. 

This distinguishes Bitcoin from other inflationary currencies such as the dollar or euro, which lose buying power over time, resulting in an increase in the price of goods and services.

The theory behind the halving works something like this:

The reward is halved → half the inflation → lower available supply → higher demand → higher price → miners’ rewards still remain, even smaller, as Bitcoin’s value can rise in the process

If demand and price do not increase as a result of the halving, miners may all quit since the payout is reduced and the value of Bitcoin remains unchanged. However, there is a mechanism that comes to help. If the payout is reduced in half but the value of Bitcoin isn’t increased, the mining difficulty can be adjusted to make mining simpler. This means that the incentive is unchanged, but the processing difficulty is lowered.

Previous halvings are associated with dramatic boom and bust cycles that have historically ended with greater prices than prior to the event.  For instance, during the 2017–2018 bubble, a bitcoin’s value rose to about $20,000 before dropping to about $3,200. This is a huge decline, but Bitcoin’s price was roughly $650 prior to the halving.

While this pattern has worked so far, halving is often accompanied by intense speculation, hype, and volatility, and the market’s reaction to these occurrences is unpredictable in the future.

What are the Bitcoin halvings’ effects?

Bitcoin halving has significant impacts on the many parties participating in the Bitcoin network. Below is how the Bitcoin halving affects key Bitcoin stakeholders.

Miners

Mining has a complex influence on the Bitcoin ecosystem. On the one hand, a decreasing supply of bitcoin raises its demand and prices. However, fewer rewards may make it more difficult for individual miners or small mining operations to remain in the Bitcoin ecosystem since they may struggle to compete with big mining companies.

According to studies, the mining capacity of Bitcoin is counter-cyclical to its price. Hence, as the crypto price grows, the number of miners in the ecosystem falls, and vice versa. A halving event is marked by a surge in price and may raise the likelihood of a 51% attack on Bitcoin’s network because miners leave the network, making it less secure.

Investors

In general, halving leads to a rise in the price of the cryptocurrency due to lower supply and higher demand, which is good news for investors. In anticipation of the halving, trading activity on the cryptocurrency’s blockchain is likely to increase. However, the rate of price increases varies according to the logistics and conditions of each price halving.

What happens when the rewards get to zero?

Given the reducing block rewards, it’s inevitable that eventually, it will taper off. However, this does not mean the role of the miners in the network would be complete. Even if all the tokens would be in circulation, there is the need to verify transactions by the nodes. The miners still need the motivation to keep on securing the network.

One of the best alternative options would be to reward the miners using transaction fees. Already, the Bitcoin users are paying transaction fees for all the transactions using the token. Therefore, the rates of the transaction costs might have to increase to sustain the miners.

Given there are various cryptocurrencies with lower transaction fees, you might wonder how it will impact the popularity of Bitcoin. From market analysis, the trading volumes in Bitcoin will be massive by then, therefore the rates wouldn’t shoot too much. Bitcoin will still remain an ideal medium of exchange and store of value.

What will happen during the next halving?

Most investors predict Bitcoin’s value will rise, and it may even grow faster between now and its fourth halving in 2024. This is based on its historical performance and the outcomes of the first and second halving occurrences. At both times before now, the prices of Bitcoin saw huge upward trends.

The first halving in 2012 resulted in a price surge from $12 to over $1,150 within a single year. In 2016, the second halving brought Bitcoin’s price to roughly $20,000 before plummeting to $3,200.

Given that new Bitcoins are mined around every ten minutes, the next halving is predicted to occur in early 2024, at which point the miner’s incentive will decrease to 3.125 BTC. For Bitcoin investors and traders, it’s worth noting that halving often results in significant volatility and turbulence for the cryptocurrency.

Bitcoin halving is a highly-anticipated event every four years, beginning in 2012. It is the digital asset’s programming to keep its total supply stable. However, no one can precisely predict what will happen during the halves and the weeks and months that follow, although halving occurrences have traditionally resulted in considerable price changes.

FAQs

What is Bitcoin halving? 

Bitcoin halving is the reduction of the miner’s reward by half after every 210,000 blocks or every four years. The Bitcoin network relies on halving to control token supply which also impacts the general market value.

At the launch of Bitcoin in 2009, every miner would get 50BTC for every mined block. A few halvings later, the reward is currently at 6.25BTC, with the latest Bitcoin halving occurring in May 2020. The last of the halvings is expected around 2140 when all the 21 million maximum Bitcoin supply will be on the market. 

Why is Bitcoin halving necessary?

Bitcoin halving is important because it controls supply. Given the decentralised nature of cryptocurrencies, there is no single authority that determines the supply or inflation of Bitcoin. It is dependent on the market supply and demand. 

The Bitcoin network works such that the more miners in the system, the harder the mining difficulty. As Bitcoin gains value there is the risk that it will have more miners, which makes it harder to mine and in turn impacts supply. With the halving, the miners stay constant, hence an assured supply. 

Why do miners still prefer Bitcoin even with a reduced reward?

Even though there have been three Bitcoin halvings so far, most miners still join the network. Companies are investing in mining rigs and special mining machines. From the face value, it seems ironic. However, this has all to do with the increasing Bitcoin value.

At the start even though the rewards were 50BTC, BTC at the time was only around $100. You can’t compare that with those who currently earn 6.25BTC when the value of the token is around $50,000.

This trend will continue into the future. As long as Bitcoin value increases, Bitcoin mining will remain lucrative even after the halving. 

The bottom line

Bitcoin halving is a much-hyped event that generally occurs every four years, with the first one taking place in 2012. The event cuts in half Bitcoin’s inflation rate and the pace at which new bitcoins enter circulation.

The rewards mechanism is expected to continue until 2140 when the total maximum supply of bitcoins is reached. After that, miners will receive rewards in the form of transaction fees. 

Previous halvings are associated with dramatic boom and bust cycles that have historically ended with greater prices than before the event.