The Bitcoin network on Friday night halved the incentives it pays to miners for the fourth time in its history.
The famous event, which takes place roughly once every four years according to the Bitcoin code, is designed to slow down the issuance of bitcoins, thereby creating a scarcity effect and allowing the cryptocurrency to retain its gold-like digital quality.
There may be some speculative trading on the event itself. JPMorgan said it expects to see some downside in bitcoin after the halving, and Deutsche Bank said it “doesn’t expect prices to rise significantly.” However, the impact may be greater months from now, even if bitcoin continues its trend of declining returns from mid-day to the top of its cycle. Two key things to watch are block reward and hash rate.
“While the upcoming Bitcoin halving will create a supply shock as previous ones have, we believe its impact on the price of the cryptocurrency could be magnified by the simultaneous demand shock created by the emergence of spot bitcoin ETFs,” he said. Mark Palmer of Benchmark.
The biggest immediate impact will be on the miners themselves, he added. They are the ones who operate the machines that do the job of recording new blocks of bitcoin transactions and adding them to the global ledger, also known as the blockchain.
“Miners with access to cheap, reliable sources of energy are well-positioned to navigate post-halving market dynamics,” Maxim’s Matthew Galinko said in a note on Friday. “Some miners, many that are not public, could exit the market with a combination of poor access to energy, efficient machines and capital. Miners with capital and relatively expensive energy will likely find opportunities in the wake of potential consolidation and turmoil due to half”.
The block reward
Miners have two incentives to mine: transaction fees voluntarily paid by senders (for faster settlement) and mining rewards — 3,125 newly created bitcoins, or about $200,000 as of Friday afternoon, when the mining reward dropped from 6.25 bitcoins. The incentive was initially 50 bitcoins.
The reduction in block rewards leads to a reduction in the supply of bitcoin by slowing the rate at which new coins are created, helping to preserve the idea of bitcoin as digital gold – whose finite supply helps determine its value. Eventually, the number of bitcoins in circulation will reach 21 million, per Bitcoin code. There are about 19.6 million released today.
“Miners use powerful, specialized computer hardware to validate transactions on the Bitcoin network and record them permanently on the blockchain,” said Deutsche Bank analyst Marion Laboure. “This process, known as mining, rewards miners with new bitcoins. But with each halving, the mining reward is reduced to maintain scarcity and control the rate of inflation of the cryptocurrency over time.”
The hash rate
Historically after a halving, the Bitcoin hash rate – or the total computing power used by miners to process transactions on the Bitcoin network – drops, causing some miners to exit the market. It generally recovers in the medium term, however, Laboure pointed out.
The network fragmentation rate has been at an all-time high for months as miners have scrambled to grab market share ahead of the halving. The growth of the Bitcoin hash rate reduces the contribution of individual miners to the hash rate of the network.
“In the previous three halves, the network recovered to pre-halving fragmentation levels within an average of 57 days,” he said. “It is also possible that the current elevated bitcoin prices will limit this short-term drop in hashrate, as bitcoin miners are enjoying record high profits ahead of the halving.”
Palmer said the halving’s impact on bitcoin mining economics could be “more offset over time” if bitcoin price rallies continue to push the cryptocurrency to new highs in the coming months.