The most recent halving of Bitcoin occurred on May 11, 2020. We must first explain a bit about how the Bitcoin network works to explain what a Bitcoin halving is.
Bitcoin and its blockchain are essentially a worldwide collection of computers, or nodes, that all have the code of Bitcoin downloaded on them. These computers each have all of the blockchain of Bitcoin stored on them. This means that each computer has the entire Bitcoin transaction history, which ensures that no one can cheat the system as the transaction would be denied by every computer. In this way, Bitcoin is entirely transparent and without everyone seeing it happen, no one can make a transaction. Even those who are not involved as a node or miner in the network can see these transactions happening live by looking at block explorers.
Mining
Bitcoin mining is the process in which individuals use their computers as a transaction processor to participate in Bitcoin’s blockchain network. A system called Proof of Work is used by Bitcoin. This means that miners have to demonstrate that they have made efforts to be rewarded in the processing of transactions. This effort involves the time and energy it takes to run the hardware on the computer and solve complex equations.
Faster computers with certain kinds of hardware yield greater rewards, and computer chips specifically designed for mining have been designed by some companies. These computers are tasked and rewarded with processing Bitcoin transactions for doing so.
In a literal sense, the term mining is not used, but is used as a reference to how precious metals are collected. Bitcoin miners solve mathematical issues and confirm a transaction ‘s legitimacy. They then add to a block these transactions and create chains of these transaction blocks, forming the blockchain. The miners that processed and confirmed the transactions within the block are rewarded with Bitcoin when a block is filled up with transactions.
In order to ensure security, transactions of greater monetary value require further confirmation. This process is called mining because the digital equivalent to the physical work done to pull gold out of the earth is the work done to get fresh Bitcoin out of the code. In our Bitcoin mining article, you can find more information about the technical inner workings of Bitcoin mining.
Halving
The reward given to Bitcoin miners for processing transactions is cut in half for every 210,000 blocks mined, or about every four years. This reduces the rate at which new Bitcoins are released into circulation by half. This is Bitcoin’s way of using a synthetic form of inflation until all Bitcoin is released and is in circulation, halving every four years.
Until the year 2140, this system will continue. Miners will be rewarded at that point with fees that network users will pay for processing transactions. These fees ensure that the incentive for miners to mine and keep the network going remains. The concept is that, after halving is completed, competition for these fees will cause them to remain low.
Halving is important because it marks another drop in the diminishing finite supply of Bitcoin. The total maximum Bitcoin supply is 21 million. There are 18,361,438 Bitcoins already in circulation at the time of writing, leaving only 2,638,562 left to be released via mining rewards.
The reward for each block mined in the chain was 50 Bitcoins in 2009. It was 25, then 12.5 after the first half and 6.25 Bitcoins per block on May 11th, 2020. Imagine if the amount of gold mined from the earth was cut in half every four years, to put this in a different context. If the value of gold is based on its scarcity, then every four years a “halving” of gold production would theoretically drive its price higher.
These halves decrease the rate at which new coins are created, thereby reducing the supply available. As other low-supply assets, such as gold, can have high demand and push prices higher, this can cause some consequences for investors.
These Bitcoin halves have correlated in the past with massive increases in the price of Bitcoin. The first half, in November 2012, saw an increase from about $12 to almost $1,150 within a year. The second halving of Bitcoins occurred in July 2016. The price at that half was about $650 and the price of Bitcoin had soared to nearly $20,000 by December 17, 2017. The price then fell from this peak to around $3,200 over the course of a year, a price nearly 400 percent higher than its pre-halving price.
The theory of the halving and the chain reaction that it sets off works something like this:
The reward is halved → half the inflation → lower available supply → higher demand → higher price → miners incentive still remains, regardless of smaller rewards, as the value of Bitcoin is increased In the process.
If a halving does not increase demand and price, then there would be no incentive for miners as the reward for completing transactions would be smaller and Bitcoin’s value would not be sufficiently high. Bitcoin has a method of changing the difficulty it takes to get mining rewards, or, in other words, the difficulty of mining a transaction, to avoid this. In the event that the reward was halved and the value of Bitcoin was not increased, it would reduce the difficulty of mining to keep miners incentivized. This means that the amount of Bitcoin released as a reward is still smaller, but there is a reduction in the difficulty of processing a transaction.
This process has twice proved successful. So far, the outcome of these halvings has been a price balloon followed by a large drop. However, the crashes that followed these gains have still kept prices higher than prior to these halving events. For instance, the 2017-2018 bubble saw Bitcoin rise to around $20,000, only to fall to around $3,200, as mentioned above. This is a massive drop, but the price of Bitcoin was around $650 before halving. While this system has worked so far, halving is typically surrounded by enormous speculation, hype, and volatility, and how the market will respond to these events in the future is unpredictable.