The Bitcoin Halving is now less than 10 days away. This inevitable evokes the questions in new traders what the halving is in the first place and secondly why it happens.
When Satoshi Nakamoto wrote out his now-famous whitepaper about peer-to-peer cash he defined that the supply of bitcoin would never exceed 21 Million.
Unlike fiat currencies, where central banks decide how much money is in circulation, Bitcoin is ruled by no-one but by its code. New bitcoins are created whenever miners verify transactions and receive bitcoin as a reward. Since bitcoin is a decentralized network, anyone can start mining, yet to incentivize enough people to do so, they receive a block reward for every block mined.
However, with a fixed supply unless mining rewards are reduced over time, the maximum supply is quickly reached. So to ensure scarcity and to prevent inflation mining rewards are cut in half every 210,000 blocks (roughly every 4 years).
Inflation vs. Deflation
Thanks to the halving mechanism and the limited supply, bitcoin is often described as a deflationary currency. But what does that even mean?
Inflation is what most of us are very familiar with when money is losing its value over time. This means purchasing power of money decreases, hence you can buy more with it now than you’ll be able to buy in the future. One positive effect of inflation is that it encourages investing activity, as people would rather invest in stocks or other assets to increase their money except for keeping it in a bank account where it just loses value.
However, inflation, when it reaches high percentages, causes economic devastation and insecurity as can be observed in hyperinflation countries such as Iran and Venezuela.
In contrast, deflation describes the opposite process when money increases in value over time, which makes it an incredible store of value as people would be able to buy more with their money in the future. Economists might point out that this is not necessarily good for the economy, because it makes people hold on to their money instead of spending it.
Some Bitcoin Maximalists even call the process of mining “quantitative hardening” in reference to quantitative easing, which is what central banks around the world are engaging in when creating huge amounts of new money to save our economies.
The current state of bitcoin
Bitcoin is deflationary in the sense that it has gained value over time and its purchasing power has increased. There have been highs and lows along the road, but overall 1 Bitcoin nowadays can buy you a lot more than 1 Bitcoin 10 years ago. Nevertheless, as bitcoin’s supply still keeps increasing, it has an inflation rate of something between 3.59 and 3.89%. After the halving in a few days, the inflation rate of bitcoin is estimated to fall to 1.8% which would be the first time, that Bitcoins inflation rate is below the inflation rate of fiat currencies.
At some point, mining rewards will be zero (estimated to happen in 2140) which will also eliminate the inflation rate of bitcoin. From that point onwards, the only thing that’ll happen to the supply is, that it diminishes — mainly because people lose their private keys and will never be able to restore that bitcoin again or they send it to invalid addresses.
Interestingly enough, exactly what economists forecast for deflation seems to be true for bitcoin: according to On-chain data, 62% of Bitcoin Owners are already holding for one year or longer which would support the saving hypothesis.
It’s also worth mentioning that Bitcoin and other cryptocurrencies are actively being used in countries with hyperinflation which seems to speak for the value-maintaining property of it at least in comparison to authoritarian governments dumping their fiat currency.
And what happens with the price at halving?
If bitcoins decreasing inflation is a factor for people to hodl remains unclear. However, it’s very obvious that so far bitcoin has outperformed many other traditional assets and has been a good investment for at least 76% of holders that are making money at the current price.
For the halving, some analysts are bullish with the simple explanation that a cut in supply usually leads to an increase in price. Furthermore, after the halving miners will either stop mining or will hold onto their rewards until the price at least covers their expenses.
Others are less optimistic claiming that the halving will be a non-event. The only way we’ll find out is to wait and see.