Bitcoin is the first Crypto and also the most famous one to date. Its price is determined by the law of supply and demand which is a fundamental axiom in economics.
Before we understand what Bitcoin Halving is, let us understand what Bitcoin mining is. The transactions of Bitcoin exist on a distributed network called the Bitcoin blockchain. Transactions are recorded on a block and new blocks are added to the Bitcoin blockchain. These transactions are encrypted in nature and the miner who decrypts them and adds a valid block first to the network is rewarded with Bitcoins. This reward is the incentive for miners to decrypt transactions.
How Does Bitcoin Halving Work?
Bitcoin halving is a critical event that takes place every four years. It essentially means that every four years the number of Bitcoins received by a miner for adding a block to the Bitcoin blockchain is halved.
Now, why is it necessary to reduce the supply of Bitcoin, and what is the philosophy behind this idea? And how does this affect the price of Bitcoin? Let’s find out in this detailed read.
Stock Flow Model Of Bitcoin
Money’s hardness (its ability to be a good store of value) is directly linked to its supply. There are two determinants of the supply of money
- Stock – The existing supply in circulation that has ever been produced minus the amount that was used (Eg: if 100 units of gold were produced since the beginning of time and 10 units have been used, the stock of Gold is 90 units)
- Flow – The supply added to the existing supply at a regular interval (Eg: 20 units of Gold are produced every year)
The ratio of these two factors is known as the stock flow ratio which is a critical determinant of the value of the asset. The higher the Stock-flow ratio the more robust the currency.
Now, most of us might not have observed the value of our currencies dropping or rising regularly. We are busy with our daily lives, and we blame ourselves for not making enough money. But on the flip side, we forget that fiat currencies drop in value because of excessive circulation and do not have the same purchasing power as they did in the past.
The Story Of Yap Islands
To learn this better, let us go back in time and understand the impact of the Stock flow ratio on the value of an asset.
Yap islands are part of the federated states of Micronesia. A long time ago, Rai stones were used as a currency on this island. Rai stones contained limestone which was not available on Yap islands. These stones came in different shapes and sizes and were bought from neighbouring islands. Some of these stones weighed as heavy as 4 tons. The rarity and the beauty of these stones made them desirable to own.
An owner of the Rai stone would declare his/her ownership of the stone in front of everyone on the island. Hence there was no chance to steal because everyone knew who owned a particular stone. If the owner wishes to trade the stone, they would have to do it publicly. Once the ownership is transferred the people of the island would be notified.
Now, Does this system sound familiar? People acquainted with Blockchain technology would recognize that this is exactly how Blockchain works.
Read about: What Is Blockchain Layer?
For centuries the Rai stones were an effective form of currency. This status quo remained until 1871 when an explorer named David O Keefe was shipwrecked on the shores of Yap island. He lived there for a while and he saw an opportunity to make wealth from Yap island. He decided to produce coconut oil from the available resources on the island but found that the natives of the Yap island would not accept anything other than Rai stones to trade.
He sailed to the nearby islands to find Rai stones and brought a ton of them onto Yap island. This huge supply of stones reduced its value because now it is not rare anymore. The village chief also banned the locals from doing business with O Keefe. Some of the villagers agreed and others disagreed which eventually led to the demise of Rai stones as a form of currency.
This flow of supply ( which the Yap natives could not control) is what the Bitcoin Algorithm controls. So how many Bitcoins have been mined till date? There will only be 21 million Bitcoins ever and no one can alter the rate at which Bitcoins can be produced every year. Close to 19 million Bitcoins have already been mined and the last Bitcoin will be mined in the year 2140. The finite nature of Bitcoin and the rate at which the supply of Bitcoins is reduced makes the Stock flow ratio higher for every four years.
Bitcoin Halving Dates
The reward for mining each block was 50 BTC in 2009. In 2013, the reward was reduced to 25 BTC and it has been halved every four years since. The current reward for adding a block to the Bitcoin Blockchain is 6.25 BTC.
When Is The Next Bitcoin Halving?
The next Bitcoin halving is going to happen in 2024 when 3.125 BTC will be the reward for mining each block. This number is going to further decrease until the last Bitcoin is going to be mined in the year 2140.
The graph shown above also shows that there is a positive correlation between the price of Bitcoin and the Bitcoin Halving event.
How Does Bitcoin Halving Affect The Bitcoin Network?
Bitcoin halving has a deflationary effect on the price of Bitcoin. Each halving event was accompanied by a rise in price. The price rise did not happen immediately but happened in the subsequent future. For example, 150 days after the Bitcoin halving event in 2020, the price of Bitcoin rose from $8821 to $10,943.
After each halving, it gets more difficult for the miner to own Bitcoins at the same time the price of Bitcoin could be higher. This would encourage more miners to be part of the Bitcoin network and compete.
Unlike traditional currencies which can be printed as per requirement, Bitcoin is modelled with a robust stock-flow ratio framework. Under similar conditions, history always repeats itself, and there could be a chance for a similar price rise to happen after the next halving. Irrespective of the price, BTC is a coin that is driven by strong economics unfettered by any centralised agency.