The halving of Bitcoin Cash
Halving means that the reward miners get for finding a block is cut in half. In the case of Bitcoin Cash (BCH), it is expected to happen over the course of the next 24 hours. A few days later, Bitcoin SV (BSV) will follow suit, while Bitcoin itself (BTC) won’t follow for more than a month. We explain the event, both technically and economically – and why it could have very unpleasant consequences for Bitcoin Cash and Bitcoin SV.
Both cryptocurrencies are populat amongst margin traders, but not that much used in the “real world”. Take gambling for example, there you will not find a cryptocurrency casino where you can gamble with BCH or BSV.
Of course, Bitcoin is a fascinating payment system. Faster than a bank transfer, non-censorable, and flowing directly from sender to receiver. But if we are honest, even today, in 2020, the focus is less on its function as a means of payment and more on its function as an investment. And this function is based primarily on a mathematical equation through which Satoshi defined the distribution of new monetary units.
The core of this equation is halving. Since it is imminent for Bitcoin Cash (BCH), will take place in the coming days for Bitcoin SV (BSV), and will also occur in a good month for Bitcoin, we will explain it here both technically and economically. In addition, you will learn why it is happening so much sooner for Bitcoin Cash than for Bitcoin, and why halving can take very dangerous consequences for both BCH and BSV.
The technology of halving
For those who are not yet familiar with the concept: Every ten minutes or so, a miner finds a new block. If he succeeds in doing so, he can credit himself with a certain amount of Bitcoins that did not exist before. He is creating money at that moment, and that is the only method by which new Bitcoins can be created. The mining rate of Bitcoins is precisely defined by a code that Satoshi has given. In the beginning, miners received 50 Bitcoins per block. However, this amount is halved every 210,000 blocks.
210,000 blocks: That’s 2.1 million minutes, 35,000 hours, 1458.3 days, or 3.995 years. Because the time between blocks isn’t always exactly 10 minutes – miners work a little faster when prices rise – the first halving took place back in November 2012, a little less than four years after the Genesis block, and the second halving took place back in the summer of 2016, meaning Bitcoin was already half a year ahead of the actual rhythm. Currently, miners still receive 12.5 Bitcoins per block. But in mid-May – presumably on May 14 – the reward will halve again, dropping to 6.25 Bitcoins.
For most investors, however, technology is secondary. They care about the economy. And there are likely to be few technical features of Bitcoin against that have such far-reaching economic consequences.
Satoshi opted for a declining rate of creation of new Bitcoins, somewhat reminiscent of a gold mine that depletes over time. Why he did this he never specified, which is why it is speculated that Satoshi was simply a hard-money enthusiast. However, there are also environmental reasons, as the overall power consumption of mining is much lower when a majority of Bitcoins are generated while they are still worth much less. Such discussions took place in the context of Wei Dai’s b-money long before Bitcoin.
But the key effect may be that Bitcoin inevitably becomes the least inflationary money in the world at this rate of funding. The inflation rate halves every four years. If there are about 18.310 million Bitcoins at this moment, the current inflation rate would be about 3.6 percent. This is already lower than many fiat currencies, but still higher overall than central banks typically target. With the next halving, the inflation rate will then fall to 1.8 percent, which will already be less than the European Central Bank is targeting for the euro. And in four years, it will then fall to less than one percent, and so on.
Halving gives investors a reliable and unavoidable forecast of Bitcoin’s inflation rate. There is no need to assume that the euros and dollars of the world will sink into hyperinflation. Perhaps the idea that central bank independence will achieve stability in the value of money works. But there is still always risk and unpredictability. With Bitcoin, on the other hand, inflation rates are already safe.
Like an oil price shock?
But what is the effect of halving in the short term? What can be expected when this event occurs? An analogy would be the oil price shock. In 1973, the Organization of Arab Petroleum Exporting Countries (OAPEC) cut oil production by five percent to put pressure on the West, which supported Israel in the Yom Kippur War. The price of oil jumped by about 70 percent and quadrupled the following year.
Do Bitcoin halvings have similar effects on the price? When miners mine fewer Bitcoins, fewer Bitcoins hit exchanges. Supply becomes tight, and if demand remains the same, the most obvious effect is likely to be that prices rise. In the past, this has proven true: Before the first halving, the bitcoin price was around $10, and over the course of the following year – 2013 – it rose first to $260, then to more than $1,000. Similarly, during the second halving in the summer of 2016, the price had previously been around $300, and over the course of the following year it jumped to more than $10,000.
OAPEC cut production by only 5 percent in 1973. The Halvings capped bitcoin’s output by 50 percent. Accordingly, the consequences for the price are much more radical. In the case of oil, the price has increased about four to five times over the course of a year. For Bitcoin, it has risen more than 30-fold so far. However, while the first oil price shock happened unexpectedly and caught the markets off guard, Bitcoin’s halvings are perfectly predictable. Therefore, there were virtually no effects in the short term. Neither the first nor the second halving had an immediate impact on the price. Afterwards, it remained where it had been before. In the medium term, however – over the course of one to two years – the effects were all the more enormous.
Will this happen again with the third halving? Some things speak for it, some things speak against it. In favor is that fewer Bitcoins will actually flow into the markets from mining, and that this will reduce selling pressure. This should inevitably result in an increase in prices if the supply/demand ratio remains the same. And at present, there is no evidence that demand for Bitcoins is falling.
However, the evidence against this is that the role that newly mined coins play in the supply and demand game decreases with each halving. When the creation rate halved in 2016, 12.5 fewer Bitcoins flooded the market every ten minutes; with the coming halving, this will be only 6.25 Bitcoins. At the same time, the number of bitcoins already in existence has increased by 2,628,000 coins since then, which will also curb the effect of halving.
This valorizes the impact of other factors: Will demand for Bitcoins continue to grow – or will it stagnate – or even decline? How many Bitcoins will flow into the markets from other sources? The PlusToken scammers have reportedly taken in 200,000 Bitcoins and have only sold a portion of them so far. After the next halving, this number will correspond to more than 200 days of mining. And this is just one example.
Why halving happens earlier for BCH and BSV
For Bitcoin Cash, halving is imminent. At this moment, BCH is at block 629,842. 158 more blocks to go, and it will have reached block 630,000. At that point, miners’ rewards will halve. This is equivalent to a little more than a day. Bitcoin SV, on the other hand, is still missing just under 400 blocks, which corresponds to just under three days.
Why are the two forks so much earlier than Bitcoin, which is only at block 624,816, meaning it still has more than 5,000 blocks to work through before the reward is halved? The reason lies in the algorithm that regulates the difficulty of mining. To fully explain this, we need to elaborate a bit. In order for them to find a block, miners have to solve hash puzzles. The more computational power they invest in this, the faster they solve the hash puzzles. In itself, this would mean that the faster blocks are found, the more computing power the miners use. To prevent the Bitcoin mine from being exhausted in the shortest possible time, Satoshi has incorporated an algorithm that adjusts the difficulty of the puzzles every 2016 blocks so that the 10-minute interval between blocks is restored. The more computing power that works in the mine, the harder it becomes to mine Bitcoins.
When Bitcoin Cash forked from Bitcoin, this became a problem. The long period of time before the difficulty was adjusted made the blockchain vulnerable. The hash power that miners use is derived from the price. If a Bitcoin is worth $10,000, but a Bitcoin Cash is worth only $1,000 – the prices are just meant as an example – then BCH miners invest only one-tenth as much as BTC miners. Logic. Accordingly, though, it would take 10 times as long for the difficulty to adjust – if it does at all, since at a lower price and the same difficulty, it’s not worth mining at all. When it does, Bitcoin Cash mining suddenly becomes very profitable. Miners flock to the chain, generate 2016 blocks in no time, and then, after adjusting the difficulty, switch back to Bitcoin. The blockchain fluctuates between long epochs of ice age and short episodes of overheating.
To prevent this, Bitcoin Cash has changed its difficulty adjustment algorithm. Instead of adjusting every 2016 blocks, it adjusts every six blocks. This smooth adjustment prevents the bipolar alternation between slow motion and fast motion – but does not completely eliminate the aforementioned effects. The new algorithm can still be exploited by miners, and it does. There are still short episodes where blocks follow each other very quickly, and periods where blocks last a very long time. The hashrate is much less steady – and there appears to be a skew that tends to generate slightly more blocks than Bitcoin.
Bitcoin SV shares this algorithm. Here, however, the consequences are minimally less drastic. This could be because Bitcoin SV collects less hashrate – and thus may be subject to less fluctuation – or because the miners at BSV tend to be more “loyal” than at BCH: They are less likely to switch erratically between blockchains, but consider it their job to stabilize the blockchain.
The consequences of halving on BCH and BSV.
A short-term effect on prices from halving would be rather surprising for all Bitcoins. The price will probably not be much different after block 630,000 than after block 629,999, which means: miners’ income will halve.
What is particularly dramatic here is that the miners’ income will remain constant for Bitcoin (BTC) for at least a good month. This is likely to further reduce the share of the SHA-256 hashrate – that is the miners of BTC, BCH and BSV – in Bitcoin Cash and Bitcoin SV. Already, the two blockchains each account for only 1.5 to 3 percent of the total hashrate, while more than 95 percent typically remains directed at Bitcoin. After halving, this imbalance is likely to worsen.
This leaves both blockchains vulnerable to attack. An increasingly smaller portion of Bitcoin’s hashrate can, if it feels like it, drive 51 percent attacks on BCH or BSV and wreak havoc in other ways as well. The security of the two blockchains relies on the goodwill of BTC miners – or rather, their reluctance to do anything illegal with their mining equipment. At the moment, it is probably still too risky for the miners to engage in illegal attacks, while the absolute majority of the machines are busy drilling on the BTC blockchain.
Therefore, the situation will become really serious only when the miners’ rewards are halved on BTC as well. Again, this is not expected to have an immediate impact on the price. Therefore, for the more than 95 percent of miners who do not mine BCH or BSV, their income will also be cut in half. This will push many to – and likely over – the edge of profitability. Beyond profitability lurk ruin and despair. Both are likely to significantly increase miners’ incentives to do something illegal after all. Given the choice of scrapping the mining equipment or going on a 51 percent assault on Bitcoin Cash, how does one choose? And if a miner chooses to scrap – then it should become easy for an attacker to buy mining machines in bulk, which may not be profitable for mining, but may be profitable for attacks.
Therefore, the upcoming halvings of Bitcoin Cash and Bitcoin SV should not necessarily be a reason to cheer. Rather, skepticism is appropriate, and, for supporters of these currencies, also trepidation as to whether the blockchains will fall victim to attacks in the coming months.