Crypto Fundamentals #73

🌞 Bitcoin: The Halving

Bitcoin had its 4th issuance halving at about midnight UTC on April 20th. This is often one of the most highly anticipated events in the Bitcoin world as we see one of the key monetary policy decisions of the world largest blockchain in action.

What is the halving?

Let’s take a step back. Bitcoin is a blockchain network that is secured by miners. Miners are entities that participate in a protocol known as Proof of Work where they compete to solve a computationally intensive puzzle for the right to build the next Bitcoin block. In order to participate, miners require extremely specialized equipment, and incur high energy costs to keep their machines running. This means mining Bitcoin is expensive. So why do miners do it? Miners are incentivized to mine through block rewards (as well as transaction fees). Block rewards are some amount of bitcoin that are freshly minted by the protocol with every new block that is added.

Bitcoin has some important monetary policies etched into its protocol. Firstly, the maximum supply of bitcoins that will ever be created is 21,000,000. Secondly, every 210,000 blocks mined, the block reward is cut in half. In 2009, when the first Bitcoin block was mined, the miner received 50 bitcoins as a reward. After about 4 years the protocol appended block number 210,000, and the block reward was cut to 25 bitcoins per block. This has happened roughly every four years, and is set to happen again on April 19/20th. This time the amount of bitcoin emitted per block will go from 6.25 to 3.125. In the graph below (Glassnode), we can observe daily bitcoin issuance alongside bitcoin’s total circulating supply. Nearly 20,000,000 of the total 21,000,000 bitcoins that will ever be minted have already been minted. The sharp drops in daily issuance mark previous halvings.

There’s already a lot of thinking and writing about the relationship between Bitcoin’s halving and its impact on the price of Bitcoin:

The halving has a huge impact on miners. Basic math tells us that if issuance of bitcoin halves, then miner revenues would halve as well. In order to reach their previous revenues in dollar terms the price of Bitcoin would need to double. In the graphs below we can see the percentage of Bitcoin mining rewards that come from Bitcoin transaction fees (left) and the frequency distribution (right). Since about 2016, transaction fees have consistently made up 1-5% of block rewards for miners, with some outliers around times of high volatility (2017, 2021). We also see transaction fees spike in 2023-24 as a result of ordinals and inscriptions, with a most recent spike likely due to hype around the Runes protocol.

The halving poses a difficult challenge for miners who will need to navigate the new environment. Some may be driven to unprofitability and be forced to disconnect from the network entirely while others figure out a way to stay afloat. Additionally, the halving could have implications on the speed of advancements of mining equipment, driving engineers to create more efficient rigs to bring down power costs which, according to VanEck, account for 75-85% of a miners cash operating expenses.

Looking farther into the future, an important question in the Bitcoin community is how to incentivize miners when all 21,000,000 bitcoin are minted. As the protocol stands today, miners would have to rely entirely on transaction fees to support their mining operations. There have also been discussion about forking the protocol at some point to introduce additional subsidies for miners. There is a possibility that transaction fees are not sufficient for miners to be profitable, forcing them to unplug their machines, ultimately leading to a weaker, less decentralized network.