Bitcoin is halved every four years. Is this distribution mechanism reasonable? What impact will it bring?

Editor’s note: This article has been edited without changing the author’s original intention.

In 67 hours, Bitcoin will experience its third block reward halving in history.

Many people have long been looking forward to Bitcoin's "halving every four years". They believe that if demand remains unchanged, the sharp drop in supply after the halving will greatly drive up Bitcoin prices . After the past two halvings, Bitcoin ushered in a magnificent super bull market. The first time Bitcoin rose by more than 580 times, and the second time it rose by 128 times, which seems to coincide with this judgment.

So, when Satoshi Nakamoto designed the Bitcoin system, was the "four-year halving" intentional or accidental? What positive effects will this model bring? Will there be any disadvantages? How do you view the crypto industry after the halving?

With these questions, Zhikuang University interviewed Lv Guoning, co-founder of the Nervos Foundation. Let's listen to his views below.

Zhikuang University : When Satoshi Nakamoto designed the Bitcoin block reward, he did not adopt a linear decrease, but chose to "halve every four years". What are the possible reasons behind this? What are the advantages of this model?

Lu Guoning : Satoshi Nakamoto chose to halve the value every four years in the implementation of Bitcoin, rather than decreasing it linearly. Judging from the results, I think it is very friendly to miners and brings a strong certainty to the system, which is of great benefit to the entire Bitcoin ecosystem.

But Satoshi Nakamoto never gave a direct explanation as to why he chose a four-year cycle. We can only dig out Satoshi Nakamoto's words from old papers and make guesses and speculations.

Why is the halving cycle 4 years? At present, what can be found is that Satoshi Nakamoto briefly explained in a private message to Bitcoin enthusiasts that he chose to set the initial block reward at 50 bitcoins, set the halving cycle at four years, and the final total circulation of 21 million bitcoins. However, Satoshi Nakamoto did not explain why he chose 4 years as the halving cycle. However, from Satoshi Nakamoto's perspective, he set the initial parameters, including four years as the halving cycle, as an "educated guess", that is, an educated guess, and then made a compromise choice, and considered many factors in the assumption, especially the initial setting and continuous issuance, the total amount of issuance, and whether it is conducive to widespread adoption, etc.

At present, we can only use the results to prove that the initial setting of this Bitcoin economic model has achieved remarkable results in terms of promotion and adoption, and the four-year halving is also in line with Satoshi Nakamoto's goal of designing Bitcoin as a continuously deflationary property.

Imagine if the block reward of Bitcoin is designed to decrease linearly, what impact will it have, and how will it be different from the current situation? Linear decrease and cliff-like decline, in themselves, will not affect the total amount of Bitcoin issuance, so the key to comparing the two issuance methods is to see whether it has a positive effect on the ecology.

The miners are the most affected by the linear issuance model. Miners participate in the mining competition and get block rewards. In a unit of time, the income is proportional to your computing power. If the income gradually decreases over time, coupled with the dynamic changes in the scale of computing power and the dynamic changes in market prices, this will cause great damage to the miners' experience. Compared with stable income, this is actually a suppression of the miners' enthusiasm for participation, because the miners' income continues to decrease, and this experience is actually not good.

Another aspect is the expected estimation of future earnings. With the dynamic changes in earnings, computing power, and market prices, it is difficult for miners to estimate future earnings more accurately, which poses a greater challenge to miners in making long-term decisions and dealing with various uncertain risks.

Therefore, from the perspective of the profit model, a stable and predictable profit experience is better and easier to attract miners to participate and promote the ecosystem.

From the perspective of the entire crypto asset community, maintaining a stable and predictable economic model design with a four-year halving is equivalent to making Bitcoin's monetary policy stable, transparent and predictable. In a decentralized and trustless ecosystem, it is actually very difficult to implement a dynamic and adjustable monetary policy. The consensus cost will be very high, and only a stable and predictable monetary policy can work.

A stable monetary policy can help all participants in the entire ecosystem, from miners to users, developers, and investors, to make long-term predictions and formulate long-term strategies based on the same policy, which is very beneficial to the long-term development of the entire ecosystem. From this perspective, four years is a relatively ideal time span, which is of appropriate length and very well balances the design goals of phased stability and long-term monetary deflation.

02 The flaws of the “four-year halving” model

Zhikuang University : This model also has disadvantages. For example, it will lead to less and less block reward income for miners in the later stage, which may pose a hidden danger to the security of the network. What do you think of this defect of the Bitcoin halving model? Can this situation be avoided?

Lu Guoning : There is currently a lot of controversy about the impact of the Bitcoin halving model on the long-term development of the Bitcoin ecosystem.

Because Bitcoin is essentially an asset with strong SoV attributes, that is, digital gold, it is more used for storing value rather than for trading. When Bitcoin is halved several times in the future, it won’t take long. After 10 years, the main income of miners will change from "block rewards" to "transaction fee rewards."

When miners mainly rely on transaction fees to earn income, they hope that there will be as many transactions as possible in one block. However, due to the size limit of Bitcoin blocks, the number of transactions that can be accommodated is ultimately limited , and currently Bitcoin blocks are basically full.

So the question is, if Bitcoin is halved multiple times in the future, miners must increase transaction fees to ensure the returns on their investment, and traders will need to pay more transaction fees to send their transactions.

The increase in transaction fees will have a significant impact on transaction scale and transaction frequency. From the perspective of transaction scale, when the fees rise, it will suppress small transactions. Due to the continued high fees, all transactions on the chain will be dominated by large transactions, and the proportion of large transactions in the total transaction volume is far less than that of small transactions. This will lead to a decrease in the total transaction volume, and the increase in fees will suppress the overall fee income of miners.

The increase in transaction fees and the total revenue of miners’ transaction fees may form a Nash equilibrium at some point, at which time the entire system will face new challenges:

1. Challenges from Layer 2. Many small transactions will go to the Lightning Network, further reducing the number of transactions on Bitcoin.

2. Faced with challenges from security. When miners do not have additional income, it is bound to affect miners' investment in network security. When miners' fee income is in a steady state and continues to be halved with block rewards, it is bound to cause miners to reduce their investment in security. Due to the reduction in investment, the computing power security will decrease. This downward trend will have an impact on the currency price. If this impact creates a negative cycle to stimulate miners to continue to reduce investment, the result may not be a good thing for the entire ecosystem.

Therefore, with multiple halvings, whether Bitcoin can develop safely and sustainably in the future is still a matter of great uncertainty.

The figure below shows the ratio of Bitcoin transaction fees to block rewards. The gap between the two is still quite large.

The economic model design of projects such as Bitcoin and Ethereum is highly uncertain in the future, and it is difficult for us to make an accurate judgment on the security and sustainability of their future systems. Based on this standard, we understand that a good economic model should have the following characteristics:

1. Maintain the long-term security and lasting stability of the system, and provide sufficient certainty to the system participants.

2. Balance the interests of every participant.

03 Cryptocurrency Industry after Halving

Zhikuang University : What do you think of the cryptocurrency industry after the Bitcoin halving?

Lv Guoning : Everyone is paying attention to the halving, which is also a major event in the industry. I think it can be viewed from the perspectives of miners and the ecosystem. From the perspective of miners, the halving has the most direct impact on the miners as a group, and then the influence will be triggered and spread through the miners.

First, the halving will drive the iteration of the production efficiency of the entire mining circle. We can see that in recent months, various mining machine manufacturers have launched their own high-power consumption ratio mining machines, and miners have gradually eliminated relatively backward machines. To some extent, this has increased the security investment of the network and has a positive impact on the value storage characteristics of Bitcoin.

Secondly, the financial services surrounding the mining industry are developing very fast. Many miners have chosen to use various financial instruments or products, such as futures hedging to hedge market volatility risks, or asset-backed lending to pay electricity bills. Before the halving, the entire ecosystem generally expected an increase, so the business related to asset-backed lending increased significantly. The development of blockchain financial services driven by the halving market has brought a lot of opportunities to the entire industry.

From an ecological perspective, Bitcoin has become the blockchain native asset with the largest scale and market value in the entire industry . After years of development, the current development direction of the entire blockchain ecosystem is to refocus on decentralized finance. Taking open finance as the entry point, through the programmability and composability brought by the issuance of assets and smart contracts, a prosperous Defi ecosystem is born, providing better financial services to more users, lowering the threshold and bringing some advantages that traditional financial services do not have.

A core indicator of decentralized finance is TVL, or Total Value Locked, which is the value of locked assets. This indicator is usually used to measure the scale of the development of the entire DeFi ecosystem. The biggest problem currently hindering the growth of TVL is the limited scale of blockchain native assets that can be pledged and locked. Driven by the strong demand for DeFi, the entire ecosystem is studying how to better and more safely introduce Bitcoin into the entire DeFi ecosystem on a large scale through cross-chain means.

I believe this problem will be properly solved in the near future, when a large amount of tradable Bitcoin will be locked in the DeFi platform as assets, and credit will be created and used to serve more users, stimulating the development of the entire ecosystem. By then, the value of Bitcoin will be further explored and more widely agreed upon, which will have a very important significance and impact on the development of the cryptocurrency industry.

Risk warning : The content of this article is only the personal opinion of the guest, does not represent the views or position of Zhikuang University, and does not constitute any investment opinion or suggestion.

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