Why I’m Cynical About the Bitcoin Halving

The crypto community should rely less on Bitcoin in order to truly develop and become the future financial industry of mankind.

Over the past few months, the blockchain community has been focusing on the upcoming Bitcoin (BTC) halving in May. Bitcoin has been performing very well during the pandemic, especially compared to commodities such as oil or gold, which have traditionally been used as a safe haven against market volatility. Part of the driving force behind Bitcoin’s price increase is the “halving.”

The halving is two weeks away, what on earth is this? Why should investors care about its existence? If what they say is true - some predict that Bitcoin will reach $30,000 by the end of the year due to the halving, is this the time for investors to enter the market? Before we analyze the halving and what it means for the market, Prime's two investment theses are that "the halving will drive the upcoming rally": 50% up, 30% sideways, and 20% down. This is a heretical view.

The impact of Bitcoin halving on Bitcoin price

The Bitcoin halving is when the block reward for miners is cut in half when they mine a block. In finance, we talk about stocks and flows. If we use the analogy of a bathtub, the stock is the amount of water in the bathtub, and the flow is the amount of water flowing into the bathtub. The halving means that the flow of water into the bathtub is cut in half. This means two things: First, it means reducing the rate at which new Bitcoins are added to the stock. Second, since Bitcoin has no endogenous cash flows, there is no need to perform a discounted cash flow analysis.

The price of Bitcoin is almost entirely psychology driven, miners are subject to some hard cost constraints such as labor, hardware and energy. Purely supply and demand determine the price. The halving is a supply side constraint, in this case we determine the rate at which new Bitcoins are introduced into the market and cut that flow in half. The market is very bullish on the halving. Historically, other halvings have led to Bitcoin rallying, so it is logical to think that way. Why should this time be different?

Halving the cost of each Bitcoin: Miners are getting half the reward for the same cost. In effect, miners are operating under a scenario where the cost of each Bitcoin doubles overnight. Unless the price rises, miners' profits will take a huge hit.

This is a problem unique to Bitcoin. If it happened in any other industry, these profits would put it out of business overnight. We only need to look at OPEC supply and oil prices in the 1970s to understand how supply-side shocks can play out in the real world.

Historically, miners have had control over the source of Bitcoin, and therefore have the most control over the circulation of Bitcoin. Just like OPEC today, the suppliers of Bitcoin have been able to influence its price by controlling the supply and holding Bitcoin until the price is right. To understand the power that Bitcoin miners have over its price, we must verify the ratio of existing supply to new supply by: dS divided by S.

Bitcoin mining supply

The main argument of Bitcoin bulls is that each halving leads to a price increase. According to the chart above, miners are subject to double fees and fixed costs. As a result, they will hold and limit the new Bitcoin supply until the price can cover these expenses. This requires capital, influence, and patience. It can be said that miners have all three.

However, if you follow the math, the dS-S ratio starts at infinity (10 million divided by zero) and ends at zero (almost zero divided by 21 million). The ratio approaches zero with each halving. When the ratio is high, a group of highly correlated miners can dictate the price, much like how OPEC dictated the price of oil in the 1970s. However, when the ratio is zero, miners are powerless and can no longer dictate the price of Bitcoin. This is similar to Iraq throwing a tantrum over its remaining barrel of oil while the United States is awash in cheap gas and nuclear resources. In other words, it doesn’t matter what the miners want.

Furthermore, the price determined by miners is dominated by sunk costs because Bitcoin has already been mined. If the price of Bitcoin were to fall below the cost of mining, the entire industry would change extremely quickly, potentially leading to disaster.

The theoretical point here is simple: at one inflection point in Bitcoin held by miners, it doesn’t matter at all. The trend of miner price manipulation should yield at this point, and possibly in the opposite direction. We like to call this inflection point “Peak Bitcoin”. The only question is when this will happen.

At this point, it may sound like we are bearish on Bitcoin, but that is actually incorrect. We are optimistic, albeit a little cynical, and here is why:

The general public still lacks understanding of how all of this works. A mix of “leeks” and financial illiterates are still running the cryptocurrency market. Likewise, most Bitcoin believers are blind followers who barely consider the technology and limitations behind the asset.

It’s no secret that the price of Bitcoin is almost entirely psychological. Popular bullish sentiment continues to drive the price higher, and there’s no point in fighting it. But at some point, the effects of the halving will wear off. At that point, we’ll be left with only a supply-side cost shock. Unlike oil, which is essential to the functioning of modern society, Bitcoin is not.

So, what to do? Investors must hedge by finding other types of crypto assets that are not correlated with the price of Bitcoin. This is where the emerging hybrid stablecoins come in. These hybrid stablecoins are able to maintain a stable price without being tied to and influenced by fiat currencies, and some may even increase in value.

Bitcoin has provided a safe haven for cryptocurrencies so far, accounting for about 65% of overall crypto valuations. However, Bitcoin’s dominance could also be catastrophic if prices fall. This urgently requires finding an alternative to Bitcoin. If we see a sideways price drop after halving, that should be the canary in the coal mine (pun intended: a harbinger of danger), and few miners will survive. At that “peak bitcoin” point, we would have three years to find an alternative before the entire crypto market collapses. Cryptocurrencies will need to find a way to survive without relying too much on Bitcoin. (Baijiahao)