OKEx Investment Research | What impact will the Bitcoin halving have?

1. Bitcoin halving

1.1 Introduction to the concept of halving

When Satoshi Nakamoto designed the Bitcoin system, in order to control the total issuance of Bitcoin (essentially simulating gold, due to the limited reserves of gold, the mining rate will become slower and slower, so Bitcoin is also called digital gold, and Bitcoin production is also commonly known as mining), he stipulated that the production of Bitcoin would be halved after every 210,000 blocks. At first, each block produced 50 Bitcoins, and then gradually halved until it approached zero. Since Bitcoin sets a difficulty coefficient based on computing power, it produces a block about every 10 minutes on average, so it is halved about every four years. According to this rule, Bitcoin will reach its set upper limit of 21 million by 2040.

The picture comes from OKEx official website, https://www.okex.me/btchalving

The last Bitcoin halving occurred on July 9, 2016, when the block reward was reduced from 25 Bitcoins to 12.5 Bitcoins. According to the OKEx official website, the next Bitcoin halving will occur at block height 630,000, which is approximately May 12, 2020, after which the block reward will be halved again to 6.25 Bitcoins.

1.2 Long-term trend changes after each halving

Bitcoin chart

Looking at the market's reaction to Bitcoin price halvings throughout history, Bitcoin assets have shown a clear upward trend. As of today, there have been two Bitcoin halvings in history. The first was on November 28, 2012, when the price was $12.3; the second was on July 9, 2016, when the price was $650.6. From the first halving in November 2012 to November 2013, the price of Bitcoin rose by 82.1%. Similarly, after the second halving in July 2016, the price of Bitcoin jumped from $651 to $2,518 in just one year, a three-fold surge. The two Bitcoin halvings were followed by a bull market in the cryptocurrency market, and the price of the currency rose by as much as 5,289% between the first and second halvings. At present, everyone generally has a positive expectation of an expected increase in the price of the currency for the halving.

After four years, Bitcoin will be halved again in May 2020. So what are the factors that affect the price trend of Bitcoin after the halving? What impact will the Bitcoin halving have on the Bitcoin ecosystem?

2. Impact of halving on Bitcoin price

2.1 Factors Affecting Bitcoin Prices

The halving of Bitcoin production will cause investors to expect a decline in supply in the future, breaking the original supply-demand balance. According to the economic pricing principle, assuming that the growth rate of supply decreases while the growth rate of demand remains unchanged, the price will theoretically rise. Of course, in reality, the change in Bitcoin prices is affected by many factors. In addition to the practicality and network performance of the Bitcoin network itself, the development of competing products, and mining costs, there are also global political and economic events, public opinion influence, changes in whale accounts, and other factors, specifically the following:

1) Practicality

The Bitcoin white paper builds a decentralized electronic cash system based on P2P network transmission. Through this system, we can achieve instant electronic cash transfer around the world and solve the problem of generating, storing and transmitting exchange value on the Internet. The application convenience and security brought by the wonderful design are the key factors that determine the consensus of Bitcoin users.

2) Network performance

Network performance affects the price of Bitcoin. In the second half of 2013, the Bitcoin network began to experience congestion, resulting in excessively high transaction fees and the inability to package transactions for a long time, which fundamentally threatened its positioning as an "electronic cash system". In 2017, BTC implemented the expansion plan of Segregated Witness and Lightning Network, but the effect was not significant. BTC still cannot get rid of the congestion and high transaction fees, and it is difficult to take on the most important function of cash "payment" and embark on the road of "electronic gold" value storage.

3) Competitive product development

The development and improvement of competing products will divert the consensus of the group on the same track. The dispute over Bitcoin's expansion plan directly led to the hard fork of Bitcoin into BCH on August 1, 2017. On November 16, 2018, BCH hard forked into BCHABC and BCHSV, and the consensus split again. The original Bitcoin community was divided into three, and all three emphasized that they were following the orthodox path of Satoshi Nakamoto's ambitions, and the demand for BTC consensus was also greatly diverted.

4) Mining costs

Mining cost is a very important factor affecting the price of blockchain tokens in the POW mining model. In the process of obtaining Bitcoin, electricity is spent on the equipment. The price of electricity and the price of the equipment determine that the production of its tokens has some costs attached to it. Moreover, the higher the degree of blockchain encryption security, the greater the difficulty of mining, and the more difficult it is to mine tokens, which also affects the price and the relationship with the cost of energy use.

5) Global political and economic events

Bitcoin has the attributes of a combination of risky assets and safe-haven assets, and reacts to certain types of global political and economic events. Bitcoin has a history of chasing safe-haven assets many times in the past year. For example, in early January this year, because the US airstrike killed the leader of Iran's Quds Force, Iran launched a missile attack on US military bases stationed in Iraq in retaliation. Bitcoin soared from less than $7,000 to nearly $8,500 that week. In mid-2019, as trade tensions between China and the United States escalated, the Trump administration announced in May that it would increase tariffs on Chinese imports. At the same time, accompanied by market concerns about the depreciation of the RMB, Bitcoin soared by more than 100% in two months.

6.) Policies of various governments

Countries around the world are generally positive about blockchain technology, but their attitudes towards Bitcoin vary. The attitudes and policies of governments towards Bitcoin will greatly affect the enthusiasm of market investors.

7.) Influence of public opinion

The mass media's attention and coverage of Bitcoin will promote Bitcoin into the public's field of vision. And the media's positive or negative coverage will affect the public's view of Bitcoin and affect everyone's purchasing decisions.

8) Security incidents

Security incidents such as hackers invading exchanges and theft of Bitcoin whale accounts will undermine users' confidence in crypto assets and cause currency prices to plummet.

9) Whale Accounts

The unusual movement of funds in Bitcoin whale accounts and wallets such as PlusToken, as well as the large amount of Bitcoin, will also make investors worry about selling pressure, leading to the accumulation of bearish sentiment in the market in the short term.

2.2 Impact of changes in mining costs on Bitcoin prices

The halving of Bitcoin will directly affect the mining cost of its miners. We mainly explore this from this perspective. The essence of mining can be simply understood as the process in which all mining machines in the world compete to calculate the random number hash value to obtain the right to record new blocks. Miners who successfully grab the right to record will receive new Bitcoin rewards from the system. Therefore, in an ideal state, the probability of a miner obtaining the mining right is the proportion of the mining machine's computing power to the total computing power in the world.

2.2.1 Factors that affect the mining costs of Bitcoin miners are:

1) Block Rewards

Block Reward is the reward that miners receive after solving related mathematical problems through computing power and creating new blocks.

2) Computing power

Hashrate refers to the number of times the hash value is calculated per second, which is used to measure the computing power of miners. The higher the hashrate, the greater the probability of mining a block.

3) Network-wide computing power

The total network computing power is the sum of the computing power of all mining machines participating in mining in the network. The greater the total network computing power, the better the overall stability and security of the Litecoin network.

4) Operating costs: (Electricity costs, mainly water, electricity and network broadband fees

Hosting costs, the portion that miners pay/deduct when they join the mining pool)

From this, we can calculate the miner's profit:

Miner profit = coin price * block reward * (miner's computing power / total network computing power) - operating cost

The profit of miners is mainly related to the price of coins, block rewards, the performance of the mining machine itself, operating costs, and the total network computing power. The block halving directly reduces the mining income of miners, while the operating costs do not fluctuate much in a short period of time, and the performance and cost of the mining machine are also fixed. Therefore, the impact of halving on miners' profits should refer to the factors of the price of coins and the changes in the total network computing power.

2.2.2 Price affects mining profit changes and is also the main factor affecting the computing power of the entire network

The rise in Bitcoin prices will lead to an increase in mining profits and a stronger attraction to miners, which will increase the computing power of the entire network. The system will adjust the difficulty in the next cycle, and the difficulty and cost of Bitcoin mining will increase. Correspondingly, a drop in Bitcoin prices will lead to a decrease in mining profits, prompting some miners to withdraw or mine other currencies with the same algorithm, which will directly lead to a decrease in the computing power of the entire network.

Of course, price drops will also lead to the accumulation of market selling sentiment. At this time, if the price drops further, more miners will quit mining until a new coin price balance is formed. Once the market warms up and the coin price rises, the mining difficulty is lower, the mining profit increases, the mining becomes more attractive, miners join again, and the competition becomes fierce again, and the cycle continues.

2.2.3 Changes in computing power caused by the halving time difference

Like Bitcoin, the forked coins BCH and BSV have completed the production cut on April 8, 2020 and April 10, 2020 respectively. Since the proof-of-work algorithm used by BCH, BSV and BTC is SHA256, the three currencies have the same algorithm and mining machines, and the computing power is mobile among the three cryptocurrency networks. The motivation of miners to pursue higher returns makes BTC, BCH and BSV have similar daily mining returns. However, the time difference of the halving of the three will have a certain impact.

Since the halving time of BCH and BSV is earlier than that of BTC, this will cause BCH mining income to halve first. In the case that the BCH price has not doubled, some miners will switch to mining BTC, which has not been halved. The network that halved first will lose a lot of computing power. The fluctuation of the currency price can change the direction of the flow of computing power. If the price of BCH or BSV rises at the same time as the halving, the outflow of computing power will be reduced; if the price of BTC rises due to the expectation of halving or other reasons, it will attract more computing power to flow to BTC. Until the mining income of the three is balanced.

2.3 Impact of halving on the long-term trend of Bitcoin

The halving will cause a sudden change in the break-even cost of Bitcoin. The break-even cost refers to the price of the coin when the income from mining with mining machines is not enough to pay for the electricity consumed by mining under normal operation of the mining farm. It can also be understood as the mining cost price or shutdown price of a certain coin, at which time the mining profit is 0. If the coin price falls below the "shutdown price", then mining will naturally result in losses.

(Image from OK Mining Pool, April 24)

From the above content, we can get the following formula for the shutdown coin price: shutdown coin price * block reward * (miner's computing power / total network computing power) = operating cost.

At the moment of halving, the operating cost of a single mining machine remains basically unchanged, and the proportion of miners' computing power to the total network computing power remains almost unchanged. The halving of Bitcoin mining rewards will lead to a halving of the number of coins mined by a single mining machine, so its "shutdown coin price" will become twice the original. Of course, since BTC\BCH\BSV have a common algorithm, some computing power will be switched to the BCH\BSV network until the mining income of the three forms a new balance.

From a global perspective, BTC/BCH/BSV have all completed halving, and the total computing power of the three remains roughly unchanged, so the overall mining cost has doubled, that is, the "intrinsic value" of a single coin has doubled. This will cause some mining machines to shut down after BTC halving.

Although the price of coins, the computing power of the entire network and the cost of electricity are constantly changing, the price of coins will also be adjusted dynamically, but it must be raised. Commodity prices are affected by supply and demand, and fluctuate around value, which is a manifestation of the law of value. The increase in the bottom cost of mining will cause Bitcoin to fluctuate around a higher value line.

2.4 Impact of halving on the short-term trend of Bitcoin

Through a longitudinal comparative analysis of the short-term historical data of Bitcoin’s last production cut, we can see that:

1. Before the production reduction date, Bitcoin will have a short-term upward trend;

2. After the halving, the price of Bitcoin fell instead.

This is because the price changes before the Bitcoin production cut not only contain value growth, but also are full of speculative opportunities. When the obvious event of supply reduction is approaching, most people will overdraw the supply positive expectations, so that the price increase caused by the supply reduction is converted into unquantifiable demand, resulting in price bubbles. When the supply reduction is realized, it is the time when demand continues to return to balance. If there are no other positive expectations to continue, then it is easy for the price to gradually fall due to the departure of these funds that speculate on expectations. It is expected that this Bitcoin halving will also follow this pattern with a high probability.

Of course, this is not absolute. There are too many factors that affect the market in the short term, and production cuts are just one of them. For example, many economists are now worried that the economy will enter a depression, which may lead to a surge in risk aversion, and Bitcoin has once again become a hype gimmick and the price of the currency has soared.

3. Impact of Bitcoin Halving on Stakeholders

1) Miners: For individually produced Bitcoin mining machines, as the global total computing power continues to increase, the income from mining BTC will definitely decrease gradually and gradually approach zero, and backward mining methods or equipment will face elimination. The halving will cause the mining rewards for miners to be halved. When the price of the currency does not rise in the same proportion, the absolute income of miners will decrease. Once the price drops too much, high-cost miners will not be able to make ends meet and have to choose to shut down.

In fact, BTC's computing power has dropped to a certain extent after the last halving. On August 27, Bitcoin made its first difficulty adjustment after the halving, reducing it by 7.61%, which means that some miners have withdrawn from mining.

2) Mining pools: Halving will lead to an increase in mining costs, which will cause BTC to fluctuate around a higher value line, which makes miners have higher requirements for the minimum price of Bitcoin. If the mining hardware remains unchanged, the halving of BTC will reduce the probability of individual miners mining coins, so the way individual miners mine will make the time of profit more uncertain. This will hinder the speed at which ordinary users enter the market to become miners and encourage more miners to join the mining pool to smooth the income. Therefore, the halving of BTC will increase the risk of mining pool centralization.

3) Mining machine manufacturers: The relationship between Bitcoin price and mining machine orders is essentially a supply-demand balance. When Bitcoin price rises, mine owners or mining machine investors expect future Bitcoin revenue to rise, and mining machine orders increase; when Bitcoin price falls, mine owners or mining machine investors expect future Bitcoin revenue to fall, and mining machine orders decrease. The increase in mining costs has put forward requirements for mining machine manufacturers to develop more efficient mining machines.

4) Investors: The expectation of rising or falling prices of Bitcoin caused by the reduction in Bitcoin production will lead to their attention to Bitcoin and their buying and selling behaviors.