Halving Economics: What Will Happen to the Bitcoin Price?

By Dominik Stroukal

Compiled by: Shared Finance Neo

Bitcoin is once again approaching $10,000, and of course, you want to know what’s next. 2020 is a special year for Bitcoin in many ways, one of which is the halving. The next halving is expected to occur on May 12, 2020, so let’s take a closer look at what’s next.

There are many theories about the impact of the halving on the price, most of which have some basis in economics. Although they often don't talk about it explicitly, they point to changes in supply and demand. Economists like this simple model. If we expect supply to decrease or demand to increase, then the price of Bitcoin should grow. Let's explore why Bitcoin should, or shouldn't, rise to new all-time highs.

Supply: Bitcoin inflation drops to 1.8%

By May 2020, miners’ rewards will be halved to 6.25 bitcoins instead of 12.5 bitcoins. Only about 900 bitcoins will be created each day. As a result, the annual growth rate of the Bitcoin money supply will drop by more than half to 1.8%.

In contrast to what we know better, in 2019, the US money supply grew by 5.15%. In the past 50 years, the dollar has only fallen below 2% in 1993 and 1994.

Of course, one could argue that many Bitcoins have been lost, so inflation is actually higher. If all lost or unusable Bitcoins account for a fifth of the total supply, then BTC's actual inflation rate is about 2.25%. This barely changes anything compared to the US. We simply add one year to each of the years between 1993 and 1994 (i.e. 1992 and 1995), when the US dollar inflation rate was below 2.25%.

In other words, Bitcoin’s inflation rate is already low and will fall further.

What does this mean economically? Fewer new bitcoins being issued means slower supply growth. Miners now spend some of their newly mined bitcoins or send them to exchanges in order to pay for electricity and other expenses. Buyers will fight for fewer bitcoins, which should push up prices at current demand.

This was the case with the last two halvings, which is why many cannot wait for the next one.

Supply: Forget Stock-to-Flow

More than a year before the third halving, all Bitcoin fans were challenged by an article from PlanB that predicted that the next halving would drive the price of Bitcoin to $90,000. Mathematically, the model looked convincing, and the idea behind it was impressive: the less new money that flows into the stock market, the scarcer the commodity. The more unique the commodity, the higher the price. With the halving of production, the scarcity measured by this stock-to-flow model will increase significantly. However, is it possible to predict prices in this way?

There is no need to beat around the bush, in my opinion, using stock-to-flow to predict price is completely meaningless. First of all, price is the result of supply and demand. Looking at supply is certainly useful, but without demand, we cannot find price. If the demand for Bitcoin falls, its price will also fall by the same amount of circulation. After all, just look at Bitcoin Cash and you will immediately see that this model does not work.

Second, if we know that Bitcoin will go up 10x with every halving due to incredible stock-to-flow, why aren’t we there yet? Are speculators so irrational? But maybe you can defend it because it’s too dangerous (which PlanB does). Third, according to the stock-to-flow model, Bitcoin should be worth more than the GDP of all the countries in the world in the coming decades. Once the number of newly created Bitcoins equals the number of lost Bitcoins, and the number is less than the number of lost Bitcoins, the model predicts that the price of Bitcoin will be infinity, and then negative.

Demand: Halving attracts attention…

There is no historical inevitability. People tend to use history to predict the future, thinking there are repeating cycles. Of course, there is no such thing, but what is interesting is the fact that people believe it. Therefore, repeating history can sometimes become a self-fulfilling prophecy.

In short, the expectations associated with the halving attract attention, which helps to meet those expectations.

In fact, this article is proof of that. We talk, write, and speak about the halving. If it prompts undecided people to try Bitcoin, then the halving of its own value will increase demand, pushing up the price.

Needs: Some are only temporary

Not everyone is attracted to the technical and economic features of Bitcoin. Many are simply looking for a way to get rich quick.

This is not wrong, it is true in all possible markets. With their own funds, speculators take the risk of correctly estimating future prices and provide the market with an important information function. Thanks to them, current prices contain information about the future expectations of those who are actually involved.

However, market prices are constantly changing, and upward movement attracts more and more people to the market. As with any asset, there are irrational short-term expectations that inflate bubbles, which then burst.

Historically, bubbles have inflated relatively quickly after the first two halvings. After January 2012, prices increased 100-fold in a year. After the second halving in 2016, it took Bitcoin a year and a half to increase its price 30-fold. In both cases, Bitcoin surpassed symbolic thresholds, first $1,000 and then $10,000. However, in both cases, it plummeted from its peak, losing about 85% of its value.

But what will the future hold? Unfortunately, none. As tempting as it sounds, it would be extremely irresponsible to take just two points and try to approach them in the future.

Demand: Is the market efficient?

But even if all this makes sense to you, there is one thing that brings confusion to it. If we knew almost exactly when the halving would happen, it wouldn’t be hard to prepare for it. Speculators are not stupid, they won’t miss this opportunity. In the past, we might have tried to explain that they don’t know Bitcoin. But in 2020, this is untenable.

Economists call this the efficient market hypothesis. Any known information should already be included in the price. But in reality, is this really how markets work?

Bitcoin’s growth since its last bottom, which was just above $3,200 at the end of 2018, can largely be explained by an expectation that there will be increased interest in Bitcoin ahead of its upcoming halving. So if you expect the value of Bitcoin to rise sharply immediately after the halving, adjust it down based on what you think other people expect. Try to separate those who understand the real and media impact of the halving on supply and demand from those who will only temporarily rise because of the price increase.

Of course, the market is not completely efficient, especially for risky assets like this, which are a great asset on the one hand, but also have risks such as unpredictable government regulation, fierce competition, and endless scammers on the other hand. At all times, it is necessary to constantly reassess not only the risks, but also the opportunities and prices.

In summary, the secret to Bitcoin's long-term success is not to wait for halvings and halvings. What we need to do is to patiently explain the existing risks and opportunities.

Limited supply is a necessary but not sufficient condition for price increases. The next Bitcoin halving is a natural demand stimulus that has the potential to inflate a bubble unless the public realizes that Bitcoin has changed more than people realize since the last halving. Of course, everything will get better and better.