What do bitcoins and anniversaries have in common? The digital currency and its corresponding worldwide network of so-called bitcoin miners is about to celebrate its 8th anniversary. In the bitcoin world, this is easy to calculate as the network, based on its complex yet elegant mathematics, halves its reward to miners who maintain the network every 4 years. The second halving anniversary is expected to occur on July 9, 2016 (or thereabouts).
Powerful networked computers that maintain the bitcoin network, known as bitcoin miners, are rewarded for solving complex cryptographic puzzles that are designed keep all bitcoin transactions and its global network secure and operational. At bitcoin’s inception, a 50 bitcoin reward was earned every 10 minutes. This is the time it takes to assemble all bitcoin transactions that have occurred worldwide during this time into a new block of transactions in the blockchain, the public ledger of bitcoin transactions that miners are incentivized to maintain. Four years later, the reward dropped to 25 bitcoins. In July, it halves again to 12.5.
This behavior is exactly as expected, as bitcoin mining was designed to simulate traditional mining of scarce commodities such as precious metals. As the easy-to-reach gold and silver gets mined, finding additional metal ore becomes more difficult and requires additional effort. Bitcoin works in a similar way. As bitcoin matures, it was anticipated that greater transaction volumes would occur, and they have. As each transaction carries a small transaction fee (typically around 10 cents USD), this provides another incentive to the miners. The price of bitcoin was also expected to rise over time, and again, that has also occurred providing even greater incentive.
Originally traded for only pennies per bitcoin, the original bitcoin award amounted to just a few dollars per block. The effort to maintain the nascent network, the fewer transactions and a smaller group of miners made this profitable to the participating miners. The cost of mining, however, grew substantially in the years that followed. Specialized mining hardware was developed, thousands of new miners joined the network, miners collaborated into several mining pools to increase their chances of earning rewards, and the price of bitcoin began to rise more rapidly. The algorithm that governs bitcoin had predicted this would occur. Bitcoin’s mathematics included from its start the concept of a difficulty factor, a self-balancing mechanism to keep the network secure and to allow new blocks to be created about every 10 minutes regardless of the number of miners or the power of the mining computers.
By the time the reward halved for the first time in late 2012, bitcoins were trading for about $12.50. The 25 bitcoin reward therefore amounted to $312.50. Six months later, the price of bitcoin rose to $130. Were these events connected? Did the increased scarcity affect the price? Did the slowing of the growth of the bitcoin money supply strengthen its value? It’s hard to say exactly what caused bitcoin to gain more than 10 times its value in just 6 months given that this was the first time that a halving event ever occurred, with a currency that never before existed.
Where is bitcoin today as we approach the next halving, just weeks away? As of today, the price per bitcoin is $728. Current mining rewards are therefore $18,200, given 25 bitcoins awarded per block. When the block reward drops to 12.5 bitcoins, will the reward immediately drop to $9,100. More importantly, though, will bitcoin remain at $728 or will it quickly rise to reflect the further slowing of the money supply growth? If history is an indication, we may see 10x multiples within several months. Will bitcoin really rise to $7,280 or more in this timeframe? Of course, no one knows.
Here’s another important consideration. As the total number of bitcoins that will ever be mined is fixed at 21 million, as 15.7 million have already been mined, how will this additional scarcity affect its value?
The impact of this halving event is potentially huge. People holding bitcoins or looking to acquire some will want to follow this important event in the life of bitcoin.
With governments printing money like it’s just paper (well, central banks just create new ledger entries when they “print” money), we will likely see the price of fiat currencies drop in the months ahead. Put another way, the price of commodities like gold, silver and dare I say, bitcoin, whose inventories remain scarce and whose demand continues to grow, will likely see their value grow over time, perhaps much more quickly than any of us expect.