Bitcoin has a limited supply of 21 million BTC. This is what makes Bitcoin so interesting. Because of the set limitation even institutional investors are openly discussing whether Bitcoin does have better properties than gold. In the case of gold, the limitation is of a physical nature, because gold has a certain rarity value and only a certain amount can be mined.
With Bitcoin, it is mathematics that ensures that it can never exceed 21 million BTC. This is an absolute result and this is very closely related to a cyclical event that recurs regularly. What is meant here is the so-called Bitcoin halving.
In this article, we want to go on a bit of a quest and explain why this event is so elementarily important and why it is playing such an important role.
It starts with the money supply
Bitcoin is a scarce commodity and strictly limited. The Bitcoin halving is very closely related to this limitation, namely because it is a mechanism that controls the inflation rate. This is because the 21 million BTC are not available in one fell swoop, but are first produced over a long period of time.
But that's only the beginning, because at the same time, the halving is closely linked to the incentive scheme that rewards miners for their work. Thus, it is part of the regulation guaranteed by the protocol and is deemed an important feature.
The Block Reward
Each block that is successfully mined contains two rewards. One is the transaction fee, which is determined by the senders of the transactions and are variable in amount. In principle, the, senders of the transactions could also decide not to pay any fees at all. In fact, however, most pay transaction fees because they do not want the confirmation time to be delayed.
Conversely, no sender will choose to pay more fees than necessary to achieve an acceptable transaction speed. Therefore, as it stands today, miners cannot live off these fees.
However, there is the second part of this so-called block reward. Here, a fixed amount of Bitcoin is generated per block, which is awarded to the miner who successfully adds a new block first. Thus, the miners generate "fresh" BTC, because with each block new ones are brought into circulation.
At the moment, the miners receive 6.25 Bitcoin per block in this way, which corresponds to approx. 146,000 US dollars (as of 23.12.2020). This means that the miners, who are often set up as companies, can certainly sustain themselves and run a profitable business. Whether it will be possible to make a living from mining in the future will depend on how much Bitcoin will be worth in the distant future. After all, the network will eventually reach a point where there will only be the fees, but no freshly minted BTC by the block reward.
The Bitcoin halving in detail
What is halved during the event is the block reward explained above. This event repeats about every four years, to be precise every 210,000 blocks. At the very beginning of the Bitcoin blockchain, however, things accelerated a bit. When it was launched on January 3, 2009, the reward for miners was still a whopping 50 BTC. But by November 28, 2012, the first halving was due and already it was only 25 BTC per block.
Since the second halving in 2016, however, Bitcoin has kept the pace of four years and reduced the reward to 12.5 BTC. Then, in May 2020, the third halving occurred, resulting in the current block reward of 6.25 BTC. The event will continue to repeat until eventually there will be no more block reward. However, there is still about 140 years until then and thus this aspect of the monetary system that Bitcoin represents is postponed to a distant future.
We can expect the next halving to occur in 2024 and the implications of the event tend to be heavily discussed in the media. Some of the media attention is certainly very speculative and ultimately serves to create hype. However, in addition to speculation, there is also a core of truth to the predictions, as past history is an excellent way to see how bitcoin halving has affected the market.
Supply and Demand
Before we get to take a look at these effects, it is worth clarifying a few basic aspects. In the classical theory of the market economy, the price of a commodity is determined by the ratio of supply to demand. If supply is high but demand is low, then the good is likely to be cheap. If, on the other hand, the good is in short supply and demand for it is extremely high, then the price for it is also extremely high because many interested parties are competing with each other for a scarce supply.
For conventional goods, supply and demand rarely take an extreme in one direction or the other. While shifts are normal, they are contained and occur cyclically. So extreme shortages or even a complete collapse in demand are very rare events. And it is exactly such an event that is produced by the Bitcoin halving.
The quantity in circulation becomes scarcer
If we go by the classical theory, Bitcoin halving ensures that fewer and fewer BTC flow into the market. In that sense, the commodity is getting scarcer. While there are over 18 million BTC already available on the market, these either already have an owner or have been lost to a not insignificant extent because many early adopters did not took care of their backups shortly after the inception of Bitcoin. After all, BTC was only worth cents or dollars at the time.
So apart from the BTC that can actually be traded on the market, you can't get your hands on new ones that quickly. This effect has definitely had an impact on the market and the Bitcoin price in recent years. Whether this will be repeated in the future, on the other hand, is speculative.
The Bitcoin Price and the Halving
Although the halving is often accompanied by a relatively large amount of media attention, very little happens on the day of the actual event. The actual effects can be regularly observed from the charts a year later. Here, primarily the price peaks are interesting, because Bitcoin has always produced a new all-time high so far.
After the halving was over in 2012, the market experienced a major price rally for the first time in 2013. Bitcoin also found its first all-time high at that time in December 2013, which caused a lot of international attention and was generally considered sensational. Just below 1300 U.S. dollars was then the end and the market began a long correction.
In 2016, however, things started to move, because the next halving took place and at the end of the year the price was able to tie in with the all-time high from 2013. And once again, the following year saw an incredible rally, with Bitcoin finally finding its new all-time high just below $20,000. And here we can already see the first parallels to the current year 2020.
Because after the rally in 2017, BTC faced a correction for more than two years until the third halving finally came in May 2020. Now that we have arrived in December 2020, we are observing the same effect as before in 2016. The Bitcoin price was able to pick up on the alltime high from 2017 and even surpass it. Now we have to wait and see whether the year 2021 holds another rally in store, as previously in 2013 and 2017.
Institutional investors entering the market
However, it would be too easy if things just kept going at the same pace. After all, there are also factors that are not at all related to the halving. For example, all rallies so far have been dominated by retail investors. They brought enough liquidity into the market, but still had nowhere near as much buying power.
That is increasingly changing as institutional investors seek to hedge their immense cash reserves against potential inflation. Among them MicroStrategy, MassMutual, SkyBridge Capital and not to forget Grayscale Bitcoin Trust. To hedge, many institutional investors often invest in gold, but also increasingly in Bitcoin because BTC is much scarcer than any precious metal. As Bitcoin's production rate has been further limited by the halving, this demand is meeting an extremely tight supply.
In addition to companies and funds, however, completely different players are entering the scene. That's because PayPal integrated bitcoin into its platform in 2020. As their service expands, additional demand is created that can no longer be met by miners and the block reward.
This forces institutional investors to buy BTC on the open market and the only thing left for them is to pay whatever price the market demands. In this sense, halving has become even more important as this additional scarcity occurs at a time when Bitcoin is experiencing a demand that has never been seen for before.
This also reveals the weak spot of this forecast. If demand does not continue to rise, even a short supply will be of no use. However, many analysts believe that we are only at the beginning of this development, which is why the year 2021 could be extremely exciting.