The Bitcoin halving is a sudden reduction in bitcoin’s issuance rate that occurs approximately every four years. It is called “the halving” because the issuance rate is divided by two. An issuance rate, also called inflation rate, is what determines how much new supply is added to the existing supply and is usually measured in percentages on a yearly basis. Before the 2020 halving, bitcoin’s annual inflation rate is at 3.7% and will drop to around 1.79% thereafter.
It’s important to understand the halving affects the issuance rate, not on the total supply of bitcoins. So, what is Bitcoin’s total supply? How has the issuance rate changed over time? How will it change with the upcoming 2020 bitcoin halving? And what will it it’s impact be on bitcoin miners? We will discuss all of this in this article.
Bitcoin is absolutely scarce, meaning that the total supply is known, fixed and completely unchangeable. It is written in the protocol that there will only ever be 21 million bitcoins created, ever. However these 21 million coins were not all created at once. Bitcoin follows a strict issuance rate with new bitcoins being created whenever a new block is added to the blockchain.
The very first bitcoin block was mined on 3rd of January 2009. This block is called the Genesis Block and, with it, the very first 50 BTC came into existence. From there on, each new block added to the blockchain, created 50 new bitcoins. After 210,000 blocks, or approximately 4 years later (given a block is created on average every 10 minutes), the first bitcoin halving took place. On 28th of November 2012 the new bitcoins created with each block halved from 50 BTC to 25 BTC.The last halving to date occurred on on the 9th of July 2016, where it issuance decreased from 25 to 12.5 BTC. These scheduled halvings are written in the bitcoin protocol and ensure that bitcoins are slowly released onto the market until reaching the hard cap of 21 million bitcoins.
At the time of writing, we are getting closer and closer to block 640,000 where the next bitcoin halving will take place. The issuance will be once more cut by two and go from 12.5 to 6.25 BTC. At that point, bitcoin’s issuance rate will be 1.79%.
Since all past, present and future halvings are scheduled, Bitcoin is the only asset in the world for which both the current and future issuance rate and circulating supply are perfectly known and predictable. We are able to project into the future to know what the exact issuance rate will be for each “halving era” as well as how many bitcoins will be circulating. Together with its absolute scarcity, this property contributes to making bitcoin one of the, if not the, hardest assets in human history and best store of value currently available.
The figure below shows the evolution of the bitcoin issuance and circulating supply over time, from inception to completion. As you can see, most bitcoins have been mined in the first decade of the protocol’s existence and as of now, around 88% of the total supply is already in circulation. However, the last few percentages of supply will take decades to be mined, with the last fraction of a bitcoin being mined somewhere in the 2100s.
The newly minted coins are offered as a reward to the miner that finds a new valid block.
Since validating a new block with a set of bitcoin transactions costs a lot of energy in the form of electricity, this feature of the bitcoin protocol ensures the miners have an incentive to keep the network secure. Bitcoin mining is a key aspect of Bitcoin and rewarding the newly created coins has allowed the mining industry to grow and the network to become more secure.
With each halving the reward drops and it becomes harder for bitcoin miners to remain profitable. The industry becomes more competitive, driving the least profitable miners out of the market. They have to keep innovating to increase the efficiency of their operations. A lot of them turn to newer hardware and cheaper renewable energy sources such as hydraulic power and solar to decrease their operational costs.
It is believed by some that Bitcoin will be abandoned once the mining reward becomes too small to sustain these operational costs. Although that is indeed a possible outcome and represents a risk, it is not the only possible outcome. In our view, there are two other (not mutually exclusive) options with a higher chance of becoming reality:
This is a popular view amongst bitcoiners who believe a natural fee market will develop to allow mining to remain profitable. This essentially means that the transaction fees will increase in time and find an equilibrium around, or slightly above, the operational costs of miners. Instead of sustaining their operations through the bitcoin rewards, miners will be able to sustain them simply through the collection of transaction fees.
This theory involves a lot of moving parts such as the evolution of operational cost over time or the price of bitcoin. Operational costs should be trending down over time as hardware becomes cheaper and production lines more distributed, meaning that miners can increase their margins on the cost side rather than on the revenue side to keep up with decreasing rewards. On the other hand, the price of bitcoin would also have an important impact on the miner’s profitability. A higher bitcoin price would certainly make less efficient miners sustain their operations for a longer time, while a lower bitcoin price would quickly push them out of the market.
An increased adoption of layer-two solutions such as the lightning network would also greatly impact the layer-one fee market. Second layer solutions aim to increase scalability and transaction throughput, thus making transactions less competitive and driving transaction fees down on that layer. As a result, smaller transactions would start taking place outside of the bitcoin blockchain.
On the other hand, the first layer would always remain the most secure option, making it more attractive for larger transactions and maintaining higher nominal fees. The first-layer would mainly consist of large “settlement” transactions (ex: a large exchange moving funds between two cold wallets) which could sustain high nominal fees, to the benefit of the miners, without hurting the user adoption.
Since there are so many unknowns in the future development of Bitcoin, it is hard to tell how or when such a fee market would take place, or even if it would be sustainable, but it remains a possible effect of the bitcoin halvings.
This is a less talked about view which needs a bit of projection into the future. If bitcoin continues to grow over the next decades, the industry surrounding it will grow with it. Exchanges, lenders and a plethora of other service providers will grow in size and influence. Their incentives will be deeply intertwined with bitcoin’s since a large part of their business models and revenues would depend on bitcoin staying relevant and healthy.
As a consequence, if bitcoin mining was to become unsustainable as a stand-alone business, it might find a spot amongst the operational costs of these service providers, just as maintaining a server is an accepted cost today. Such businesses would have an incentive to maintain the network secure and contribute to its survival. If they ran a small mining facility, at a relatively small cost, this could lead to an even greater distribution of the mining operations around the globe while maintaining the security and resilience of the network.
Of course, both options above are highly speculative. They remind us how early we still are in this journey and how young bitcoin is both as an asset and as an industry. Bitcoin mining itself has only become an industry in the last couple of years and it would not be surprising to see it change drastically in the coming decades, or even years, to integrate itself more deeply into the operational structures of bitcoin-related companies, either through a fee market or through a complete merging of the two. The bitcoin halvings remain a focal point in bitcoin’s growth and will keep challenging bitcoin miners for years to come.