Dial H for Halving: Unpacking the technicalities of Bitcoin’s halving

The crypto industry is less than a week away from a monumental milestone: Bitcoin halving at block 840,000, scheduled to take place on Apr. 20, 2024. This event is one of the most eagerly awaited developments across the entire crypto sector. Despite considerable attention from mainstream media in recent weeks, there has been a lack of understanding of the halving’s technical aspects. The dominant conversation around the halving focuses on the expected volatility in Bitcoin’s price, and the fundamental technical underpinnings and the mechanisms triggering the halving always seem to be left out of the picture.

Halvings are an integral part of Bitcoin’s economic model. It is designed to reduce the rate at which new coins are created, thereby halving the reward for mining a block. This event occurs approximately every four years and fundamentally enforces Bitcoin’s supply scarcity. This built-in scarcity is what makes the halving such a significant event.

In this report, CryptoSlate dives deep into the Bitcoin halvings, exploring its technical underpinnings, the historical context of previous halvings, and their long-term impacts on the network. We will clarify the halving process, examine its purpose within the broader framework of Bitcoin’s economic principles, and discuss its profound impact on the network’s security, miner economics, and the broader market. By providing a comprehensive overview, this report aims to bridge the knowledge gap and equip readers with a clear understanding of why the halving is more than just a potential catalyst for price fluctuation—it is a cornerstone of Bitcoin’s value proposition and longevity.

The Bitcoin halving is a fundamental protocol event that occurs once every 210,000 blocks, or approximately every four years, and plays a crucial role in its economic design. At its core, the halving event reduces the reward that miners receive for confirming transactions and adding them to the Bitcoin blockchain by 50%. This mechanism was incorporated into Bitcoin’s design by its pseudonymous creator, Satoshi Nakamoto, to create a controlled supply of tokens that mimics the extraction and depletion of natural resources like gold.

Initially, the reward for mining a single block was 50 BTC. Following the first halving in 2012, this reward was halved to 25 BTC, and it has continued to halve subsequently at the completion of every 210,000 blocks. As of the last halving in 2020, the block reward stands at 6.25 BTC. The next halving in 2024 will reduce this reward further to 3.125 BTC. This reduction in block rewards is a critical component of Bitcoin’s deflationary monetary policy, designed to cap the total supply of Bitcoin at 21 million coins.

From a technical perspective, the halving event is triggered by the Bitcoin codebase itself. The network counts the number of blocks that have been mined and automatically adjusts the reward structure every 210,000 blocks through a piece of code embedded in the Bitcoin protocol. This countdown is algorithmically managed without any manual intervention, ensuring that the supply schedule of Bitcoin is predictable and transparent.

The rationale behind implementing such a mechanism was to provide a synthetic form of inflation that decreases over time, ensuring that the currency becomes more scarce as it approaches its total supply limit. Nakamoto introduced this feature to provide a deflationary contrast to traditional fiat currencies, where inflation is controlled by central banks and often subject to changes in monetary policy.

The programming logic of the halving is embedded in the Bitcoin code, specifically within the function that calculates the subsidy for miners. This logic checks the height of the latest block and uses a simple mathematical shift to the right operation—effectively a division by two—on the reward amount after every 210,000 blocks. This automated process ensures that Bitcoin’s supply will continue to decrease over time until the maximum supply is reached, which is estimated to occur around the year 2140.

Since its inception, Bitcoin has undergone three halvings, each fundamentally changing the landscape of mining and economic incentives within the network.

The first halving occurred on Nov. 28, 2012, at block 210,000. Before this event, the block reward was 50 BTC and dropped to 25 BTC post-halving. This reduction had a direct impact on miners as their earnings from newly minted coins halved instantly, although many were partially offset by increasing Bitcoin prices and greater network participation.

The second halving took place on July 9, 2016, at block 420,000, reducing the block reward further to 12.5 BTC. This event came during a period of significant technological advancements in mining hardware, such as the development and widespread adoption of more energy-efficient ASIC miners. Despite the reduced block reward, improvements in hardware efficiency and a concurrent rise in the price of Bitcoin helped mitigate the impact on miners’ profitability.

The most recent halving happened on May 11, 2020, at block 630,000, decreasing the reward to 6.25 BTC. This halving was significantly different from the previous two, as it showed the increasing maturity of the Bitcoin network and the broader crypto market. The 2020 halving took place during a period of heightened institutional interest, which led to what was, at the time, unprecedented investment in the crypto sector. The halving also happened during a very volatile period after the onset of the COVID-19 pandemic, which crashed both the crypto and traditional markets in March 2020.

No previous halving emphasized the need for higher operational efficiency than that one. With blocks clashing to 6.25 BTC and a mass exodus of miners from China, the industry’s competition intensified, and many were racing to find the most profitable and efficient way to stay in business.

These halvings have had significant long-term effects on Bitcoin’s supply and the mining community. The diminishing block rewards are designed to create scarcity, which theoretically drives up the price per Bitcoin as fewer new coins enter circulation. In response to these halvings, the mining community has had to adapt by scaling operations and seeking cheaper power sources to maintain profitability.

Network usage and transaction fees have also shown notable changes surrounding each halving event. As block rewards diminish, miners increasingly rely on transaction fees to sustain operations. This reliance tends to drive an increase in transaction fees as each halving decreases supply while demand continues to grow or remains steady. For instance, average transaction fees spiked significantly in the months following the 2020 halving, reflecting the growing cost of transaction processing on a more congested network.

Each Bitcoin halving has reduced the reward for mining new blocks and precipitated significant technical and economic shifts within the mining sector.

Following each halving, the Bitcoin network automatically adjusts the mining difficulty to maintain a consistent block discovery rate of approximately one block every 10 minutes. This adjustment is essential as the reduced block rewards can influence the number of miners willing to expend resources on mining efforts. For instance, after the 2016 halving, there was a notable increase in mining difficulty as more efficient mining hardware became prevalent and more miners joined the network, spurred by rising Bitcoin prices.

The immediate effect of each halving is a reduction in profitability for miners, as the rewards for mining blocks halve. Miners must adapt quickly to these changes to sustain their operations. This adaptation has often involved technological upgrades to more efficient hardware, such as ASIC miners, which offer superior processing power and energy efficiency compared to older systems. Large-scale and institutional mining operations have become increasingly prevalent, driven by the need to optimize costs and manage profitability. These entities often have the capital to invest in the latest technologies and secure more affordable energy sources, positioning them advantageously within the market. Efficiency improvements in mining hardware have been pivotal in counteracting the profitability challenges posed by halving events. Over the years, ASIC technology has seen significant advancements, allowing miners to process transactions more quickly while using less energy.

The security of the Bitcoin network is directly tied to its hash rate—the amount of computing power used to process transactions and mine new blocks. Typically, the hash rate has continued to grow despite halvings, although growth rates can decelerate as miners evaluate the cost-benefit ratio of continuing operations under reduced rewards. However, the increasing participation of institutional miners has helped sustain and even boost the network’s hash rate over time, reinforcing network security.

While Bitcoin halvings are often perceived as having the most visible impact on price, they trigger a cascade of more profound effects across the blockchain and broader crypto market.

This is because, historically, each halving led to a significant bull rally. This pattern is usually attributed to the basic economic principle of supply and demand: as the reward for mining new blocks halves, the rate at which new Bitcoins are introduced to the system slows down, leading to reduced supply. If demand remains constant or increases, the price naturally tends to rise. In the months following the 2020 halving, Bitcoin’s price began to climb, culminating in all-time highs.

However, halvings can also have substantial implications for miner consolidation and the geographical distribution of mining operations. The reduced block reward increases the cost pressures on miners, leading to a trend where only the most economically efficient mining operations can sustain profitability. This economic pressure favors large-scale mining farms and institutional miners who can achieve economies of scale. This can lead to increased centralization within the mining community, as smaller operators might find it difficult to compete and either merge with larger entities or exit the market altogether. Furthermore, miners are increasingly drawn to regions offering cheap electricity and favorable regulatory environments, influencing the geographical spread of mining activities.

Smaller mining operations often face the brunt of the impact of halvings. With margins squeezed by the reduced rewards, these players find it challenging to cover operational costs. Large miners usually negotiate electricity prices directly with grid operators and can earn substantial additional income by shutting off during high demands and acting as buyers of last resort. Hardware manufacturers also often prioritize large mining operations, leaving small miners unable to acquire the latest and most efficient mining hardware. This economic squeeze inevitably leads to a reduction in the number of small operators.

The need to remain profitable amidst diminishing rewards has catalyzed significant innovations in mining technology. Miners must adopt more efficient hardware and explore alternative energy sources to power their operations. Advances in ASIC technology and improvements in energy efficiency are directly spurred by these economic pressures, illustrating a direct link between halving events and technological progress in mining.

Halvings also reverberate through secondary markets related to Bitcoin, such as derivatives and mining equipment sales. For example, the anticipation of reduced miner revenue can lead to increased volatility in Bitcoin options and futures markets as traders speculate on price movements. Meanwhile, the market for mining equipment experiences shifts in demand, particularly for older and less efficient models that become less viable under new economic conditions. Stock prices for publicly traded hardware manufacturers also fluctuate significantly during periods of high demand.

The 2024 Bitcoin halving will happen under circumstances significantly different than those surrounding previous events, both in terms of Bitcoin’s maturity and the broader economic and regulatory environment.

Since the last halving in 2020, the Bitcoin network has seen significant advancements in both protocol development and infrastructure. The implementation of upgrades such as Taproot has enhanced the blockchain’s efficiency and privacy, paving the way for more complex smart contracts and expanded utility in the network. These technological strides have optimized transaction throughput and improved the network’s overall scalability, which is crucial as Bitcoin continues to attract more users. Technical upgrades and developments like these also led to the creation and proliferation of Ordinals and paved the way for fungible tokens (Runes) that are set to launch after the halving.

The global economic and regulatory landscapes have also evolved considerably. Unlike the 2016 and 2020 halvings, which occurred in relatively stable regulatory environments, the upcoming halving is set against a backdrop of increasing scrutiny and evolving policies from governments worldwide (think El Salvador). This shift could influence Bitcoin’s adoption rates differently, as regulatory clarity might either bolster institutional confidence or impose new constraints on how digital assets are traded and mined.

Market participation is expected to change significantly with this halving. There has been a massive increase in institutional investors entering the crypto space, driven by the launch and popularity of spot Bitcoin ETFs in the US. This growing institutional interest and a more informed and technologically equipped retail base suggest a broader and more diverse market participant pool going forward.

The effects of this halving are expected to be profound for the mining industry. As mining rewards decrease, miners will be under greater pressure to improve efficiency and reduce costs. This scenario will likely accelerate the industry’s shift towards larger, more institutional mining operations, which could lead to volatility in publicly traded mining companies and their stocks.

Based on historical patterns observed in past halvings, the effects on the market could be substantial, influencing everything from market volatility to investor behavior.

Historically, Bitcoin halvings have been catalysts for major price movements. Typically, these events have led to reduced immediate market supply due to the halved mining rewards, which in turn has often precipitated a rise in Bitcoin’s price over the following months to years. For example, following the 2016 halving, Bitcoin reached a new all-time high (ATH) within 17 months. Similarly, after the 2020 halving, the price surged to another ATH within 15 months.

The immediate effect of the halving is a decrease in the rate at which new Bitcoins are created, as rewards for miners are halved. If accompanied by steady or increasing demand, this constriction of supply can lead to heightened market volatility and significant price increases.

Both traders and long-term investors adjust their strategies in anticipation of the halving. There may be increased buying activity in the months leading up to the event as traders and investors anticipate the supply cut and potential price increases, often leading to heightened market volatility. This pattern was identified in previous CryptoSlate analyses of changes in long-term and short-term holder balances. Immediately following the halving, the market might experience a correction as some investors take profits. However, if historical patterns hold, the market may gradually progress toward new ATHs as the reduced supply pressure begins to impact pricing significantly.

Investors are now more sophisticated in their approach to navigating the halving cycle. Institutional investors, in particular, who have significantly increased their presence in the crypto market since the last halving, are likely to employ more strategic, long-term positions. Retail investors, armed with more accessible information and resources, might also engage in similar strategic buying, although their impact is often more pronounced in short-term market movements.

Next week’s halving is set to occur under vastly different circumstances than previous events. With a significantly matured market and a more diverse range of participants, including a substantial increase in institutional involvement, the implications of the upcoming halving could be far more pronounced than the market expects. The reduction in supply is likely to heighten market volatility initially, followed by a potential increase in Bitcoin’s price as the market adjusts to the new supply regime.

Moreover, the continuous evolution in mining technology and the global shift towards renewable energy sources are likely to mitigate some of the cost pressures faced by miners, possibly influencing the decentralization of mining activities despite tendencies towards miner consolidation.

In sum, the upcoming Bitcoin halving is poised to test the resilience and adaptability of the mining community and catalyze significant market movements. The halving is not just a procedural necessity but a transformative event that will undoubtedly change Bitcoin’s future—both technically and economically.