(Terrible title, I know, but how often do I get the opportunity to start with a string of “h” words?)
First of all, what is the halving? It’s when the amount of bitcoins that the block validators (the “miners”) get as a reward for processing transaction blocks is reduced by half. The bitcoin protocol has the reward falling by 50% every 210,000 blocks, to control the supply of bitcoins and permit a gradual tapering off of new coins as the limit of 21 million is approached (we have a way to go yet, that’s not expected until 2140). The last halving was in November 2012, when the reward fell from 50 bitcoins to 25. The next one is expected tomorrow.
It’s one of the reasons cited for the sharp increase in bitcoin’s price over the past few of weeks. And now that it’s so close, it’s one of the reasons for its sharp fall today. Which totally makes sense (not really).
The potential vulnerabilities the halving leaves us with:
- A concentration of mining power. Many miners will have to drop out of the businesses as their operations become unprofitable. We’ve already seen the beginning of this, as KnCMiner announced their bankruptcy a few weeks ago, citing the upcoming event as one of the reasons. What would this mean for the sector? Increasing concentration in the hands of the powerful. This goes against the very idea behind bitcoin: a network run by everyone. That undermines the credibility of its story and its goal. But a more insidious worry is the vulnerability to manipulation. In a decentralized network, we can trust the honesty of the crowd. In a centralized one, not so much.
- Slower transaction times. The removal of part of the hashing power (computers running the network) would make block confirmations even slower. As you know, blocks are confirmed by finding the right random value that gives a hash (= a condensed string of characters that results from passing the block through a certain algorithm) within a certain range. The range is set to be narrow or broad enough to ensure that blocks can be validated in about 10 minutes. If they get validated faster, the difficulty increases. Slower, it decreases. With fewer machines churning the random numbers and algorithms, it’s very likely that the block validation time will slow. Fewer machines searching for the right random variable will lead to a longer time to find the correct one, just as fewer people searching for a needle in a haystack leads to it taking longer to find the pesky needle. Slower transactions will lead to the system re-setting the difficulty, but that only happens every 2016 blocks. Until then, big frustration for people trying to pay with bitcoin.
- An offloading of bitcoins. To help cover profitability shortfalls until faster and cheaper equipment appears, miners may well have to start selling some of their considerable bitcoin holdings on the market. That could push prices down. Or, given the fickleness and jitteriness of markets, the possibility that that could happen could be enough to trigger a fall.
Basic economics says that when the supply of something decreases, the price increases. So, many bitcoin experts are convinced that the bitcoin price will increase right after the halving. And so far, they’ve been proved right, the bitcoin price has gone up over 50% in the past three months.
But here’s the thing: the supply is not decreasing. In fact, it’s increasing. At a slower rate, true, but it’s steadily increasing. And here’s something else that I don’t understand: this slowdown in the rate of increase is totally expected. It has been expected since the beginning of bitcoin. So in a rational market, the price would have already discounted this halving, and would have no reason to increase in the run-up to it. The expected effect would already be in the value. It should be, in a rational market, price neutral.
So, either there’s something else going on (hello, China? You feeling ok?). Or, bitcoin’s market is not rational. Neither makes me feel particularly good as an investor.
And yet I am still a bitcoin fan. I want the volume to be strong and the price to increase. But this focus on the price, and the inherent volatility of the market, is not what bitcoin needs. It’s great for speculators. But for bitcoin to occupy the place in the world economy that it deserves, as a decentralized alternative to global transfers, we should be focussing on its inherent value, on its utility and on its future.
The halving will have a market impact. But it’s very unlikely that it will be long-lasting. Miners may drop out. Others will step in to take their place, with newer and faster and shinier machines. The price could go haywire. But it will calm down. There could be structural problems. But they will be fixed. And we will probably see some impacts that no-one expected. We’re new at this. But we’ll figure it out. I believe that focussing on this event is short-termist, and missing the big picture. The price increase is exciting, and I couldn’t be more pleased, but relating the price movements to halving event is latching on to easy explanations and buying into the media hype. And that the fundamentals of bitcoin deserve better.