When Bitcoin (BTC) was first created, its protocol (or rules) contained a few specific features to keep inflation under control.
For starters, the digital currency placed a hard cap on the total units that can exist at any one time by limiting this figure to 21 million. Further, Bitcoin Protocol implemented the halving mechanism, which caused the supply of new bitcoin entering the market to decrease over time.
For starters, this article will review a few basics that potential investors should know.
New units of Bitcoin are created through mining, which is the process of confirming the digital currency's transactions and combining them into blocks. To verify these transactions, miners must leverage specific hardware and consume substantial amounts of electricity. To make it worthwhile, they must receive some kind of reward.
Initially, the mining reward was 50 BTC. However, the amount has decreased twice—in both 2012 and 2016—and at the time of this writing (15 June 2018), the mining incentive was 12.5 BTC.
Why The Halving Mechanism Matters
The basic idea behind taking the halving approach was that economically, Bitcoin functioned more like a commodity, such as gold, than a fiat currency, like the U.S. dollar or the Japanese yen. Theoretically, a government's central bank could always issue more units of a fiat currency, therefore decreasing its purchasing power.
By controlling the supply, the creator of Bitcoin could help ensure that the digital currency would remain valuable. Part of this control comes in the form of capping its total eventual supply at 21 million, and the other aspect is providing systematic declines in the supply's rate of growth.
As for how halving events impact miners, every one of these incidents reduces the amount of bitcoin that a miner receives for mining a block. Without accounting for transaction fees, a halving means a 50% decrease in compensation for miners.
However, miners should keep in mind that as technology advances, processing power is expected to become less expensive, which could help make up for the reduced mining reward.
Bitcoin Halvings' Potential Impact On Price
While it is difficult to predict how future halvings will affect Bitcoin's price, market history can provide some insight. When it experienced halvings in 2012 and 2016, the digital currency's price did not experience extreme fluctuations.
In 2012, for example, the digital currency had one of these events, and it did not suffer sharp volatility as a result. Bitcoin's price did not experience any robust changes until 2013, when it began climbing sharply.
In the runup to the second halving, Bitcoin's price experienced a notable climb, rising upwards of 50% between the beginning of 2016 and the time that the long-anticipated event took place. However, market observers also pointed to economic uncertainty in China and Europe as potentially fueling this increase. After this halving took place in 2016, Bitcoin did not experience any significant price fluctuations, at least not immediately.
Bitcoin was designed with a few safeguards created specifically to keep inflation under control. The cap on the total supply (set at 21 million) and the series of halvings were both created to help ensure that Bitcoin's purchasing power would not diminish.
Investors should keep in mind that every time a halving takes place, the mining reward is reduced by 50%, which in turn causes the rate at which new Bitcoins are added to the total supply to fall by half.
As for how these developments affect price, investors can look to prior market history around these events to get a better sense.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…