Credit: Shutterstock photoAt some point in the next few days, an event will occur that many believe could define the future of Bitcoin. It is, in theory, simple; the number of bitcoin awarded to miners when they succeed in creating a new block (in effect, when they “find” bitcoin as a result of their efforts) will be cut in half, from 25 coins to 12.5.
This halving, as it is generally referred to, is neither a new thing nor a surprise, but this time around could have lasting effects. What is not known is whether they will be good or bad for Bitcoin as a whole.
Like most things Bitcoin related, the issues can be complicated, but when laid out in everyday English as opposed to couched in computer jargon, the basics can be pretty easily understood.
Those less familiar with Bitcoin are probably first asking themselves a simple question; if the effects of this are unknown and could be damaging, why do it at all? The answer to that is because it was pre-ordained. When the anonymous person known as Satoshi Nakomoto wrote the original code that established Bitcoin, it was set up to address what many see as one of the problems of traditional government issued currency: the fact that continued and infinite issuance of that currency results in constant devaluation.
To counter that, Bitcoin mining was established in a way that guaranteed that only a total of 21 million coins would ever be issued, something which is achieved by halving the reward to miners every 4 years. (A more detailed explanation can be found here). The halving is written into the algorithm that is Bitcoin. It is an essential part of its existence rather than a decision that can be changed.
Knowing that it will happen is one thing, but assessing the consequences is something else. Those with a basic understanding of economic theory will know that one of two things, or more likely a combination of both, should normally happen when the number of coins paid for mining is halved. Either supply will decrease as miners shut down operations (see the effects of oil’s big drop over the last couple of years) or the supply restriction will cause an increase in price that makes continued operation profitable.
In this case, which of these two things happens, or in what ratio they happen if both occur, is extremely important. Bitcoin is built on a distributed ledger system, meaning there is no central record keeping. That task is given to the miners, so, for the system to work as intended, there needs to be some diversity among them. Fewer miners means more centralization, and that would introduce several risks, including the possibility of something known as a 51% attack.
As with most things Bitcoin, that is not as simple in some ways as it sounds. It would not automatically happen if a miner controlled 51% of issuance, but it could happen if that situation arose and would have a good chance of success.
Basically it would mean that whoever controlled the 51% could manipulate the records at will, or essentially steal all of the bitcoin. (For the intrepid few with a thirst for knowledge a good description of how that could work can be found here).
What needs to be understood is that if the halving takes place without a corresponding price increase, and we get even close to the 51% situation, confidence in Bitcoin would decline rapidly.
That doesn’t mean, though, that the price of Bitcoin (its exchange rate against other currencies) would have to double overnight when halving happens for us to know that the problem is averted. At least part of the increase in BTC/USD this year, something that has happened despite a generally strong dollar, is down to buying in anticipation of the event, so some of the price increase is already priced in.
In addition, as indicated above, the effects are likely to be spread out: some loss of production and some price increase initially, with the path then clear for a sustained, if erratic, price increase over time.
That is what happened after the last halving, back in 2012. That reaction is the best guide we have, but what introduces the element of risk here is that Bitcoin is in a completely different place now to where it was then.
BTC/USD was around $12.50 in 2012, immediately before the halving, and it was hugely easier to mine coins. The computing power and amount of electricity needed was relatively small. That meant that getting to 51% control would be extremely difficult as there were low barriers to entry for miners and dropouts would quickly be replaced.
Also, the rewards of doing so and then launching an attack were relatively small. Now, with BTC/USD at over $670 and mining no longer possible from home, it is a little more likely, but most calculations and studies suggest that an attempt would still be cost prohibitive.
What could happen, though is that a “bad actor,” motivated by something other than monetary gain, launched an attack. That is, of course, possible, but the effort involved would be huge, and for what?
As you can see, then, as much as “The Halving” sounds like a Steven King title and something to be scared of, the actual effects of it are more likely to be beneficial to current holders of Bitcoin and to the community as a whole. If so, it will, once again, demonstrate that Satoshi Nakamoto was wiser than the rest of us, even when peering into the future.
*A quick note to the Bitcoin community: I realize that this is a simplified version of the debate, but it is intended to be so in order for as many people as possible to understand what is coming. I believe that spreading the word is more important than including every complexity.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
