Halving: Why Bitcoin Is Immune To Inflation
July 9, 2020
The halving is one of the most important and famous features of Bitcoin for inflation control that differentiates bitcoin from all fiat currencies such as the Euro and Dollar.
In order to prevent inflation, the Bitcoin code integrates within it several basic regulatory principles:
Bitcoin’s Limited Issuance
Central Banks are the bodies responsible for controlling and managing the issuance of money within a centralised monetary system, thus controlling the money supply and inflation rate.
Bitcoin, on the other hand, does not have central control, boards of directors or managers: so how is the amount of money to be issued regulated?
Back in 2008, Satoshi Nakamoto had a brilliant idea: to exclude the human factor from the financial equation. In the Whitepaper entitled “Bitcoin: A Peer-to-Peer Electronic Cash System”, he (or she) explained how this would be possible.
As a decentralised monetary system, the creation of new bitcoins is completely under the control of a specific cryptographic algorithm, which follows the rules of peer-to-peer networks. This algorithm determines the frequency, time and quantity of money units issued. Any attempt to change the number of new money units issued is cryptographically rejected.
Satoshi wrote a visionary program that was intended to last over a hundred years so that Bitcoin could regulate itself. Its users would not have to worry about sudden political or economic changes or crises.
For bitcoin to be valuable it had to be scarce, as gold is for example. That is why the most important point of Satoshi’s plan was not to mint more than 21 million bitcoins. Moreover, to maintain the scarcity over time, considering that bitcoin would grow and the market would change, Satoshi devised a second solution: the halving.
This would have allowed the long-term release of new coins, in a predictable and unchangeable way.
How the Halving Works
The amount of bitcoin that goes as a reward to the miners, so the amount of newly minted bitcoins, is regulated by the halving. The term refers to the regular halving of the reward that bitcoin miners receive and, consequently, the bitcoins that are created with each block.
In the early years of Bitcoin, the reward for miners was 50 BTC for each newly mined block. Such a high incentive allowed the bitcoin network to develop quickly. On the contrary, the remuneration derived from the fees was almost zero, because there were few transactions to be validated since few users were interested in exchanging them. Then, 1 BTC was worth less than €0.50. With the current value, a reward of 50 BTC would mean giving the miner millions for each validated block!
The halving program planned by Satoshi is very gradual: since 2009 it happens about every 4 years (every 210,000 blocks to be precise), just like the US presidential elections or leap years.
In May 2020, Bitcoin’s third halving occurred, reducing the reward to 6.25 (3rd halving), after the previous ones: 12.5 BTC (2nd halving) and 25 BTC (1st halving).
Only 32 Bitcoin halving events will occur. Once these have been completed, there will be no further halvings and no more bitcoins will be created, as the maximum supply of 21 million will have been reached.
The halving is a progressive reduction in the number of bitcoins with which miners are rewarded, which results in a lower supply of bitcoins. The halving is governed by a cryptographic algorithm in the bitcoin protocol.
The Effect of the Halving on the Price of Bitcoin
As time went by and the halvings occurred, the number of new bitcoins produced decreased. Bitcoin has therefore maintained its scarcity.
Following the 2012 halving, a price peak was reached after 12 months, touching $1,031 for 1 BTC, with an annual increase of +8,500%.
After the second halving, the price peak was reached in 17 months, reaching an absolute record of $20,089 (about €17,300) and growing by 2.990%.
The following chart confirms the positive pattern historically following the halvings but it should be analysed very carefully.
In fact, we cannot say that the price peaks that occurred one year after each halving are actually due to the event: we cannot know if there have been other contingent situations that have affected its market value.
As a consequence of the last halving in 2020, which reduced the reward to BTC 6.25, many traders have high expectations (as seeing a six-digit bitcoin) while others believe that the market has already anticipated the event.
The Effect of the Halving on Inflation
Reducing the issuance of new money by 50% every four years leads to a substantial reduction in bitcoin inflation.
- 2025: the level of inflation will be less than 1% and will amount to 0.83% per year.
- 2037: will reach 0.1%
- 2053: the level will be so low that it will be practically invisible.
If we perform a comparative analysis with fiat currencies that are prone to inflation, the advantage of bitcoin is obvious.
Let us now analyse the main currency in the world: the US dollar.
In the period from 1914 to 2014, it always showed a moderate inflation rate, exceeding 10% only three times between 1968 and 1983. It is also possible to observe moments of deflation, which occurred close to periods where the gold standard played a central role (the two world wars, during which only the USA maintained the standard and respected the Bretton Woods agreements). It is indicative that the dollar has not experienced periods of deflation since the gold standard was abandoned by President Nixon in 1971.
Did you know that…
The gold standard stipulated that each currency had a fixed exchange rate against gold. Within each state, this created proportionality between the amount of money in circulation and the central bank’s gold reserves. In relations with other countries, on the other hand, it defined a system of practically fixed exchange rates, as the fluctuations were contained between the so-called “gold points”.
There are still many unanswered questions about the consequences of the halving that has just occurred and what awaits bitcoin in the near future.
What is certain, and not to be taken for granted, is that this system is working according to Satoshi’s predictions. The vision is progressing, despite all the obstacles that could have arisen over time: lack of miners interested in participating or of demand from the market, malfunctions that could have blocked the system or made it uncontrollable, external attacks. All this did not happen and it is estimated that for over 99.98% of the time, from 2009 to today, Bitcoin has been working properly and without interruption.