Bitcoin emerged in 2008 just after Occupy Wall Street accused big banks of misusing borrowers’ money, duping clients, rigging the system, and charging boggling fees. Bitcoin pioneers wanted to put the seller in charge, eliminate the middleman, cancel interest fees, and make transactions transparent, to hack corruption and cut fees. A pseudonymous software developer going by the name of Satoshi Nakamoto proposed bitcoin in 2008, as an electronic payment system based on mathematical proof. The idea was to produce a means of exchange, independent of any central authority, that could be transferred electronically in a secure, verifiable and immutable way.Bitcoin is similar to conventional currencies as it could be used in the digital transactions like euro, pound etc..,
It differs from fiat currencies in certain important ways like
• Limited supply
These features of bitcoin comes with the following benefits:
• Lower fraud risk for buyers
• No risk of inflation; individuals can preserve coins
• Reduced transaction fees
• Easy to use in any situation
• No involvement of any third party
• Quick payments
• Safer eco system
• International payments made easy for smaller business ventures
Fiat currencies are printed by the central banks to manage the supply demand of the country based on monetary and fiscal policies, in case of bitcoins, there is no central authority, in order to generate more bitcoins they need to be mined.
Bitcoin mining is performed by high-powered computers that solve complex computational math problems. The chance of a computer solving one of these problems is about 1 in several trillion. The result of “bitcoin mining” is twofold. First, when computers solve these complex math problems on the Bitcoin network, they produce new Bitcoin. And second, by solving computational math problems, bitcoin miners make the Bitcoin payment network trustworthy and secure, by verifying its transaction information.
Purchase or sale using bitcoin is called a “transaction.” Transactions made in-store and online are documented by banks, point-of-sale systems, and physical receipts. Bitcoin miners achieve the same effect without these institutions by clumping transactions together in “blocks” and adding them to a public record called the “blockchain.” Nodes then maintain records of those blocks so that they can be verified into the future.
When bitcoin miners add a new block of transactions to the blockchain, part of their job is to make sure that those transactions are accurate. Digital information can be reproduced relatively easily, so with Bitcoin and other digital currencies, there is a risk that a spender can make a copy of their bitcoin and send it to another party while still holding onto the original. Blockchain comes to the aid in this scenario, every block created in the chain is verified by all the people in the network, thereby ensuring it isn’t duplicated.
Verifying each of those transactions can be a lot of work for miners, which gets at one other key difference between bitcoin miners and the Federal Reserve, Mastercard or Visa. As compensation for their efforts, miners are awarded bitcoin whenever they add a new block of transactions to the blockchain. The amount of new bitcoin released with each mined block is called the “block reward.” When bitcoin started the reward was set to 50 coins per block, But Nakamoto put into the protocol a rule where every 210,000 blocks or roughly every 4 years the reward will be cut in half, so is named halving event.
At this rate of halving, the total number of bitcoin in circulation will approach a limit of 21 million, making the currency more scarce and valuable over time but also more costly for miners to produce.
Reason for halving of bitcoin lies in the laws of supply and demand. If the coins are created too quickly and there is no end to the number of bitcoins that can be created; eventually there will be so many bitcoins in the circulation that they would have very little value.
One of the main reasons is to keep inflation under control. Bitcoin simulates the commodity like gold instead of fiat currencies in circulation. Quantity of gold remains fixed only the value keep changing, whereas fiat currencies value and quantity can both change. Even with quantity fixed, gold is able to sustain the value all these years. Bitcoin after reaching the optimum level, aims to achieve the same as there is no flexibility or incentive of mining more when cost of mining becomes equal to the reward of mining.
Cost of mining = Reward from mining
Effect of halving on the price of Bitcoin:
The price of Bitcoin has dropped right before and after the two block-reward halving events in 2012 and 2016. BTC is demonstrating a similar trend approaching the May 2020 halving.
A theory has emerged that miners tend to sell before the halving to accumulate enough Bitcoin to finance their operations for many months after the halving occurs, allowing them to hold onto the majority of Bitcoin they mine.
Theoretically, such a practice would be beneficial for miners because the break-even price of Bitcoin mining spikes significantly when a block-reward halving occurs. Following the Bitcoin halving, miners’ estimated breakeven costs will rise from ~$7,000 today to ~$12,000–15,000 per BTC after. Because the halving drops the amount of BTC that is mined as Bitcoin approaches its fixed supply of 21 million, miners will earn less BTC after the halving for performing the same work. If the Bitcoin price does not increase substantially after the halving, and if the difficulty of mining remains put, miners will see a higher break-even price with similar revenues as before.
For that reason, it would make sense for big mining centres to accumulate large amounts of capital before the halving to finance their operations in advance in case the price of Bitcoin does not increase right away after the halving. The next bitcoin halving is expected to occur in the week commencing 18 May 2020, when the number of blocks hits 630,000. It will see the block reward fall from 12.5 to 6.25 bitcoins.
The first halving:
The first halving occurred on November 28th 2012 when one BTC was worth around $11. A year later, bitcoins price surged to $1,100 in 2013.It had only been one year since the halving and Bitcoin had grown 100x. Bitcoin’s price eventually fell to around $220 and it remained below $1,000 for the next few years. Even at its bottom Bitcoin was still up 20x from its price before the halving.
The second halving – The second halving took place in July 2016. Bitcoin maintained a price of around $600–$700 before reaching $20,000 in 2017. Bitcoin had grown over 33x from its price before the second halving and over 1,818x from its price before the first halving.
A halving event leads to a meaningful reduction in liquid supply. Bitcoin price starts rising in anticipation of the upcoming halving event. The rising price attracts fresh demand from investors and speculators with increasingly deeper pockets, as Bitcoin finds acceptance among VCs, hedge funds and institutional investors. The new demand exceeds expectations and price continues to rise after the halving event. Increase in demand resulting from a rising price was grossly underestimated in past cycles.
So far in 2020, the price of Bitcoin has not shown an inverse correlation with stocks and gold even with the anticipatory halving in May. Due to the coronavirus outbreak across Asia, Europe and now the United States, investors have started to frantically sell all sorts of assets, regardless of their risk-on or risk-off nature. In the last few weeks, Bitcoin, stocks and gold have moved similarly, all reacting in the same way to macro events. The big impact coronavirus could have on Bitcoin is not necessarily on the price, but rather the supply chain of miners and mining manufacturers.
About the Author:
Veenanjali is currently doing her MBA from IIM Lucknow. She comes from an Electronics engineering background with two years of work experience in the financial services sector (Forex Markets). She strongly believes in the potential of technology aids in business. Her work ethos is focused around the unlimited scope of technology in current financial services and banking.
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