This Miner Insights piece was originally published in crypto mining publication MinerUpdate.

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The 2020 Bitcoin halving was one of the most discussed topics over the past year. MinerUpdate reviews the dominant theories relating to how Bitcoin will respond to the block subsidy declining.

Quick take;

Analysts and mining industry leaders have noted that the block subsidy declining could be a long-term concern for the Bitcoin network

Bitcoin price increasing and transaction fees rising are the two ways by which Bitcoin miners can be compensated for declining block subsidies. To date, the evolution of transaction fees as a proportion of total miner revenue has looked promising.

There is no solid evidence to ascertain that Bitcoin price will increase in the lead-up to or directly after the halving

A recurring theme discussed among Bitcoin miners in 2019 has been how Bitcoin as an asset will respond to its inflation schedule halving in 2020. One of the most endearing but divisive features of the Bitcoin network is the predetermined inflation schedule whereby the bitcoin subsidy miners receive for appending blocks is halved every 210,000 blocks.

With block subsidy rewards currently representing the vast majority of Bitcoin miner revenue, the impact future halvings will have on the incentive for miners to secure the network is a topic which has been vastly debated. Reputable analysts and industry leaders have noted that the declining block subsidy could be a concern.

“If a robust blockspace market doesn’t develop… a decline in block rewards poses a substantial risk for the future” (Hasu, Prestwich, and Curtis, 2019)

MinerUpdate reviews several dominant theories exploring how the 2020 halving may impact Bitcoin. This review further explore the two ways which bitcoin miners can be compensated for the block subsidy halving – transaction fees rising and/or bitcoin price increasing – and the likelihood of both.

HALVING THEORY 1 – HALVING WILL RESULT IN BITCOIN PRICE INCREASE

With the newly issued supply of the Bitcoin network scheduled to halve with no change in demand, a commonly jumped to conclusion is such a phenomenon will result in a price increase. Economics 101 would suggest that if the demand curve remains unchanged while the supply issuance declines, bitcoin price would need to find a higher equilibrium to adjust to the new market dynamics. Analyst Parker Lewis nicely illustrates the change in market dynamics from 2016 to 2019 where demand increased by orders of magnitude while supply increased only marginally.

Providing further support for the outlook that bitcoin price will increase in response to the 2020 halving is the prior bitcoin price increases observed during the past two halvings. Bitcoin price reached local highs within 1.5 years of the previous two halvings as illustrated by CoinMetrics.

Although these previous bitcoin price increases post-halving generate considerable interest and discussion, the bitcoin market is agnostic to prior events. Two previous bitcoin price increases is simply not strong evidence to ascertain that bitcoin price is destined to increase after its third halving.

In our previous analysis of the 2020 Bitcoin halving, we suggested that FOMO from Bitcoin investors as the halving approaches may result in significant upside movement. We believe that the most likely reason bitcoin price increases may materialise around the time of the halving would be due to the increased media attention and analysis which the halving spurs.

“Market prices are based on the cumulative expectations of market participants. Halving events result in increased media attention, speculation from analysts, and likely a degree of FOMO among the talks of less bitcoin being issued into existence.”

HALVING THEORY 2– EFFICIENT MARKETS HYPOTHESIS

Efficient markets hypothesis (EMH) poses one rebuttal to the claim that the halving could alone drive price increases. EMH refers to the market theory that publicly available information is priced into an asset.

With the Bitcoin halving schedule already known, EMH would suggest that the price of Bitcoin already reflects the impending reduction in supply issuance. In fact, EMH would suggest that Bitcoin price already reflects all of the future halvings.

However, Bitcoin’s predetermined inflation schedule is only one of a myriad of variables which the market needs to price in. Market participants also needs to factor in several other factors such as the potential future utility and risks associated with the Bitcoin network.

If EMH holds true, it means that mixed up in Bitcoin price is not only every halving that is scheduled to take place but all the key factors that could affect the Bitcoin network along the way. This means that when pricing in future halvings, market participants also need to account for the possibility that the halving may never happen if some development resulted in the destruction or alteration of the Bitcoin network. We hold the probability of such events to be minuscule but it nonetheless needs to be factored in under the theory of EMH.

The implication which is commonly held when relating EMH to upcoming Bitcoin halvings is that the price will increase ahead of the halving as investors anticipate the bullish effect of fresh supply being cut in half. Litecoin in 2019 was a textbook example of this phenomenon. Litecoin price outperformed all major crypto assets in terms of USD-returns in 2019 leading up to its halving in August. However, post-halving, the network suffered sharp price declines as illustrated below by the CoinMetrics team.

Our viewpoint regarding the EMH theory as it relates to the impact of the halving on bitcoin price is that there are simply too many variables at play to ascertain any meaningful relationship between the upcoming halving and how the market will price it in.

THEORY 3 – TRANSACTION FEES ADJUST TO REFLECT LOWER BITCOIN BLOCK SUBSIDY ISSUANCE

Whether transaction fees will rise to compensate for decreasing block subsidy is a topic which has been much discussed and can be contentious. Bitcoin Cash advocates would propose that rising fees act against the attractiveness of Bitcoin as digital money.

On the other hand, many view rising fees as a necessity if Bitcoin miners are to continue to play their important role in securing the Bitcoin ledger with hash power. To date, the proportion which fees represent of bitcoin miners block reward has shown promising progression.

In the early years of the network, bitcoin miner revenue was entirely comprised of block subsidies. Transaction fees paid by users to bitcoin miners started arising in 2011.

Transaction fees initially accounted for minuscules amounts of miner revenue but have grown as the network has evolved. For 2019, transaction fees mostly ranged between 1-2% of total block reward. Many analysts such as Dan Held anticipate that this percentage will grow as the block subsidy continues to decline.

THEORY 4 – STATISTICAL MODELS

A statistical model exploring the relationship between bitcoin’s price and it’s scarcity properties holds an extremely bullish outlook for the impact of the 2020 halving. Plan B’s regression study modelling bitcoin price to its stock-to-flow (S2F) achieved nothing less than virality in Bitcoin circles this year.

“The model predicts a bitcoin market value of $1trn after next halving in May 2020, which translates in a bitcoin price of $55,000.”

While the specifics of the model are beyond the scope of this piece, several critiques have been made against the Plan B model. The S2F model has also sparked several discussions online regarding the predictive power of the model.

EXPERT OPINIONS – POOLIN, BLOCKWARE, & SLUSH POOL

MinerUpdate received several interesting comments on the halving over the past year. Poolin co-founder Chris Zhu referred to the dynamic of the halving acting as somewhat of a self-fulfilling prophecy on Bitcoin price.

“My personal opinion is the halving fundamentally does not affect the price of bitcoin. But everybody thinks the event will make bitcoin price go up. So the price must go up.”

Blockware Solutions CEO Matt D’Souza highlighted how bullish he expects the halving to be on Bitcoin price.

“The halving is so bullish because the buy-side will stay the same but the supply-side will get cut in half, meaning the sell pressure gets cut in half, and the market anticipates this. Post halving there will be half the sell pressure from miners. The inefficient miners will get blown out and the efficient miners will enjoy healthier margins. Half the sell pressure on the Bitcoin Network will be removed creating an upward shift in the equilibrium price of Bitcoin”

Braiins Co-CEO Pavel Moravec pointed out an interesting attack vector which may arise as a result of the halving. With S9-generation hardware estimated to represent the vast majority of the hash rate on the bitcoin network, in the scenario that the halving resulted in this hardware becoming obsolete, a new attack vector would open where an entity with a large budget can acquire enough obsolete hardware to start working on building a longer chain.

“If there’s not a large price increase, a lot of hardware becomes obsolete with only some of the miners remaining profitable. In this case, you’re increasing the chance that somebody can acquire all this hardware and pay for the electricity to attack the network. In this case, it becomes a matter of money. Currently, the Bitcoin network is a matter of chips. The whole world strives to increase hashing power.”

THE YEAR OF HALVINGS

Ultimately, despite several theories circulating, little can be done regarding the upcoming halving. The decrease in supply will have its natural impact on Bitcoin fees and price, and mining operations will adjust accordingly.

Some mining operations may be forced to shut down but such is the nature of the mining business. Efficient mining operations will force those that are inefficient out of business while dropping difficulty levels will lure miners back in.

2020 may prove to be a year where we learn a lot about how halving impacts the price and fees of a network. Bitcoin is over a decade old now and its fee market may start significantly evolving to reflect declining block subsidies.

There are also several altcoin networks with halvings scheduled in 2020 including Zcash, Bitcoin Cash, Bitcoin Cash SV. As the year of the halvings gets underway, everyone can agree that it will be interesting to see how the Bitcoin mining industry evolves over the course of the year.