Bitcoin halving: what is it and how will it affect pricing?

Cryptocurrency investors are getting ready for the hotly-anticipated Bitcoin halving this month, which will see the number of new Bitcoin being created cut by half.

With an estimated eight days left on the clock, prices rallied above US$9,000 per Bitcoin last week for the first time since February and are currently around US$8,800.

The impending event will mark the third time block rewards have halved and going by the previous occasions, market watchers are expecting it will add substantial value to the commodity.

Though Bitcoin expert and DigitalX (ASX: DCC) executive director Leigh Travers told Small Caps that the asset’s best performance is expected to be seen about a year post-halving when supply and demand principles take effect.

“I think buyers  at the moment should have a positive outlook over the next year or so,” he said, adding that traders who are trying to time a one or two-week trading event around the halving should understand that it is a relatively high-risk trade due to Bitcoin’s volatility.

What is the Bitcoin halving?

A Bitcoin halving occurs when block rewards, or the number of Bitcoins entering circulation whenever a block is produced (approximately every 10 minutes), is reduced by half. This means new Bitcoin will be subsequently issued half as fast as before.

It occurs on a schedule built into Bitcoin’s programming and happens every 210,000 blocks with the purpose being to issue the total supply into the market less frequently over time. This supply effect increases Bitcoin’s scarcity, which has, historically, increased the price.

When Bitcoin first started, 50 Bitcoins were rewarded to miners per block produced. The reward was cut down to 25 Bitcoins in the 2012 first halving, then 12.5 Bitcoins in the 2016 second halving. Thus, the upcoming halving will decrease the block reward to 6.25 coins per block or around US$8 million a day, at current prices.

Halving events will continue until the block reward reaches zero. The process will end with a predetermined total of 21 million Bitcoins, estimated to be around the year 2140.

Why is it important?

The functionality of the Bitcoin network relies on the coin retaining its monetary value. A distribution schedule with regular halvings is designed to support this by creating a supply squeeze.

Each halving also sharply reduces Bitcoin’s inflation rate, with the upcoming May 2020 halving expected to drop the inflation rate to about 1.8% – not far from gold’s 1.45% inflation rate.

“The inflation rate is essentially equivalent to the inflation rate for gold, which is pretty exciting for those that have advocated for Bitcoin as the “digital gold” based on its inflation rate and scarcity.,” Mr Travers said.

Halving events are important for Bitcoin investors because it is anticipated to have a positive effect on Bitcoin prices, though not necessarily instantly.

Of course, nothing is certain, but the basic principles of supply and demand would justify an associated price rise with curtailed supply, so long as demand stays the same or continues to rise.

Bitcoin halving history

The first Bitcoin halving occurred in November 2012, when the network reached 210,000 blocks.

The event was preceded by enthusiastic trading and traders around the world hosting halving parties, with prices rallying from under $4 at the start of 2012 to reach $13 by year-end.

The second halving was in July 2016, but anticipation peaked a month before the event, resulting in a sell-off by some investors before the event, and market watchers were more practical in general this time around.

But by early 2017, prices had reached $1,000 then rocketed close to $20,000 by the end of the year.

After sliding back to the mid-$3,000s at the start of 2019, prices have been rallying again in anticipation of the third halving.

The price is currently up more than 30% this month at US$8,865 with market watchers expecting the next halving to add significant value to Bitcoin, in line with the previous events.

Pricing outlook

According to Mr Travers, the Bitcoin halving is anticipated to have a positive effect on Bitcoin prices over time, as has been the case historically.

He said instead of a once-off spike in the price of Bitcoin at the time of the halving, the year after the previous two halvings were “the best two years in Bitcoin’s history”.

“In 2013, the price went from $10 to $1,000 and in 2017, the price went from $1,000 to $20,000; history suggests a price increase post this halving,” he said.

According to Mr Travers, the price history showed investors “you don’t need to pick the price bottom to achieve significant returns from Bitcoin”.

He also noted DigitalX’s long-term buy and hold strategy for Bitcoin means investors don’t miss out on the best trading days of the year.

“Predicting short-term movements in any asset class with high probability is difficult. If you missed the best 10 trading days each year in Bitcoin over the last six years, you would be down around 25% annually,” he said.

Although DigitalX has not released any price forecasts, stock-to-flow crypto analyst Plan B recently predicted the price of Bitcoin could reach US$288,000 by 2024.

Mr Travers said while Bitcoin is currently outperforming all major asset classes for 2020, it is still a minnow in terms of a global store of value, comparing its $160 billion value to the $90 trillion central bank money market or physical gold’s $10 trillion asset size.

“It is still very early and there is a lot of room for upside,” he said.

“It’s certainly not there yet but what we are seeing, particularly among younger investors, is there is a greater affinity for Bitcoin than there is for gold,” Mr Travers added.

Millenials to drive Bitcoin demand

According to Mr Travers, Millennials are now the largest income generator by demographic and as such, are one of the biggest drivers for Bitcoin demand.

“As your income starts to increase, you start to make more investments outside of just cash savings and the other more significant factor is wealth transfer – there’s a an estimated $68 trillion that’s going to be passed down from older generations to Millennials over the next 25 years. A portion of that, in our view, will continue to go into digital assets like Bitcoin,” he said.

“Baby Boomers essentially hold an index style portfolio and Gen X have roughly that, but a greater favour for tech stocks like Netflix and Tesla.”

In an investor presentation, DigitalX also noted Millenials’ high measure of government distrust as a reason for investing in cryptocurrencies.

“Most Millenials and all of Gen Z are also digital natives who are comfortable with holding value digitally,” the company stated.

Mr Travers outlined other factors driving Bitcoin demand over the next three to five years, including institutional acceptance with all major banks and many corporates having experimented with digital assets, and more than 30 exchanged traded funds being proposed to the Securities and Exchange Commission for launch.

A safe haven asset in times of financial instability

In addition, data shows Bitcoin prices have responded positively to financial uncertainty, as demonstrated by the Cyprus bailout deal in Greece and as a result of Brexit.

“Similar to gold, Bitcoin is now becoming a preferred asset to hedge against financial instability,” Mr Travers said.

“In Hong Kong recently, when China was looking to take greater control, local demand of Bitcoin spiked because people wanted assets that were held outside of banks and outside of brokerages,” he added, also noting excessive quantitative easing and devaluations in economies like Argentina and Venezuela have prompted investors there to look at Bitcoin as an alternative choice.

There are over 100 currencies worldwide and Bitcoin is becoming larger and more stable than a growing number of these, according to Mr Travers.

In its March quarterly report, DigitalX said the current COVID-19 pandemic has created a new environment of financial uncertainty in which investors would need to consider their portfolios.

“The initial panic sell-off that hit global markets through March saw most liquid assets, including digital assets, experience selling as investors rushed for liquidity. The Bitcoin market has recovered strongly and is sitting on a year-to-date gain,” the company reported.

Mr Travers said in addition to pensions being largely underfunded globally, many people are currently out of work and thus generating less tax revenue, so governments and central banks will need to print more money and artificially prop up their economies.

“If you’re printing more money – debasing a currency – something like Bitcoin that’s got a finite, scheduled supply that can’t be changed or can’t be printed, is something that becomes quite attractive,” he said.

DigitalX Bitcoin Fund

At the start of this year, DigitaLX launched its own Bitcoin Fund designed to track the Bitcoin price and provide sophisticated investors including family offices and high net worth individuals with direct exposure to the asset.

The wholesale fund uses independent partners including multi-billion-dollar Bitcoin custodian BitGo, which is insured up to $100 million, and is licenced and administered by Boutique Capital.

In addition, world-leading blockchain professional audit firm BDO Australia is providing audit and assurance services as part of the fund’s offering.

“The fund is the lowest cost and easiest way to access Bitcoin for institutions and family offices. It’s for those that want exposure to Bitcoin but don’t necessarily want to go through the technical understanding of the asset; they can make their investment and allocation decisions and the fund will manage the admin and the technical complexity,” Mr Travers said.

“We have seen over the years using exchanges can be a costly as well as a risky proposition – in terms of the amount of exchanges that have gone under – so going through that process with the DigitalX Bitcoin Fund reduces the risks of Bitcoin ownership,” he said.