Bitcoin Halving 101: How It Works and Why It Matters

Every Bitcoin user and miner is familiar with the term "Bitcoin halving" and what it means for the cryptocurrency. The halving is the term used to refer to one of the most pivotal events on Bitcoin's blockchain. This event regulates the amount of Bitcoin in circulation, preventing it from growing exponentially. The Bitcoin halving has implications for all stakeholders in the Bitcoin ecosystem.

What is Bitcoin halving?

To put it simply, Bitcoin halving, sometimes referred to as "the halvening," is the process by which the incentives for mining Bitcoin are cut in half each time 210,000 blocks are mined.

By reducing the rewards for mining Bitcoin as more blocks are mined, Bitcoin halving restricts the supply of new Bitcoins being generated. This differs with fiat currencies such as the US dollar or the euro, which lose purchasing power when governments issue an excessive amount.

How does Bitcoin halving work?

To comprehend how Bitcoin halving works, it's necessary to grasp the fundamentals of cryptocurrency creation. The creation process is known as mining.

Bitcoins are created via a decentralised system in which individuals known as miners join the network as transaction processors and validators. They utilise high-powered computer systems to solve complicated mathematical puzzles to validate transactions on the Bitcoin ledger. After validating transactions successfully, miners receive the newly generated bitcoins as rewards.

Bitcoin mining is a kind of competition. Bitcoin uses a consensus protocol called Proof-of-work (PoW), which requires miners to process and verify transactions to get rewards in return. Miners essentially compete to be the first to add new blocks to the blockchain. They are rewarded with a set amount of fresh bitcoins for each block mined.

For every 210,000 blocks added by these miners, the payout for each block is halved. Since it presently takes four years to add that many blocks, Bitcoin halving occurs at around four-year intervals. The third Bitcoin halving occurred in May 2020, and the next is expected in 2024.

Why does Bitcoin halving occur?

Satoshi Nakamoto (pseudonym), the founder of Bitcoin, set a limit on the total amount of Bitcoins that may ever be created. This limit is 21 million Bitcoins, with the last Bitcoin expected to be generated in 2140. With halving taking place typically every four years, Bitcoin will become more scarce, while preventing extreme price inflation simultaneously.

This distinguishes Bitcoin from other inflationary currencies such as the Dollar or Euro, which lose buying power over time, resulting in an increase in the price of goods and services.

The theory behind the halving works something like this:

The reward is halved → half the inflation → lower available supply → higher demand → higher price → miners' rewards still remain although they are smaller, as a result Bitcoin’s value can rise in the process

In the extreme case that demand and price do not increase as a result of the halving, some miners may quit since the payout is reduced and the value of Bitcoin remains unchanged. However, there is a mechanism that comes to help. If the payout is reduced in half but the value of Bitcoin isn’t increased, the mining difficulty can be adjusted to make mining simpler. This means that the incentive is unchanged, but the processing difficulty is lowered.

What are the Bitcoin halvings’ effects?

Bitcoin halving has significant impacts on the many parties participating in the Bitcoin network. Below is how the Bitcoin halving affects key Bitcoin stakeholders.

Miners

Mining has a complex influence on the Bitcoin ecosystem. On the one hand, a decreasing supply of bitcoin raises its demand and prices. However, fewer rewards may make it more difficult for individual miners or small mining operations to remain in the Bitcoin ecosystem, since they will struggle to compete with big mining companies.

According to studies, the mining capacity of Bitcoin is counter-cyclical to its price. Hence, as the crypto price grows, the number of miners in the ecosystem falls, and vice versa.

Investors

In general, halving leads to a rise in the price of Bitcoin due to lower supply and higher demand, which is good news for investors. In anticipation of the halving, trading activity on the cryptocurrency's blockchain normally increases. However, the rate of price increases varies according to the logistics and conditions of each price halving.

What will happen during the next halving?

The first halving in 2012 resulted in a price surge from $12 to over $1,150 within a single year. In 2016, the second halving brought Bitcoin's price to roughly $20,000 before plummeting back to $3,200.

Given that new Bitcoins are mined around every ten minutes, the next halving is predicted to occur in early 2024, at which point the miner's incentive will decrease to 3.125 BTC. For Bitcoin investors and traders, it’s worth noting that halving often results in significant volatility and turbulence for the cryptocurrency.

Bitcoin halving is a highly-anticipated event every four years, beginning in 2012. However, no one can precisely predict what will happen during the halves and the weeks and months that follow.

The bottom line

Bitcoin halving is a much-hyped event that generally occurs every four years, with the first one taking place in 2012. The event cuts in half Bitcoin's inflation rate and the pace at which new bitcoins enter circulation.

The rewards mechanism is expected to continue until 2140 when the total maximum supply of bitcoins is reached. After that, miners will receive rewards in the form of transaction fees.