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September 23, 2020
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Bitcoin

Bitcoin halving is bad for miners and good for everyone else

A lower rate of creation of new Bitcoin units (thanks to halving) means that the network consumes less energy

The bitcoin network underwent a significant change on Monday, as the number of new bitcoins produced in each block halved. This is in line with a timeline established by BTC founder Satoshi Nakamoto almost 12 years ago.

Previously, each block of the blockchain came with 12.5 new bitcoins worth approximately $ 110,000. Now, each block includes only 6.25 new bitcoins worth $ 55,000.

This is a challenge for the BTC mining industry, which derives most of its revenue from these block rewards. But it has a happy side effect for everyone: the energy consumption of the bitcoin network is likely to drop in the coming months, with lower profits from BTC miners forcing their participants to tighten their belts.

Lower mining revenue will mean lower energy consumption

To build a block, miners make a list of all transactions sent since the previous block was created. They race against each other, performing millions of trillions of SHA-256 hash calculations every second, looking for a block that produces a hash below an arbitrarily low value.

The winner receives the block reward (previously 12.5 bitcoins, now 6.25 bitcoins), as well as any transaction fees included in individual transactions. At the moment, transaction fees are worth much less than the block’s reward value – about 0.6 bitcoins, or $ 5,000, per block. Therefore, halving means that miners’ income has dropped by almost half overnight.

This sudden decline in mining rewards means that mining is suddenly much less profitable. Except for a big increase in the price of BTC, we can expect bitcoin miners to temporarily stop investing in new mining hardware in the coming months. If bitcoin mining becomes unprofitable, some miners may even disable less efficient mining hardware because it is not generating enough bitcoins to cover operating costs.

In the short term, less resources spent on mining should lead to a slower bitcoin creation rate. However, the network has an automatic process to ensure that bitcoins are generated at a more or less constant rate. Every two weeks, the network changes the difficulty of the hash problem to keep the network producing about six blocks per hour.

If the network is producing blocks very slowly, it reduces the difficulty of the hash problem by increasing the range of hash values ​​considered “winners”. If the network is producing more than six blocks per hour, it will do the opposite: making the hash problem more difficult to decrease the block creation rate.

The result is that, in the long run, the bitcoin network always produces one block every 10 minutes, no matter how much hashing power the network has.

Miners, of course, want to make a profit, and competition between them keeps profit margins reasonably constant in the long run. So, if bitcoin mining revenues drop by half, it will end up translating into miners spending about half to produce those bitcoins. Electricity is one of the biggest costs of BTC mining; therefore, halving should reduce the amount of electricity consumed by bitcoin mining by a similar proportion.

And that is significant because the bitcoin network is stupendously useless. The exact numbers are known only to the miners themselves, but the Digiconomist website estimates that the network has consumed between 50 and 70 TWh per year – roughly the same energy as the 8 million people in Switzerland. We should not expect that number to drop by half immediately, but if the price of bitcoin remains at the same level, we expect to see it drop in the coming months.

Halving will raise the price of Bitcoin – but not too much

Obviously, higher BTC prices could offset this effect. Higher bitcoin prices raise the revenue for each block, and therefore the amount people are willing to spend to extract a block. Thus, a higher price of bitcoin would induce miners to buy more mining hardware and increase electricity usage.

There has been much discussion in the bitcoin world about the likely effects of halving on the price of bitcoin. Yesterday was the third time the bloc’s reward declined. Previous cuts occurred in 2012 and 2016 (the next is expected in 2024). The price of bitcoin increased 30 times in the year after the November 2012 halving. It tripled the following year with the July 2016 halving – then went up even further in the second half of 2017.

Bitcoin bulls expect a 50% decline in the new BTC supply to put increasing pressure on the price of bitcoin.

However, we should expect that effect to be much quieter this time. Bitcoin creation is decreasing exponentially over time, while the stock of existing bitcoins has increased. Currently, there are more than 18.4 million bitcoins in circulation, out of a total of 21 million that will be created. Only 656,250 were created in the year before yesterday’s halving, a number that will drop to 328,125 next year. In other words, halving reduces the BTC’s annual “inflation rate” from 3.6% to 1.8%.

This is probably not a big enough difference to have much impact on the price of bitcoin. This does not mean that the price of BTC does not rise – the currency is famous for being volatile. But any impact of halving on the price of bitcoin is unlikely to be noticed.

Source: ARS Technica

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