Don't Believe the Hype!

The Bitcoin Halving

The Bitcoin code includes a built-in mechanism to limit the total number of bitcoins. Governed by algorithm, the protocol generates new bitcoins at a fixed rate: a fixed number of coins every ~ten minutes 1. This implies a steady increase in the coin supply. But there's a second half to that algorithm: every four years, the per-ten-minute reward is halved. This ensures that the emission rate of the coin eventually reduces to what becomes effectively zero. Since this creation rate is halved each cycle, the event surrounding this reduction is referred to as the halving.

The third such halving event will occur on or about May 12th. At that moment, each new Bitcoin block will then include 6.25 newly mined (minted) bitcoins compared to the 12.5 mined for each block now. Interestingly, this will be the first time that Bitcoin's monetary inflation rate will be under the Federal Reserve's 2% target for price inflation.

The History

Historically, Bitcoin halvings have been quite uneventful. I teach at the collegiate level; I distinctly remember being between two classes when the first halving occurred. As the event approached, I was engrossed, staring at my computer screen, as I watched each new block being generated. The busy college campus hummed along blithely unaware as first a block was generated with a 50 bitcoin reward, and then in the next moment, a 25 bitcoin reward. Blockchain.info thoughtfully displayed some fireworks on the screen at precisely that historic moment. Shortly thereafter, my students convened for their algebra class: not a single mention, by anyone, of the event for which I was so excited.

From a technical standpoint, the whole flow of events was impressive. I was impressed that humans could write a program that dictated the behavior of a network years into the future.

The effect of the halving—and the corresponding supply reduction it represents—to bitcoin's pricing, was difficult to discern in those first couple four-year iterations. There were price spikes six months after each halving, but whether there was a causal relationship, we simply don't know. A correlation does not automatically imply a causal relationship.

Analysis

Here's the thought process I went through in November of 2012. I made the following assumptions:

• Bitcoin is a currency.

• Demand for bitcoin is a constant.

Today, the first assumption is no longer valid as the number of transactions can no longer support the currency use case. The second assumption I considered, at least at the time, to be a conservative one. I measured the demand for bitcoins as the amount of money it took to buy the newly mined coins—their value, in fiat.

The Hype

On some social media, I commonly see mention of the halving in connection with a price increase. Some quality tweeters have re-tweeted a stock-to-flow analysis applied to bitcoin. But this analysis utilizes stock-to-flow concepts in a way I find to be, frankly, underwhelming. They contend that one parameter, the stock-to-flow ratio, determines the price of an item. A claim that, for me, seems to oversimplify price expectations in this case.

This analysis considers three items: gold, silver, and bitcoin. The stock-to-flow ratio of gold and silver are each measured for one point in time. Those two data points are then used to make predictions about the price of bitcoin over time.

Though, to be convincing, the author has much more work to do. At a minimum, I would expect them to show how this stock-to-flow theory has successfully determined the price of gold throughout its history. Specifically, how does this ratio explain gold's rise from $300 in 1973 to $1,700 today? Additionally, other failures of prediction for similar commodities—litecoin, for example—need to be addressed.

1

The timing of the per-block emission rate is approximate, but it averages to approximately every ten minutes.