How Will the Third Block Reward Halving Affect Bitcoin?

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In around five months, Bitcoin will go through with the third block reward halving event — expected to occur on May 13, 2020 (you can find a countdown here).

Source: bitcoinblockhalf.com

In this article, we’ll look at the theories put forward for why the halving will (or will not) influence the price of bitcoin and assess previous block reward reductions to uncover some clues as to how the price of bitcoin may behave this time round.

What is the Block Reward Halving?

The block reward subsidy is cut in half every 210,000 blocks (around four years) as part of Bitcoin’s programmed monetary policy, which guarantees its fixed supply. From May 13, 2020 onwards, miners will receive 6.25 BTC instead of 12.5 BTC for each block they mine until the next halving in 2024.

Bitcoin’s monetary policy also ensures that inflation gradually falls over time, which will decrease from 3.68% to 1.80% per annum during the third halving event.

Source: BitcoinTalk.

Inflation in most major economies is pretty low but the statistics are not necessarily representative of the average consumer (with many important items excluded from inflation calculations). For instance, inflation in the US is estimated to be around 6% if the relatively more robust methodology from 1990 were to be used.

Therefore, it will be the first time since the cryptocurrency’s inception that inflation rate of bitcoin is lower than it is in the developed economies of Europe and North America. Bitcoin’s inflation rate will also fall below gold’s after the May 2020 halving.

An inflation differential between a fiat currency like the euro and bitcoin opens up a potential carry trade with a long-term horizon. This is exactly why some people are excited about the Bitcoin halving: it reinforces bitcoin’s rules-based approach versus the discretionary approach of central banks, i.e., the setting of interest rates relies on decisions made behind closed doors by unelected monetary policy committees.

But not everyone is so optimistic about the milestone. Let’s have a look at the differing views on the impact and significance of Bitcoin’s upcoming halving.

Differing Views on Bitcoin’s Halving

As the halving has come into focus in 2019/2020, there has been a lot of debate in recent months with differing views on the event’s impact on the price of bitcoin.

There are those that believe each halving spurs a new wave of demand, as the reduction in supply bids prices higher as players expect higher prices in future because of the fixed supply. However, there are only two data points to go from, and extrapolation could turn out to be inaccurate or misleading.

Some investors are not so sure the third halving will be bullish for bitcoin, reasoning that because the block reward reductions are known well in advance, the event is already priced in. Let’s look at this argument in more detail below.

Advocates of the Efficient Markets Hypothesis (EMH) argue that all the major players have known about the halving well in advance and is therefore accounted for by the current price of bitcoin.

Nic Carter of Castle Island Ventures wrote a great introduction to EMH if you’re unfamiliar with the theory. In the article, Carter discussed the exceptions to the EMH and stated the only one that applies to bitcoin, namely the lack of a shared valuation model for cryptocurrency. All other exceptions are not applicable to bitcoin.

While many argue that not everyone knows about bitcoin (and even less know about the halving), EMH only requires enough rational participants to be aware of the halving for markets to be efficient. This is reflected in the available data, as the price showed little reaction to each halving. Since no new information was revealed, the price does not react immediately in either direction.

But the EMH relies on rational expectations — which cannot be held true for all market participants. Many laboratory experiments in game theory have shown that participants act in a non-rational manner and that the conclusions of rational analysis sometimes fail to conform to reality. Therefore, the EMH may not be an adequate explanation for why the halving will not affect the price — if enough traders act in a non-rational manner.

Also, EMH does not explain why bitcoin tends to rise following the halving months or even a year or so later, which could be explained instead by traders anticipating a reduction in the selling pressure of miners.

The bullish narrative for the bitcoin halving is that the reduction in newly mined bitcoins cuts the selling pressure originating from miners in half and increases demand for bitcoin as the scarcity of the crypto-asset becomes more apparent.

A slowdown in the flow of miners’ bitcoin sales can have a large impact on price over time. Since each miner’s cost is denominated in fiat currency but their earnings are in BTC, they must sell BTC to cover their costs. At each halving, the amount of bitcoin extracted by miners is cut in half — translating into a lower supply of bitcoins on the open market.

One research study found that the changes in the remuneration to miners and the average price of bitcoin are positively correlated (although that doesn’t necessarily imply causation). The results show that the halving starts to affect the price of bitcoin after around five months.

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