Expectations are high as the next Bitcoin halving approaches. The event will take place in the week commencing 18 May 2020. After the halving, the block reward will drop from 12.5 to 6.25 Bitcoins. While communities in the blockchain space are steaming with excitement, there are some reasons to remain cautiously optimistic. The effects of the Bitcoin halving cannot be ignored.
The Bitcoin Halving Effects
Bitcoin halving refers to the halving of the payouts to Bitcoin miners when they mine a block. In finance, we talk about stock and flow. If we use the analogy of a bath, the stock is the amount of water existing in the bath. The flow is the amount of water flowing into the tub. The halving would mean halving the flow of water into the bath. This means two things: First, it represents a deceleration of the rate at which new Bitcoin is added to the stock; and second, because Bitcoin has no endogenous cash flows, it is not subject to discounted cash flow analysis.
The Bitcoin halving could be compared to stock and flow in finance. Stocks represent the economy at a point in time while flows represent the change in an economy over a period of time. Flows are the rate of movement of items in and out of stocks. Flows can add to stocks while outflows can reduce stocks. In a similar vein, the halving reduces the flow in the Bitcoin economy. Rates of Bitcoin supply to the sector reduces as a result. A major difference between flows in Bitcoin and stocks, however, lies in the fact that Bitcoin does not go under discounted cash flow analysis.
Bitcoin has exceeded the expectations of many sceptics and proponents during the season of global gloom brought about by the coronavirus pandemic. The cryptocurrency has performed better than commodities such as gold and oil. This surprises trader. The commodities are usually considered as a safe hedge against market volatility.
Limited Supply of Bitcoin
With Bitcoin outperforming many other assets, it is hoped that the halving event will give an additional boost to the cryptocurrency. Some predict that the event will lead to the apex cryptocurrency reaching $30,000 by the end of 2020. Such predictions are accompanied by propositions that the halving could add fuel to the fire of the incoming rally.
The cost of Bitcoin increases after a halving event as miners receive less reward. Consequently, miners are hit by lower profit margins. For their profit margins to bounce back, the price of Bitcoin must rise. This raises questions or most people who are new to cryptocurrencies. One of such questions revolves around why the halving event is such a highly favoured event.
One of the reasons why many in the blockchain community like the halving event lies in the fact that many miners limit their supply of Bitcoin until the price of the cryptocurrency rises to a level appropriate enough to operate profitably. This should, in theory, increase the price of the cryptocurrency over time. However, there is much cause for concern.
Realities of Price Manipulation
Analysts worry that the price manipulation by miners could reach an inflexion point at which their attempts to control the price of Bitcoin may no longer matter. If the price of Bitcoin were to fall below the cost of mining it, the sector could experience a change as the technical limitations of the coin are met. If negative sentiments on the technical limitations of the coin were to come into fruition, cryptocurrency investors may have to opt for viable alternative cryptocurrencies.
In anticipation of the halving event, some miners have started investing in new opportunities in a post-halving Bitcoin market. A Chinese miner, Bixin, recently revealed plans to invest over $60 million worth of Bitcoin in a new fund of funds. The relatively lower costs of production in Asian and South American markets means that miners in such regions will be able to continue operating profitably for the foreseeable future. Conversely, miners in Europe and North America may face higher costs.
Confirmation Bias
If history repeats itself, the least efficient miners in the industry will have to close operations as costs rise. The most efficient miners will gain market share. After the completion of the cycle, miners may be able to return to business as usual with improved capacity to support the future prices of the cryptocurrency industry.
The excitement (surrounding Bitcoin’s prospective post-halving value) alone drove prices up. Reports show that activity surrounding the incoming Bitcoin halving contributed to $13 billion in market activity in the cryptocurrency sector. Prices of Bitcoin pushed past $10,000 on Friday morning as a result. The Bitcoin price dropped from $9,500 to $8,100 shortly after, raising questions about whether the halving event would lead to positive price trends as it has in times past. Changes in sentiments of investors, miners, and new entrants will change price trends.
Auto-Deleveraging
Experts suggest that auto-deleveraging is the cause of the sudden fall in prices. This process can cut short gains made in the value of investments. When Bitcoin experiences a sharp increase or decrease in price, the likelihood of a short by traders can increase significantly. The change in trader activity can cause an imbalance in the order book. An imbalance in order books can cause a wave of liquidations which reduces the price of Bitcoin.
A trader explains,
“There is a light for the auto deleverage queue on the trading page when you’re in a position. Deleverage is used as insurance for long liquidation, in this case, to help sustain cascading liquidations and resulting in mega dumps. High leveraged trades are usually first.”
There are a lot of activities in the markets that ultimately do not hold water when analysed against past trends. New metrics shed light on opportunities for the creation of value in the halving period. Unfortunately, many of these metrics have not been tested. Market movers (whales) can easily change the prices with a few clicks. Many take advantage of their holdings of Bitcoin to change the value of the cryptocurrency for their personal gain.
Edel is an Editor with a decade of print and digital media experience – specializing in Science, Technology, Finance, Entertainment, and Advertising. He is also a stock and cryptocurrency investor. When Edel is not editing or analyzing charts, you can find him with his DIY lightbox taking timelapses of plants.