It’s a key milestone that happens every four years in the Bitcoin network: Bitcoin halving.
Bitcoin halvings have long divided the Bitcoin community since the first halving in 2012, even since the Bitcoin network has grown to focus on scaling solutions that would enable the use of applications built on the blockchain. Some believe that they support the network, while others argue that they could set the ecosystem up for more harm than good in the future.
To understand the intent behind Bitcoin halving cycles, why they operate the way they do, and what their future holds, we need to begin by breaking down the Bitcoin mining economy.
We’ll start with Bitcoin miners.
What are Bitcoin miners?
Bitcoin miners are at the very core of Bitcoin halving events. Therefore, it’s important to understand how they operate and interact with the Bitcoin blockchain.
Bitcoin miners are individuals or organizations that participate in the process of adding new transactions to the Bitcoin blockchain by solving complex mathematical problems. In exchange, they earn a reward of newly-created bitcoins as well as any transaction fees associated with the transactions that they process.
Proof of Work (PoW): everything you need to know
Miners validate and confirm transactions on the network via a consensus mechanism called Proof of Work (PoW). Under the PoW mechanism, miners use their computing power to solve these complex mathematical problems.
A typical PoW algorithm normally begins with a new block of transactions that is broadcasted to the network. Bitcoin miners solve the puzzle associated with the new block and attempt different solutions to the puzzle (known as “hashes”). The first miner to solve the puzzle and find a valid hash broadcasts the solution to the network. The other miners in the network then verify the solution and the block is added to the blockchain (one block is added every 10 minutes).
Here, the miner who solved the puzzle is rewarded with new crypto (in this case, bitcoin) for their efforts as well as transaction fees from transactions they added to the blockchain.
The challenges of Proof of Work
But PoW is difficult and resource-intensive. To participate in the PoW process, miners must invest in specialized hardware and software, such as ASICs (Application-Specific Integrated Circuits), which are specifically designed for Bitcoin mining and can perform the necessary calculations more efficiently than traditional CPUs or GPUs.
A big part of the reason why the PoW mechanism was designed to be so difficult and resource-intensive was to discourage malicious actors from attempting to manipulate the blockchain. The idea was that by requiring miners to invest in significant computing power and energy in the mining process, the PoW mechanism would help to maintain the security and integrity of the Bitcoin network.
But naturally, the PoW mechanism has come under criticism for the energy consumption required to carry out the process, as it requires a significant amount of electricity. It has led critics to claim that the energy consumption associated with Bitcoin mining is unsustainable and environmentally damaging. Many have also argued that alternative consensus mechanisms, such as Proof of Stake (PoS), should be explored instead.
This shows that while the PoW mechanism has been successful in maintaining the security and integrity of the Bitcoin network – the original intent behind the consensus mechanism’s employment – it remains a topic of debate and discussion within the broader cryptocurrency community.
What you need to know about Bitcoin halving
The biggest incentive for Bitcoin miners to mine blocks, as you can imagine, is the rewards they get for participating in the PoW mechanism to mine new blocks. These rewards are the crux of Bitcoin halving cycles.
Bitcoin halving, also known as Bitcoin block reward halving, is an event that occurs roughly every four years on the Bitcoin blockchain. During this event, the reward for mining a new block on the Bitcoin network is cut in half, which means that miners receive fewer bitcoins for their efforts.
A history of Bitcoin halving
Thanks to the first three halving events, we can get an idea of when the next halving will occur and how previous halving events will affect rewards (but not necessarily Bitcoin price, more on that later).
The first Bitcoin halving occurred in November 2012, when the reward for mining a new block was reduced from 50 BTC per block to 25 BTC.
Subsequently, the second halving occurred on July 9, 2016, reducing the reward to 12.5 BTC. The most recent halving, the third halving, in May 2020 reduced the reward to 6.25 BTC. The impending fourth halving – which will occur in early 2024 – will drop the reward down to 3.125 BTC.
The purpose behind Bitcoin halving
Bitcoin halving is also an important event because it has a direct impact on Bitcoin supply.
No new Bitcoin will be released beyond the 21 million bitcoin coin limit established. As of March 2023, around 18.7 million bitcoins had already been mined, meaning that the remaining 2.3 million will be mined over the next few years. Essentially, the next few halving events will control this supply of 2.3 million bitcoins that will be entering the market and the inflation rate.
As the mining reward is reduced, it becomes more difficult and expensive for miners to mine new bitcoins. This, in turn, can lead to a decrease in the supply of new bitcoins, which can increase the value of existing bitcoins in circulation.
This speculation has led many Bitcoin investors and traders to closely monitor the halving events with the belief that they can have a significant impact on the price of Bitcoin. However, it’s important to note that past performance is not indicative of future results, and Bitcoin's price and price movement are influenced by a variety of factors beyond just the halving events.
The future of Bitcoin mining rewards
As one can imagine, there has been concern within the Bitcoin community about providing incentives for Bitcoin miners when the rewards they obtain for mining blocks is halved every four years.
However, many in the Bitcoin ecosystem do believe that ultimately, miners will continue to mine new BTC blocks thanks to another type of reward: transaction fees.
Transaction fees: the new primary incentive?
Bitcoin transaction fees are fees paid by users to miners in order to have their bitcoin transactions processed and added to the blockchain. When a user sends a bitcoin transaction, they can choose to include a transaction fee.
The transaction fee is determined by the sender and can vary depending on several factors, including the size of the transaction in bytes, the urgency of the transaction, and the current level of network congestion. Transactions with higher fees are typically processed more quickly than those with lower fees, as they provide a higher incentive for miners to include the transaction in the next block they mine.
And given that the size of the transaction matters, the more satoshis per byte (sat/B), the higher the fee and, subsequently, the higher the priority of the transaction.
It’s also worth noting that the cost of transaction fees can fluctuate over time due to changes in network demand and miner behavior. During times of high network congestion, transaction fees can rise significantly, which can make using Bitcoin more expensive. During times of low network congestion, transaction fees can be relatively low.
What can impact Bitcoin transaction fees?
Given what we know about Bitcoin blockchain transaction fees, there are a number of factors at play that could drive transaction fees in the future. These factors will ultimately determine whether the Bitcoin community can count on transaction fees to offset Bitcoin halving cycles.
Most notably, transaction sizes have once again become a point of discussion, particularly with the introduction of the Bitcoin Ordinals protocol in 2023. The protocol effectively allowed users to assign individual numbers to satoshis, which allowed for accurate ordering and tracking.
However, the protocol also enabled data and content to be ascribed to sats and processed as a Bitcoin transaction. These were known as Ordinal inscriptions, and they effectively revived discussions about Bitcoin NFTs as the data inscribed onto those sats settled directly on the Bitcoin blockchain.
Much of this content, however, was large in size and required a significant amount of block space due to the size of the transactions needed to make inscriptions. In the subsequent weeks following the launch of Ordinals, transaction fees did, in fact, increase as demand for Ordinal inscriptions meant that many people were engaging in transactions of significant block size.
On top of that, the flood of people wanting Ordinals also meant that network congestion was high, which also likely contributed to the higher transaction fees and, consequently, the higher incomes that Bitcoin miners saw in the aftermath of Ordinals launch. These observations and predictions about transaction fees is one of the biggest arguments adopted by proponents of Ordinals, as they believe these higher fees will benefit miners in the long-run.
The next halving: Bitcoin halving countdown
Of course, the Ordinals protocol is just one example of a development that could affect miners heading into the next Bitcoin halving event in 2024.
Regardless of the result, much of the same arguments for and against Bitcoin halving cycles still stand, with new developments poised to potentially make their mark on subsequent events.
At the end of the day, Bitcoin halving is still key in discussions to preserve and expand on the Bitcoin blockchain’s capabilities, the future of the mining economy in general, and whether every halving event could affect the value and price of 21 million BTC in circulation.
