Update 3:56am UTC, 8th June: Attribution & link added for Chandler Guo 'Blockchain will shut down' quote source.
At the heart of Bitcoin is a process known as mining, adding transaction records to Bitcoin's public ledger. The ledger is made up of blocks of transactions linked in a chain, forming the widely touted technological breakthrough, the Blockchain.
Individual blocks must contain a proof of work to be considered valid, Bitcoin uses the hashcash proof-of-work function. This process is intentionally designed to be resource-intensive and difficult, and the protocol provides a block reward to incentivize miners. The reward is also a way to initially distribute coins into circulation, since there is no central authority to issue them.
The block reward currently supplements transaction fees, paid at the user's discretion. As more users send bitcoin transactions, and blocks become full, those transactions with the highest fees will be included first. This guarantees a swift transaction for users willing to pay more, and is designed to eventually fund the entire process of mining. However, transaction fees are currently average less than half a bitcoin per block.
While the reward currently supplements the fees, the amount of bitcoins rewarded is designed to reduce over time, halving every 210,000 blocks. With fewer than 5000 blocks remaining till the next halving event, predicted to occur on July 10th this year, the reward is poised to decrease from 25 bitcoins per block, to 12.5.
“Although Bitcoin miners will receive less Bitcoin for each block mined, according to Bitcoin theory, they believe decreased supply of Bitcoins will yield higher prices over time.”
- The Bitcoin Foundation
While the event, and the mechanics that drive it, are well documented and understood, the potential ramifications are hotly debated. What the greater bitcoin mining community will do in response is currently impossible to know.
Simple arithmetic would seem to indicate that miners with less-efficient mining equipment may be inclined to shut down their operations. Large mining operations often have several locations, with hundreds or thousands of mining 'rigs' at each. Aside from the initial setup costs, the main ongoing expense is electricity.
Chandler Guo, founder of Chinese multi-service bitcoin banking platform Bitbank fears that the reduced reward may lead to fewer miners. “When halving comes the cost of the electricity is the same, so it must shut down,” Guo explained. “If mining equipment can only mine the electricity payment, they don’t need to work.”
The problem that Guo points out is Bitcoin's difficulty rate. To compensate for increasing hardware speed and varying interest in running mining operations, the proof-of-work difficulty number is determined by a moving average, targeting an average of six blocks per hour. If blocks are generated too fast, the difficulty increases, and vice versa. This re-balancing occurs every 2016 blocks, roughly every two weeks, and has the effect of ensuring that miners produce the right number of blocks. According to Guo, it might also have more scary effects under a halving condition.
During an interview with CoinDesk, Guo made the bold claim that the blockchain could shut down;
“When the difficulty doesn’t change, but the hashing power shuts down immediately, there will be no next block. If, after the halving, the price does not go up, but the prices goes down, there will be heartache. It means no next block, no blockchain, all of the blockchain will be shut down immediately.”
- Chandler Guo, Bitbank Founder, speaking to coindesk.
While Guo highlights a worst case scenario for the fledgling alternative financial system, he also highlights the systems saving grace; the value of bitcoins on the open market. Miners pay their bills in fiat currency.
Immediately after the 2012 halving, there was a month or so of downward price movement, and then 2013 then became one of the most bullish and exciting years in Bitcoin's history. So the question becomes whether or not the 2012 block reward halving was one of the causes of that bullishness. Many feel that it was not; the market price reflects the event well in advance.
“One thing is certain though: at the time of Halving, the supply reduction will already be priced in the exchange rate, thanks to market anticipation. So don't expect a big price movement on Halving Day.”
The price of bitcoin rose gradually over the six-month period leading up to the 2012 halving, more than doubling in price between June and November 2012
This effect could easily be explained by traders preemptively pricing in increased scarcity. Bitcoin developer David Perry pondered this issue in his last-minute blog post preceding the 2012 event. A poll of the community showed that far more people believed the value of bitcoin would rise more after the halving, but they didn't seem to consider it priced-in before the event. The debate and theoretical discussion continue to this day.
Other than the previous bitcoin reward reduction, the closest thing we have to another halving happened on the Litecoin blockchain, last August. TheHalvening.com website states that, “a wild speculative rally took the price from 2$ to more than 8$, before crashing back to 3$,” two months prior to the event. It is now starting to look like Bitcoin's price may be headed in the right direction to match the doubling in time as well.
The price of Bitcoin has nearly doubled over the last six months
While commentators can only speculate what the price will be on block 420,000, the trend is certainly headed higher, with Bitcoin approaching $600.
If the price at halving is $600, miners will effectively be earning the same reward as they did with bitcoin at $300 - a price point that the cryptocurrency was below for much of 2015. The hashrate increased 78% in 2015.
If the price were to go above $700 before the halving, an amount that is double where we were six months previously, then miners would be compensated at roughly the same rate after the halving event as they were in February. Not only would that defeat the purpose for Guo's concerns; it would also be the best evidence yet for the popular theory that doubling happens in advance of halvings. More importantly, however, it is an indicator that miners will be able to stay profitable in the long run.