What will happen to the Bitcoin Price when the Block Reward Halves in 2016?

31 Jan 2016

The Bitcoin block reward halving is one of the most exciting and potentially volatile periods coming up in Bitcoin's timeline. The Block reward halving was built into Bitcoin by Satoshi Nakamoto, whoever he may be, and is designed to make bitcoin deflationary. What this means is that the amount of Bitcoin coming into circulation decreases over time and this is mathematically pre-programmed into the DNA of Bitcoin - it cannot be changed.

The Bitcoin block reward is supposed to halve every 210,000 blocks where each block is supposed to take about 10 minutes to mine - so this occurs roughly every four years. When Satoshi released the first block, Genesis Block, back in January 2009 the block reward was 50 bitcoins per block - so each day 7200 Bitcoins were being created. Then the first block reward halving occurred after 10.5 million bitcoins had been created and the block reward became 25 bitcoins, or 3,600 Bitcoin per day.

These block reward halvings occur every four years until the full 21 million bitcoins ever to be mined have been mined - then miners secure the network by being rewarded from the transaction fees - so they will be incentivised to increase transaction fees across the network - no doubt there will be another crisis of governance for the Bitcoin network at this point.

The first block reward halving from 50 bitcoin to 25 bitcoins occurred when the network wasn't so big. The one due in mid July 2016 is starting to cause people to wonder how the price is going to be affected considering the amount of mining capacity that has been invested in the network.

So what is going to happen to the Bitcoin Price in July 2016?

The first thing that is sure is that mining is going  to become less profitable - by 50%. So that mining rig set up that is earning 0.01 BTC per day is suddenly going to be earning 0.005 BTC per day - which is going to mean the costs of running the equipment in local currency might not be covered. This in turn should have two effects. The first is that a number of machines will be switched off which will mean that the hashing power of the network will come down and therefore increase the returns of the remaining profitable machines. There will be  a shakeout of legacy mining equipment.

The second is that a number of mining equipment contracts have a clause that allows them to be shut down at this point of unprofitability. Some revert back to the mining equipment provider when they become unprofitable - when the fee exceeds the daily mining revenue - and it is not clear if they get reactivated when the profitability returns. 

The question of the how the price will move is an interesting one. In theory it should be priced in and there should be no mass panic or huge price jump. But of the mining hashing power comes down this has traditionally been correlated with a decrease in price. The opposing move will come from the increase in news which generally will mean an increase in price as more people are made aware of the crypto currency sphere and bitcoin itself. 

So on the one side you have a huge paradigm shift in the nature of the mining industry but on the other you have a huge potential influx of demand from new entrants trying to capitalise on the bitcoin scarcity getting scarcer. 

Who can tell what is going to happen - the one thing that is sure is that there will be volatility, so perhaps the only trading strategy to take account of the block reward halving is a volatility straddle!


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