Every 210,000 blocks —approximately four years— the amount of new bitcoin issued per block is reduced by half. These events are know as halvings, and are vital to Bitcoin.
Understanding Bitcoin’s architecture
To thoroughly explain how halvings work, it is first necessary to understand the Bitcoin network’s architecture.
Every time a user sends a bitcoin transaction, their wallet broadcasts it to the network’s nodes, which validate it. Then, nodes send transactions to the mempool, where miners confirm them through a process called mining.
When miners confirm transactions, they include them into blocks. The blockchain then permanently stores the data in the public ledger. Every time miners add a block to the network, they receive a reward, composed of:
- All the fees from the transactions included in that block.
- A block subsidy, which is newly minted bitcoin.
Summarizing, besides ensuring the network’s security, mining is also the process through which new bitcoin enter circulation. This is where halving comes in.
You can learn more about the Bitcoin mining process in our educational article: How does Bitcoin mining work?
Bitcoin halvings explained
As we mentioned, halvings are the process that reduces block subsidies —and thus, new bitcoin entering circulation— by half.
Why do we need to do this? Bitcoin has a hard cap of 21,000,000 BTC. That’s all the coins there will ever be. The network automatically reduces emission using halvings to moderate inflation so it doesn’t affect price until all coins enter circulation.
Halvings happen every 210,000 blocks exactly —approximately four years. When Bitcoin went live in 2009, 50 new bitcoin entered circulation 3.125.
The process will continue until approximately 2140, when Bitcoin will reach its maximum supply, and all the coins will enter circulation.
Halvings implications in markets and mining
The Bitcoin community often expects and celebrates halvings since, in the past, every one of them has had substantial implications for Bitcoin.
From a markets perspective, halvings significantly reduce the bitcoin supply. At reduced supply but sustained demand, price tends to surge. Consequently, halvings often kickstart an upwards trend that lasts for months.
Halvings also have massive repercussions for Bitcoin mining. As we said before, miners’ revenue comprises the fees from the transactions included in a block and the new bitcoin minted after that block.
Each Bitcoin halving significantly reduces miner rewards, although that doesn’t necessarily mean less profitability.
Miners don’t pay their expenses in bitcoin. They do so in their locations’ fiat currency. So as long as halvings keep having the appreciating effect on bitcoin, mining profitability in fiat terms shouldn’t be affected. Moreover, if the price increase is more than 50%, mining may even be more profitable than before.
To sum up, we could explain the widespread impact of halvings on bitcoin as follows:
- A halving occurs, new bitcoin entering in circulation decrease 50%.
- Inflation (emission) drops. With fewer bitcoin available, people rush in to buy, increasing demand.
- Lower supply and higher demand lead to a price increase against fiat currencies.
- Miners, who receive less bitcoin, still earn the same (or more) when converting to fiat due to BTC appreciation.
What happens when we reach maximum supply?
Once all 21,000,000 bitcoin enter circulation, halvings will stop and no more coins will be minted. Mining rewards will also change, as miners will receive only transaction fees.
You may be wondering why people would continue mining when rewards drop. Many scenarios could still play out for Bitcoin mining to still be profitable in the future, even without block subsidies:
- Bitcoin may reach worldwide levels of adoption. The more people use Bitcoin, the more transactions they will perform. Thus, the more fees they will pay to miners.
- Additionally, when there are many pending transactions on the mempool, users often willingly pay higher fees to push their transactions through. So the increase wouldn’t only be in quantity but also in quality (financially speaking).
- Finally, it’s also logical to expect that bitcoin’s price will surge when supply reaches its cap. Since transaction fees are paid in bitcoin, a nominal increase would mean miners would earn more when converting to fiat.
All things considered, it’s tough to predict what will happen in the coming years. Mining has evolved a lot since its beginnings, and it will probably keep doing so. We can only wait and see what the future holds for Bitcoin.