12 min readEven though we’ve already been through two halvings, the results of which are well known, there’s still widespread disagreement on the likely outcome of this next one, both on price and the mining network.
Among the reasons for continued disagreement we hear doubts that two data points are enough to establish a pattern, various structural or fundamental underpinnings that have changed since last time––essentially a collection of arguments for why this time is different.
In order to help investors get a better understanding of what these arguments are and what reasoning underpins them, we’ve decided to collect five of the most prevalent hypotheses and analyse them based on their impact and likelihood.
Click here for a quick technical refresher on the 2020 BTC Halving.
#1 - The Halving Will Cause a Mining Death Spiral
This take is as common as it is old (in Bitcoin terms). Its main thesis is that a large reduction in mining reward––either from a halving or a very large price drop––will make mining unprofitable causing miners to immediately shut down their hardware. In turn, the reduction of hashrate will cause the block frequency to grow to the point where the next block might be hours, days, months (or even forever in the most hardcore scenarios) away.
As blocks become rarer and rarer, the usefulness of the system gets worse and worse, putting further negative pressure on the price. This causes the mining reward to fall further and the vicious cycle repeats and reinforces itself until the whole system grinds to a screeching halt and price hits zero.
In theory, this scenario warrants concern. If the mining reward was to immediately fall––with no real probability of recovery––by such a large amount that miners were to instantly and irrevocably turn their gear off, blocks could be excruciatingly slow until the next difficulty adjustment.
Timing would play in too. Bitcoin’s mining difficulty is automatically adjusted every 2016 blocks. When blocks are found too fast, difficulty goes up, and when they take too long, difficulty goes down. The further away from the next difficulty adjustment of the hashrate crash event, the longer it would take until the difficulty would be adjusted downwards (more on this topic here).
In practice though, this scenario never plays out as imagined. And since we’ve already seen two halvings and several price drops of more than 80%, we can be fairly certain it will likely never actually happen.
The main reason is that shutting off a multi-gigawatt mining industry is not a mere matter of pulling a plug from a wall-socket. Today’s mining industry is an energy enterprise on the scale of a small country, so even if every single miner was convinced that the future purchasing power of Bitcoin was irrevocably doomed, the sheer logistics of shutting the entire network down would probably take many weeks if not months.
Sources: EIA, CoinShares Research
Sources: CIA, CoinShares Research
As one out of many examples of logistical issues preventing immediate shut-downs consider the following: Many large-scale miners have offtake agreements with utilities that preclude them from simply not taking delivery of the agreed-upon amounts of electricity, and many would be forced to keep mining until they default on their bills (often paid monthly).
Mechanics like these are the reason why even when the price of bitcoin has dropped sharply and deeply, or when previous halvings have activated, at worst, we’ve seen relatively modest difficulty drawdowns in the following few weeks.
In the absence of a large spike in bitcoin prices, a difficulty decrease is a highly likely outcome of this halving. A mining death spiral, under any actually realistic scenario, is not.
#2 - Bitcoin’s Post-Halving Stock-to-Flow Ratio Will Cause Upwards Price Pressure
The stock-to-flow metric of commodity inflation rates was popularised in a Bitcoin context by economist Safedean Ammous, and later formalised into a statistical model of bitcoin price growth by anonymous quantitative researcher PlanB.
The stock-to-flow metric itself is simply the inverse of inflation––the current stock of a commodity divided by its annual production flow. For example, if there exists a stock of 1,000 tonnes of a commodity and its annual production flow is 20 tonnes, it’s stock-to-flow is 1,000/20=50. Inversely, we would say that its inflation rate is 20/1,000=1/50=0.02, or 2%.
Thinking in terms of stock-to-flow has traditionally been a method of the commodities industries, especially precious metals, where the metric has been in use for decades.
In short, the stock-to-flow price model of bitcoin is a statistically derived relationship which shows that throughout its entire history, the price of bitcoin and the stock-to-flow model (the stock-to-flow ratio raised to a fixed exponent and multiplied by a fixed constant) has been more than 95% correlated.
So far, no known study has been able to falsify this result, and on the contrary, independent analyses have claimed that the regression is non-spurious and cointegrated. However, there have been some more recent concerns about whether the cointegration analysis as previously performed is actually valid.
Visualisation of PlanB’s Stock-to-Flow Model Against the Bitcoin Price
Source: digitalik.net
According to the model, the price of bitcoin always moves within a fixed band of the model price, in percentage terms. Every time there’s a halving, the stock-to-flow ratio doubles, meaning that the model price increases as well (its magnitude is determined by the exponent and the multiple). Currently, the model states that within 2021, the bitcoin price must hit $100,000 at least once, or the model will be invalidated.
He has since released another model that is even more aggressive in its predictions, but we would like to see more independent verification of this newer model before we cover it in further detail.
While we agree that the supply reduction is likely to have a positive impact on Bitcoin’s supply-side, we’re not convinced that the supply reduction in itself is enough to materially impact the bitcoin price. It is indeed plausible that the model is correct and predictive, and we remain intrigued, yet skeptical.
#3 - Traders who have been Buying the Rumor Will Sell the News
This hypothesis claims that there is significant speculative demand baked into the current price due to bullish narratives surrounding the halving. Comparing it loosely to equity markets, it’s similar to rumors of takeovers or mergers.
A common strategy among traders is trying to anticipate retail sentiment before an event and then buy/sell into retail demand/supply when the event happens.
There’s an argument to be made that the most recent litecoin halving offers a potential precedent to this hypothesis. Shortly after its halving on 5 August 2019, litecoin experienced a large sell-off, shaving off nearly ⅔ of it’s pre-halving price over the next four months.
One obvious problem with this analysis, however, is that litecoin correlates strongly with bitcoin and bitcoin also experienced a significant sell-off over the same time period, a sell-off that cannot be rationally explained by litecoin’s halving event.
This scenario is particularly hard to analyse on merit because it requires access to information that very few traders are likely to share. It is likely in our opinion that at least some speculative demand has been added by the halving narrative, but that flipping this demand into supply in and of itself is unlikely to cause a large price decrease.
However, if it is combined with the effects of the next scenario, we consider it more likely that we may see a moderately sized downwards pressure on the bitcoin price in the time around the halving.
#4 - The Halving Will Cause Extra Selling Pressure From Miners, Driving Prices Down
When miners enjoy bitcoin prices that are higher than their ROI-breakeven mining costs, they do not have to sell all the coins they produce on an ongoing basis. This can cause a positive feedback loop on the upside to bitcoin prices during periods of rising prices.
When miners are subjected to bitcoin prices below their ROI-breakeven levels, the opposite happens. They are then forced to sell not only all of the coins they mine on an ongoing basis, but they may also be forced to tap into their balance sheet reserves, causing additional selling pressure on top of their persistent sales.
Estimated All-In ROI Breakeven Cost of Bitcoin Miners with Sensitivity to Electricity Cost and Depreciation Schedule (pre-halving)
Source: CoinShares Research (May 2020)
Estimated Cashflow Breakeven Cost of Bitcoin Miners with Sensitivity to Electricity Cost and Overhead (pre-halving)
Source: CoinShares Research (May 2020)
This effect can be extra pronounced if bitcoin prices drop suddenly and unexpectedly, as we observed during bitcoin’s recent March 2020 market downturn. The halvings however, are known in advance. And while the mechanics from the perspective of miners are effectively the same from a 50% price drop and a 50% supply halving, knowing about the event in advance at least offers miners the opportunity to more effectively interact with markets ahead of time.
There is also a major difference between the two scenarios in that a price drop does not reduce bitcoin production and therefore does not offer any relieving effects on the persistent selling of miners. The halving on the other hand does reduce new flow by 50%, thereby providing significant relief on persistent selling pressure even if miners must dip into reserves during a limited transition period.
Which leads us to our next scenario.
#5 - The Halving Will be a Big Fat Nothing-Burger (At Least Initially)
This statement needs to be qualified. What people mean when they say that the halving will be a bit of a non-event, is that it will not be the cause of anything out of the ordinary in bitcoin price terms or Bitcoin technical terms. In bitcoin price terms, daily volatility between 1% - 5% is normal. Any volatility within this band would be hard-pressed to qualify as anything different than the status quo.
With that in mind, one can make the argument that the halving is not likely to cause any particularly large perturbations in the price and that any effects on the overall supply and demand balance will take long enough to make themselves felt that we will be hard-pressed to observe any significant immediate effects.
While there might be a short-term downwards pressure on prices as miners dip into reserves to cover any potential revenue losses, this pressure should be more steady and well-balanced than what we observe during large drawdowns in price. As mentioned above, unlike a 50% price drop the halvings are known in advance, giving miners ample opportunity to interact with the market in a more efficient manner, and free from surprise and panic.
Within a few months after the halving, we expect that most miners (who have not already done so) will either have upgraded their gear, or been wiped out. This supply side impact could, over the mid- to long-term, positively impact the price of bitcoin.
More on that in the last subsection.
Is the Halving Priced In?
Even if one believes that markets are generally efficient in the sense that all knowable information is immediately integrated into the price (but to be clear, bitcoin markets can not really be argued as broadly efficient), the future balance of supply and demand in bitcoin markets depend on unknowable information and can therefore not be fully priced in.
In other words, only knowable information can be priced in and it is likely that bitcoin markets are at least efficient enough to have priced in all knowable information relating to the halving.
However, no one knows the full constitution of the global mining industry and therefore no one fully knows the complete structure of the mining cost curve. Some actors may have a fairly good view, but this information is in no sense well disseminated publicly so the market at large does not have access to it in any real sense.
As a result, the market at large, to the extent that it is trying to price in post-halving information is mostly relying on guesswork. And those few players who may have a fairly good sense of the post-halving supply landscape do not have enough market power to fully price it into the market at large.
What We Think is the Likely Outcome
In our opinion, the likely outcome of the halving is a positive supply-side impact over the mid- to longer-term. The dual mining shakeout from the recent drop plus the halving has accelerated a reinvestment cycle among the lowest cost miners who have been the last ones to make the switch into the most modern generation of mining gear.
If the halving hits in the absence of a very large price rise it all but guarantees the immediate obsolescence of previous generation mining gear for all but a tiny handful of the most extreme low-cost electricity miners. As this last cohort of miners upgrade their gear to the newest hardware over the next year or so, the overall cost-basis for the mining industry will be significantly lowered, enabling miners to sell less of their ongoing production to cover costs.
Any drawdown in mining difficulty resulting from the removal of almost all previous generation mining hardware only exacerbates this effect.
The pairing of a 50% reduction in available new supply with a reduction in the proportion of ongoing supply offered for sale in the market might drastically reduce the persistent selling pressure caused by miners. These dynamics, in combination with the macroeconomic tailwinds presented by global governments, and the existing and growing inflows into passive bitcoin investment products we’re currently observing, could cause a perfect storm for the bitcoin price over the mid- to long-term.
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