The economic implications of Bitcoin halving: a macro perspective

Scarcity is a key feature of bitcoin. One way Satoshi Nakamoto, the pseudonymous founder, attempted to preserve it was by building a mechanism into the underlying protocol that periodically cut in half the block rewards paid to miners. Block rewards are the only way new bitcoins are issued, and this mechanism slows the rate at which they come into circulation.   

Investors closely monitor ‘halvings’, as they’ve become known among the crypto community, because of the impact on price. This article explains how these events work before exploring their role in driving supply and demand and bitcoin’s correlation with other asset classes when they occur. 

Bitcoin Halving Mechanics

Miners play a crucial role in maintaining the bitcoin protocol. They solve complex mathematical puzzles, which require substantial amounts of computational power, for the right to validate transactions and add new blocks to the chain. In return, they receive block rewards in the form of freshly minted bitcoin. 

As Satoshi explained in the original whitepaper:

“The steady addition of a constant amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended.”

The primary mechanism used by Satoshi to preserve bitcoin’s scarcity was a limit to the maximum supply of 21 million btc (19.6 million are in circulation as of May 2, 2024). This cap was designed to avoid the effects of the kind of inflationary monetary policies employed by central banks to stimulate a sluggish economy, such as quantitative easing. Satoshi hinted at this motivation by including the following message in the first block of transactions, mined in early 2009:

“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”.

Halvings occur every time the bitcoin protocol processes 210,000 blocks, which takes about four years. Several of these events have already happened: the original block reward of 50 btc fell to 25 btc after the first one in November 2012 and halved again as a result of subsequent events in July 2016, May 2020 and April 2024. The reward currently stands at 3.125 btc.

Cutting block rewards may appear to disincentivise miners, especially since they’ll disappear once the final halving takes place, estimated in 2140. But these rewards only represent one revenue stream, as miners also earn bitcoin from processing transactions.    

Supply Dynamics and Price Behavior

The law of supply and demand has a major influence on financial markets, and bitcoin is no exception. Capping the total circulation and controlling the issue of new coins should theoretically support its price.  

This effect has played out in previous halvings:

• November 2012 - bitcoin rose from $10 at the time of the halving to $140 by the following April. It went on to surpass $1,000 by the end of 2013.

• July 2016 - After steadily rising in the run-up to this event, bitcoin continued on the same trajectory until March 2017 and then surged to $16,000 by the end of the year.  

• May 2020 - A similar pattern unfolded for the third halving: bitcoin climbed from $9,000 in May to more than $10,000 by October before hitting a new record high of $63,000 in April the following year.

Learn how halvings impact bitcoin’s price.

Scarcity also reinforces the digital gold narrative. Bitcoin demonstrates many of the characteristics of a store of value, not just scarcity but divisibility, portability and durability. In fact, it could be argued that bitcoin is superior to gold, given that it’s easier to transport and its smallest denomination is one-millionth of a bitcoin, known as a Satoshi.

At $15.5 trillion (as of May 2, 2024), gold’s market capitalisation is significantly bigger, despite the latest rally, which has seen bitcoin surpass $73,000 for the first time. But this gap signifies the scale of the opportunity. Analysts at Goldman Sachs have predicted that bitcoin will erode gold’s market share as it becomes more widely adopted. A 50% share would boost its price to $100,000.

Learn about bitcoin’s status as digital gold.

Correlation with Other Asset Classes

Correlation is an important concept in investing as it measures the degree to which two assets move in the same direction. Bitcoin has historically displayed negative correlation with traditional asset classes- the chart below shows that bitcoin moves in the same direction as gold 18% of the time and the S&P 500 34%.

This negative correlation holds during halvings. Here’s a comparison of bitcoin with gold and shares during the 2020 event.  

As mentioned above, bitcoin was effectively flat before the halving and then rose steadily until October 2020, when it experienced a strong bull market that led to a 500% gain by March 2021. In contrast, gold started trending upward at the end of 2019 and continued until August 2020, when the trend reversed. It had handed back over 60% of those profits by March 2021. As for shares, using the S&P 500 as a proxy, the index crashed in early 2020 by 30% as the Covid pandemic forced economies to shut down. However, it rebounded relatively quickly and rallied until the end of 2021, rising by 100% from the trough earlier in the year. 

Understanding correlation is useful when building a diversified portfolio because it means that if one asset class underperforms, it shouldn’t disproportionately affect overall returns. CoinShares tracks several model portfolios to measure the impact of holding bitcoin. A standard portfolio of 60% shares and 40% bonds with a 4% rebalanced allocation to bitcoin returns 15% compared with a standard portfolio with no bitcoin (7.9%) and one holding 4% rebalanced gold (8.1%). 

Learn how to diversify with crypto.

Conclusion

Bitcoin halvings, when block rewards paid to miners fall by 50%, are a mechanism Satoshi Nakamoto built into the protocol to preserve scarcity. They happen roughly every four years, and investors monitor them closely because of the impact on bitcoin’s price, which has rallied after previous events. By reducing supply, halvings also contribute to bitcoin’s status as digital gold. Given gold’s market cap is $15.5 trillion, this trend is worth monitoring.

Bitcoin has traditionally displayed negative correlation with traditional assets, which means it can help to diversify a portfolio. This pattern holds up during halving periods.