Osho Jha is an investor, data scientist and tech company executive who enjoys finding and analyzing unique data sets for investing in both public and private markets.
Many bullish investment theses for bitcoin are grounded in expectations that the upcoming halving of block rewards will cause the bitcoin (BTC) price to increase. Previous supply constrictions, from 50 BTC to 25 BTC and 25 BTC to, where we currently stand, at 12.5 BTC, have had that effect. Still, given the rare nature of these events, our data points are limited and increase the anticipation and speculation around upcoming halving some time in May 2020.
There are many great pieces on the mechanics of a BTC halving and how they were described in the original white paper and subsequently coded into the structure of bitcoin. So I will assume familiarity with these concepts going forward as we try to understand the supply constriction narrative of the halving thesis.
Unfortunately, many investors are pointing to the halving as a catalyst for a price increase in the face of a difficult bitcoin market, which has had three straight quarters of negative returns, and have set sky high expectations for what sort of price action we may see after. I certainly believe that the halving will have a positive impact on price, but I am concerned by investors expecting parabolic gains in the fashion of 2017.
As it currently stands, the bullish thesis around the halving is that as block rewards get cut in half, the number of miners able to sustain their operations will decline. Since fewer BTC are being brought into circulation, there should also be some reduced sell pressure as miners often sell BTC to fund operations in their local currency. One could then conclude that the supply constriction will allow the price to appreciate.
While I generally believe this thesis to be sound, I think it hinges on the assumption that a drop in block rewards will force miners offline, and that demand for bitcoin will not decline and this merits further analysis.
Mining is a difficult game of balancing BTC inflows with fixed cost outflows of hard dollars. Their most prevalent cost is electricity. In order to cover this cost, miners sell BTC, creating a consistent sell pressure in the market.
Next-gen miners are more efficient on a hashes-to-electricity-consumption basis helping alleviate some of concerns around electricity cost. According to recent research piece by BlockWare Solutions, a large distributor of mining rigs in North America, roughly 62 percent of miners are using new-gen miners (the Bitmain S17 and up) and 38 percent are using old-gen miners (the Bitmain S9 and below). The table below, from BlockWare Solutions, shows a breakdown of the mining landscape based on their internal data, which has insight into 20 percent of the total hash rate on the network.
I believe the recent downward price action has already caused a miner capitulation, which is reflected in the recent drop in hash rate and the compensating downward adjustment of difficulty. At current bitcoin prices (roughly $6200), 19 percent of bitcoin miners are operating at a loss. With the halving being a doubling of break-even price, we can see that roughly an additional 38 percent of miners will join them. That’s roughly 57 percent of the market in. And while that constitutes a majority of the hash power, the reality is that miners can and often do operate below break-even prices. To sustain themselves, they sell bitcoin from their own treasury, adding to the selling pressure.
While the halving will certainly take miners offline, I believe this will be a gradual change as opposed to an instantaneous change. It will likely be preceded by additional selling pressure from miners operating below break-even costs, unless there is a substantial spike in price or consistent decline in difficulty allowing these miners to stay online.
Price action as a gauge for demand
“Isn’t it priced in?” is the most common question I hear from both short term traders and long term investors. I find this question to be shallow because it is nearly impossible to answer for any asset, let alone one as nascent as bitcoin. Despite the steady press coverage, I feel that the true impact of the halving is not priced in – certainly not outside the core long term BTC holders.
Current futures price would suggest market participants are unaware of a halving or do not expect it to have a big impact on price with post halving expiry contracts trading in line with pre halving expiry contracts.
Historically, bitcoin has had large run-ups in the year leading into the halving followed by parabolic gains in the year after.
Mature markets require patience
While this narrative was certainly compelling in the summer of 2019 with bitcoin peaking around $13k, bitcoin is currently up 20 percent on a year over year (Y/Y) basis. This is still a phenomenal return, especially compared to the -13 percent Y/Y return in SPY – the exchange-traded fund tracking the S&P 500. Since the returns leading into the 2020 halving are compressed compared to the parabolic returns leading into the past two halvings, the returns after the 2020 halving should be positive but more constrained.
A measured response is in no way a condemnation of the halving thesis. It is the natural evolution of an asset class that is becoming understood by a broader market. Recent price action has been encouraging as the market has been able to absorb the selling pressure created by miners in the face of a large price decline due to a global flight to USD. While the price decline was substantial and primarily driven by short-term holders, the ensuing stability in the $6,000 range is positive and shows that demand for bitcoin has remained strong. With stablecoin capitalizations at an all time high, there is plenty of capital on the sidelines, but as markets mature, a singular, well broadcast event rarely causes outsized impact on price after the fact – certainly not one as talked about as BTC’s halving.
Early in its life BTC traded like a venture investment. Even in 2017, the crypto boom was fueled by a belief that distributed ledger technology would revolutionize all industries and that adoption of digital cash was close. But bitcoin is unique in being both a technology and a representation of strong money principles – digital gold. Its strong money principles are encompassed in a self correcting system incentivizing miners while slowing the rate at which this fixed supply asset is trickled out. I believe we will look back at bitcoin’s third halving and instead of parabolic gains see bitcoin come into its own during a period of global macro distress.
Quick gains usually turn into quick losses. Investing is a matter of patience. The halving will bring a positive impact to price but we should be measured in our expectations. Current actions by central banks around the world have given more positive catalysts to bitcoin than a singular event. Macro trends (such as the debasement of the U.S. dollar by the Federal Reserve) occur slowly and we have yet to see the impact of these events in traditional markets, let alone bitcoin. Patience and measured expectations are key in this market. After all, no asset has rewarded those two principles as handsomely as bitcoin.
NOTE: This article has been changed to reflect that currently post-halving futures are trading in line with pre-halving expiries.
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