Sometimes, when the US economy is going through a rough period, the Federal Reserve stimulates it by increasing the number of US dollars in circulation. They tend to do this by buying large amounts of securities from banks.
At other times, when the economic climate is better, the Fed wants there to be fewer dollars changing hands, at which time they can opt to sell those securities. If we look at the years between 2000 and the end of 2022, we see that the supply of US dollars has actually tripled.
When it comes to bitcoin, however, there is no institution monitoring and adjusting the amount of currency available. Rather, the digital token’s founder wrote a system of operations into its underlying code, and this system prescribes that the rewards people receive for “mining” bitcoin, (which adds new blocks to the bitcoin blockchain and secures the entire system) drop as time passes. Since the identity of bitcoin’s founder is unknown, we cannot ask him or her why they made the system in this particular way, but it’s set in place nevertheless.
The event that functions to lower those rewards is called “halving” because it cuts the reward for mining bitcoin in half. One of these events is programmed to happen after the addition of each new set of 210,000 blocks in the chain (which occurs approximately once in every four years) and, when they do happen, the rate at which new bitcoins are created is reduced. “The theory”, explains Michael Dubrovsky of PoWx, “is that there will be less bitcoin available to buy if miners have less to sell”. Join us now for some more explanation of bitcoin halving and its implications, especially in the arena of cryptocurrency trading.
Mining for bitcoin requires heavy machinery but it doesn’t normally involve boring holes in the ground. In this case, “mining” actually means using powerful computers to validate transactions on the bitcoin blockchain. When a digital block recording a transaction stands waiting in line for verification, each miner vies to offer this service, which is done through solving mathematical puzzles. As a reward for doing this, the successful miner receives bitcoin, and this keeps him motivated to stay in the business.
Since bitcoin halving reduces these rewards, a result could be that the incentive to keep on mining will steadily drain away, which would undermine the security of the blockchain. Bitcoin’s founder was aware of this issue and addressed it when he wrote that, “In a few decades when the reward gets too small, the transaction fee will become the main compensation”. If this is true, however, and the fees paid by users of the network for buying and selling cryptocurrency will sufficiently compensate miners, it could lead to a situation where transactions become a lot pricier than they are now.
Oftentimes, a bitcoin halving event whips up considerable trader excitement, and the reason is that a spike in prices is anticipated. The logic of the expectation is that, if fewer digital tokens are coming into the system, but demand stays constant, prices should rise. Indeed, the halving event that occurred in November 2012 , when a bitcoin cost $11, seemed to lead onto a surge in prices. The following event, in July 2016, was, in fact, marked by a 10% drop in bitcoin prices but a rebound followed and, one year later, prices had mushroomed by as much as 284%, which some people saw as a result of the halving. The most recent halving event, back in May 2020, also seemed to work by delayed reaction, leading ultimately – after a year – to a 559% rally.
Analysts warn, however, that it is by no means guaranteed that a price surge will result from a bitcoin halving event and that, in reality, the effect on prices could diminish over time. “Today and into Bitcoin’s maturity, each halving is likely to have less and less impact on the price”, explains Tom Frazier of Redivider Blockchain. The reasons have to do with growing global bitcoin use and the progress made in establishing a proper regulatory structure to oversee the sector.
Bear in mind that the fluctuating prices of bitcoin aren’t only determined by the number of coins being generated. Media items about the failure of crypto firms tend to negatively influence public perception about the sector and digital assets in general. When this occurs, people are less willing to pay the high prices for newly mined crypto, which pushes down prices. In addition, when the cost of electricity goes up, many miners can be discouraged from continuing their operations and drop out of the business. So, even if a halving event exerts some influence on prices, it’s only one of many factors working behind the scenes.
If you’re involved in CFD trading in bitcoin prices on the iFOREX platform, spend some more time learning about the other forces that move crypto prices. At iFOREX, you can take advantage of both spikes and dips in bitcoin prices by opening either “buy” or “sell” deals on the world’s biggest crypto.
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