Bitcoin has again approached the mark of $ 10,000, and you, of course, are interested in what happens next. 2020 is a special year for Bitcoin in many ways. Its main feature – halving – is forever inscribed by Satoshi Nakamoto himself in the DNA network. The next halving is expected on May 12, 2020, and I suggest thinking about what will happen after it.
There are many theories regarding how halving affects price, and most of them are economically justified. Although often these theories do not explicitly state this, they refer to changes in supply and demand. Economists like this simple model. If we expect a decrease in supply or an increase in demand, then the cost of bitcoin should increase. Let’s dive together into the economic features of halving and see why bitcoin should – or should not – rise to new, unprecedented heights.
Supply: Bitcoin inflation drops to 1.8%
This is the principle of halving: in May 2020, the reward for miners will be reduced by half – to 6.25 BTC instead of 12.5 BTC. Every day, only about 900 coins will be created, as opposed to the current 1800. The annual growth in the total supply of bitcoin in this way will be reduced by more than half, to 1.8%.
Compare this with something more familiar: in 2019, the money supply growth in the USA amounted to 5.15%. Over the past 50 years for the US dollar, this figure was below 2% only in 1993 and in 1994.
Someone, of course, may object that a lot of bitcoins were lost, which means that inflation is actually higher. If all lost bitcoins or bitcoins that cannot be spent represent one fifth of the total supply, then real BTC inflation is about 2.25%. This, in comparison with the USA, does not change practically anything. We would only have to add one year on each side of the period 1993-1994 (i.e. 1992 and 1995), when dollar inflation was below 2.25%.
In other words, the monetary inflation of bitcoin is already low, and it will decrease even more. And what does this mean from an economic point of view? Less new bitcoins means lower supply growth. Miners will partially spend new mined bitcoins or send them to exchanges to pay electricity bills and pay off other expenses. Buyers will fight for a reduced number of bitcoins, which, with current demand, will lead to higher prices. This was the case with the previous two halvings, and therefore many do not wait until the next one comes. But, of course, everything is not as simple as it seems. It is at this moment that the basic laws of economics come to the rescue.
Suggestion: Forget about Stock — to — Flow
More than a year before the third halving of all Bitcoin fans, the PlanB article puzzled the author in anticipating a BTC price increase of up to $ 90,000 as a result of the next halving. From a mathematical point of view, the model looked convincing, and the idea on which it was built was impressive. The smaller the influx of new money to their total stocks, the scarcer the goods. The more unique the product, the higher its value. And due to halving, the deficit measured by this Stock-to-Flow model (the ratio of stocks to the growth of the total number of assets) will increase significantly. Is it possible to predict the price in this way? This topic definitely deserves a separate article, but let’s try to describe it briefly.
Let’s face it: using the Stock-to-Flow model to predict prices is extremely ridiculous. First of all, the price is formed under the influence of demand and supply. Of course, to analyze the proposal is very useful, but without demand, the price cannot be determined. If the demand for bitcoin falls, the price will fall even with the same Stock-to-Flow indicator. In the end, look at Bitcoin Cash and you will immediately see that this model does not work. Or create your own cryptocurrency, the Stock-to-Flow rate of which is ten times higher than the Bitcoin rate. Most likely, it will be useless, because there will be no demand for your cryptocurrency.
Secondly, if we know that Bitcoin needs to skyrocket because of the magical Stock-to-Flow and grow ten times after each halving, then why are we inactive? Are speculators so foolish? Although here you can reasonably object that it would be too risky (as PlanB concluded in his article).
Thirdly, in accordance with the Stock-to-Flow model, after several decades, the value of bitcoin should be higher than the GDP of all countries in the world. And when the same quantity will be created, and then fewer coins than lost, the model will predict the infinite and then negative value of bitcoin.
Deficiency is a necessary but not sufficient condition for value. The Stock-to-Flow model correctly draws attention to scarcity, but misses the second necessary variable of the equation. As a result, the model is not applicable for price prediction and remains only an expression of the dreams of all Bitcoin fans.
Demand: halving attracts attention …
There is no historical need. People tend to turn to history to predict the future, and believe that there are repeating cycles. Of course, this is not so, but the fact itself is interesting that people believe in it. As a result, a recurring story sometimes becomes a self-fulfilling prophecy.
In a word, the expectations associated with halving draw attention to Bitcoin and speculation on changes in its course, which allows these expectations to come true. And this article also confirms that: we say, write and give instructions regarding halving. If halving will push the indecisive to try bitcoin, then demand will increase and, as a result, the price.
Demand: … but for some – only temporarily
Technical and economic characteristics of Bitcoin are not appealing to everyone. It is reasonable to admit that many people are simply looking for an opportunity to quickly get rich. This is completely natural, and occurs in all markets. At the risk of their own money, speculators are trying to correctly determine the future price and provide the market with an important information function. Thanks to them, the current price carries information about the future expectations of real interested parties.
Nevertheless, the market price is constantly changing, and its growth attracts more and more people to the market. As in the case of any assets, this gives rise to unjustified short-term expectations, due to which a “bubble” is formed, which later bursts.
In the past, it happened that, after a short period of time after the previous two halving, price “bubbles” formed. After the first halving in 2012, the price in just a year increased 100 times. After the second, in 2016, the price of bitcoin for a year and a half increased 30 times. In both cases, bitcoin overcame symbolic thresholds – first at $ 1,000, and then at $ 10,000. However, in both cases, bitcoin fell from the achieved heights and lost almost 85% of its value. There is indeed a predisposition to “bubbles”.
But do any conclusions for the future follow from this? Despite the temptation of such an approach, choosing two data points and trying to build forecasts for the future based on them is extremely frivolous.
Demand: are markets efficient?
But even if it all seems meaningful to you, one detail brings chaos to the situation. If we know with almost perfect accuracy when the halving will occur, this means that preparing for it will not be difficult. Speculators are not like fools, and they would not have missed such an opportunity. If in the past we could say that they simply do not know anything about Bitcoin, then in 2020 this argument is unacceptable. Economists call this the “efficient market hypothesis”. Any known information should be reflected in the price. But is this really happening in the markets? In fact, even more so than it seems.
The growth from the latest lows reached by the price of bitcoin at the end of 2018 at around $ 3,200, no doubt, is largely due to expectations and increased attention to the upcoming halving. So if you expect a sharp increase in the cost of bitcoin right after halving, lower your expectations as much as, in your opinion, others expect this to happen. In addition, try to divide for yourself people who are aware of the real and media effect of halving on supply and demand, and those who are only interested in bitcoin for a while due to rising prices.
Of course, market efficiency is not fully ensured, and no one counts on it, especially in the case of such risky assets where, on the one hand, there is an excellent asset and, on the other hand, an unpredictable government, fierce competition, vigilant schemers and other risks. Constantly, at any moment of time, there is a reassessment of both risks and opportunities. And with them the prices.
Supply and demand: space for optimism
The recipe for Bitcoin’s long-term success is not to wait for one halving after another. It consists in reducing existing risks, in seeking new opportunities and patiently explaining existing risks and opportunities.
All this is encouraging, because now Bitcoin can offer much more than before the first or second halving. It’s hard to believe, but let’s remember that, for example, before the last halving SegWit did not exist. And just imagine that there was no safe way for long-term storage of crypto assets, and that before the first halving there was not even Trezor.
Expectations of what will happen after halving are supported by both supply and demand. Limited supply is a necessary but not sufficient condition for price increases. The next bitcoin halving is a natural stimulus for demand, which could potentially lead to a bubble, unless the public realizes that since the last halving, bitcoin has changed beyond recognition and has changed for the better.