Wednesday, 8 January, 2020
The Digital Investor
Bitcoin halving: buy in May and go away?
The Bitcoin supply schedule has been known from day one, as it is written into the code that every 210,000 blocks, approximately once every four years, the block reward is halved. The next halving is expected to take place in May 2020, when the miner’s reward will decline from 12.5 to 6.25 Bitcoins.
The question currently concerning every crypto-investor is whether this event will lead to a doubling (or more) of the price of Bitcoins.
In this edition, we investigate how the upcoming halving could impact Bitcoin’s price. In the course of this article, we will look at the history of Bitcoin, Litecoin and Ether to understand the likely price effect of the forthcoming Bitcoin halving.
Empirical evidence shows that halving events have been broadly supportive (either neutrally or positively) for prices when confidence in the network is high.
Why is halving important?
Every 210,000 blocks, the Bitcoin miner’s reward or coinbase reward is halved. In May 2020, it will be halved again from 12.5 to 6.25 Bitcoins (BTC) for every block added to the blockchain. For an introduction to mining, we invite readers to have a look at our latest educational pieceeducational piecelink1 on Mining: the essence of proof of work.
As a consequence of this, miner revenue1 earned from block rewards drops by virtually 50% after every halving. As block rewards represent almost 97% of mining revenuemining revenuelink1, if the dollar price per Bitcoin does not rise to compensate for the halving, miners are adversely impacted.
Miners play a central role in the proof-of-work blockchain as they “perform two critical functions for the network: they clear and settle the transactions and supply new Bitcoins to the network2.” Therefore, how mining dynamics shape up after the halving is important for the Bitcoin ecosystem and hence the price.
What happened in the previous halvings?
Bitcoin has experienced two halvings since its inception, in November 2012 and June 2016. Before we jump into arguments around the upcoming halving, let’s see how previous halvings have affected Bitcoin prices.
Exhibit 1 shows that after halving, gains are significant with respect not only to the price at the time of halving, but also to the pre-halving peak.
Exhibit 1: The impact of halvings on Bitcoin
Source: SEBA Research, Coinmetrics
Immediately after the first two halvings, miner revenue dropped (Exhibit 2). However, we did not see any impact on the hash rate, a measure of mining activity. This is an indication of the faith that miners place in the Bitcoin ecosystem.
Exhibit 2: The impact of halvings on miner revenue and hash rate
Source: SEBA Research, Glassnode, Coinmetrics
Although both halvings seem to have had a significant impact on the price of Bitcoin, the price did not react as vigorously to the second halving. Indeed, after the second halving, the upward trend did not steepened contrary to the previous one (Exhibit 1).
The first halving episode had a positive effect on price development as the upward price trend became even more vigorous, while in the second episode, the effect was neutral in the sense that the upward trend was unaffected.
This can be explained by multiple factors. One of them is that market capitalization was much higher given that more market players had entered the market the second time, and more investors were aware of the Bitcoin halving phenomenon. If this is true, future halvings will have a lesser impact on the price as information percolates through to the wider diaspora.
How have other crypto-assets reacted to reward changes?
Apart from Bitcoin, we looked at two other major crypto-assets, Litecoin and Ether. Although Ether (Exhibit 3) has reacted to reward changes in a similar way to Bitcoin, there is no evidence of consistency in the way Litecoin has reacted to halvings, as shown in Exhibit 4 (Interested readers are invited to have a look at the August 2019 Digital InvestorDigital Investorlink1, Implications of Litecoin’s reward halving).
Exhibit 3: Impacts of changes in block rewards on Ether
Source: SEBA Research, Coinmetrics
Exhibit 4: Impacts of Litecoin halvings on Litecoin
Source: SEBA Research, Coinmetrics
In our view, there is an explanation for this behaviour by Litecoin. Price and hash rate have a recursive relationship. A growing hash rate means that miners appreciate the fundamentals and expect the asset to perform well enough to keep a steady stream of revenue. As miners are mid- to long-term investors in the network, the hash rate indicates their confidence level in the network. If the hash rate dwindles after the reward halving, it can be concluded that the miners do not expect the price to compensate for the reduction in revenue in native asset terms.
Out of Bitcoin, Ether, and Litecoin, the former two have a healthy developer commitment towards respective projects. When it comes to Litecoin, the number of developers, as well as the frequency of upgrades, are tiny in relation to the other two. As a result, miners are not confident about the fundamental drivers of Litecoin compared to those of the other two. Which essentially means that miners are doubtful about the upside potential to Litecoin’s price. As a result, after the recent halving in August 2019, Litecoin’s hash rateLitecoin’s hash ratelink1 dropped by more than 70% from the all-time high that had occurred just before the halving.
Empirical evidence based on past halvings for Bitcoin, Ether3 and Litecoin shows that there have been significant gains after halving when the hash rate remained stable, as miners were confident about the network fundamentals which led them to believe in price appreciation. As Bitcoin’s hash rate is trending upwards, we have good reason to believe that market reaction to the forthcoming Bitcoin halving will be positive, as in the past.
However, there are two arguments to contradict this conclusion:
Exhibit 5: The impact of halvings on Bitcoin’s annualized inflation
Source: SEBA Research, Coinmetrics
The role of demand
Although these are compelling arguments, there is one missing piece of information. The price exists only when demand and supply meet. Without analysing demand, any verdict on the impact of supply on the price is incomplete. Even if we assume that the Bitcoin market is efficient, market participation has a lot of room for growth. We acknowledge that there is no way to accurately predict demand. However, we can find a few useful proxies to analyse demand.
Exhibit 6: Number of addresses with more than 0.1 and 1 Bitcoins
Source: SEBA Research, Glassnode
There have also been other indications of a consistent rise in demand. Square, a payment company founded by Jack Dorsey – Twitter co-founder –, has doubled its Bitcoin revenue each quarter. TD Ameritrade – a broker offering an electronic trading platform – is testing crypto-asset trading. These two examples illustrate the rise in supply to meet the rise in demand.
Our analysis shows that until now, halving has been either neutral or positive for crypto-asset prices as long as mining activity has remained strong.
Looking at how crypto-asset prices have performed before and after halving when mining activity has remained solid, we can see that the price either continues the broadly increasing trend (neutral effect) or accelerates (positive effect). The first Bitcoin halving was positive while the second was neutral according to this classification.
Following the second Litecoin halving, the price declined in line with the decrease of mining activity.
Based on our findings and given that Bitcoin mining activity is solid, there is good reason to believe that the price effect will be neutral or positive.
1Miner revenue comprises two components: 1) rewards for finding blocks and 2) transaction fees. As of now transaction fees contribute only 3% towards miners’ revenue. ↵
2December 2019 SEBA research: The Bridge – Mining: the essence of proof of work. ↵
3In the case of Ethereum, the block reward is not halved. It has been reduced twice – from 5 ETH to 3 ETH and then from 3 ETH to 2 ETH. ↵
4Grayscale Investments is a company that manages cryptocurrency investment funds. ↵
5With 12.5 BTC every 10 minutes, the monthly supply of Bitcoin is 540,000 BTC. 5,962 BTC it is about 11% of the supply. ↵
6Bakkt is an exchange company specialized in crypto-assets. It belongs to Intercontinental Exchange (ICE). ↵
7Bakkt has physically settled Bitcoin futures. ↵
8Source: Bakkt Volume bot. ↵
Subscribe to the research newsletter and get weekly updates about the latest articles of SEBAresearch
Subscribe to newsletter↓
This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is published solely for information purposes; it is not an advertisement nor is it a solicitation or an offer to buy or sell any financial investment or to participate in any particular investment strategy. This document is for distribution only under such circumstances as may be permitted by applicable law. It is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction.
No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained in this document, except with respect to information concerning SEBA. The information is not intended to be a complete statement or summary of the financial investments, markets or developments referred to in the document. SEBA does not undertake to update or keep current the information. Any statements contained in this document attributed to a third party represent SEBA's interpretation of the data, information and/or opinions provided by that third party either publicly or through a subscription service, and such use and interpretation have not been reviewed by the third party.
Any prices stated in this document are for information purposes only and do not represent valuations for individual investments. There is no representation that any transaction can or could have been effected at those prices, and any prices do not necessarily reflect SEBA’s internal books and records or theoretical model-based valuations and may be based on certain assumptions. Different assumptions by SEBA or any other source may yield substantially different results.
Nothing in this document constitutes a representation that any investment strategy or investment is suitable or appropriate to an investor’s individual circumstances or otherwise constitutes a personal recommendation. Investments involve risks, and investors should exercise prudence and their own judgment in making their investment decisions. Financial investments described in the document may not be eligible for sale in all jurisdictions or to certain categories of investors. Certain services and products are subject to legal restrictions and cannot be offered on an unrestricted basis to certain investors. Recipients are therefore asked to consult the restrictions relating to investments, products or services for further information. Furthermore, recipients may consult their legal/tax advisors should they require any clarifications. SEBA and any of its directors or employees may be entitled at any time to hold long or short positions in investments, carry out transactions involving relevant investments in the capacity of principal or agent, or provide any other services or have officers, who serve as directors, either to/for the issuer, the investment itself or to/for any company commercially or financially affiliated to such investment.
At any time, investment decisions (including whether to buy, sell or hold investments) made by SEBA and its employees may differ from or be contrary to the opinions expressed in SEBA research publications.
Some investments may not be readily realizable since the market is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. Investing in digital assets including cryptocurrencies as well as in futures and options is not suitable for every investor as there is a substantial risk of loss, and losses in excess of an initial investment may under certain circumstances occur. The value of any investment or income may go down as well as up, and investors may not get back the full amount invested. Past performance of an investment is no guarantee for its future performance. Additional information will be made available upon request. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. Tax treatment depends on the individual circumstances and may be subject to change in the future.
SEBA does not provide legal or tax advice and makes no representations as to the tax treatment of assets or the investment returns thereon both in general or with reference to specific investor’s circumstances and needs. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of individual investors and we would recommend that you take financial and/or tax advice as to the implications (including tax) prior to investing. Neither SEBA nor any of its directors, employees or agents accepts any liability for any loss (including investment loss) or damage arising out of the use of all or any of the Information provided in the document.
This document may not be reproduced or copies circulated without prior authority of SEBA. Unless otherwise agreed in writing SEBA expressly prohibits the distribution and transfer of this document to third parties for any reason. SEBA accepts no liability whatsoever for any claims or lawsuits from any third parties arising from the use or distribution of this document.
Research will initiate, update and cease coverage solely at the discretion of SEBA. The information contained in this document is based on numerous assumptions. Different assumptions could result in materially different results. SEBA may use research input provided by analysts employed by its affiliate B&B Analytics Private Limited, Mumbai. The analyst(s) responsible for the preparation of this document may interact with trading desk personnel, sales personnel and other parties for the purpose of gathering, applying and interpreting market information The compensation of the analyst who prepared this document is determined exclusively by SEBA.
Austria: SEBA is not licensed to conduct banking and financial activities in Austria nor is SEBA supervised by the Austrian Financial Market Authority (Finanzmarktaufsicht), to which this document has not been submitted for approval. France: SEBA is not licensed to conduct banking and financial activities in France nor is SEBA supervised by French banking and financial authorities. Italy: SEBA is not licensed to conduct banking and financial activities in Italy nor is SEBA supervised by the Bank of Italy (Banca d’Italia) and the Italian Financial Markets Supervisory Authority (CONSOB - Commissione Nazionale per le Società e la Borsa), to which this document has not been submitted for approval. Germany: SEBA is not licensed to conduct banking and financial activities in Germany nor is SEBA supervised by the German Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht), to which this document has not been submitted for approval. Hong-Kong: SEBA is not licensed to conduct banking and financial activities in Hong-Kong nor is SEBA supervised by banking and financial authorities in Hong-Kong, to which this document has not been submitted for approval. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Hong-Kong where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not “professional investors” within the meaning of the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) and any rules made thereunder (the “SFO”). Netherlands: This publication has been produced by SEBA, which is not authorised to provide regulated services in the Netherlands. Portugal: SEBA is not licensed to conduct banking and financial activities in Portugal nor is SEBA supervised by the Portuguese regulators Bank of Portugal “Banco de Portugal” and Portuguese Securities Exchange Commission “Comissao do Mercado de Valores Mobiliarios”. Singapore: SEBA is not licensed to conduct banking and financial activities in SIngapore nor is SEBA supervised by banking and financial authorities in Singapore, to which this document has not been submitted for approval. This document was provided to you as a result of a request received by SEBA from you and/or persons entitled to make the request on your behalf. Should you have received the document erroneously, SEBA asks that you kindly destroy/delete it and inform SEBA immediately. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Singapore where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not accredited investors, expert investors or institutional investors as defined in section 4A of the Securities and Futures Act (Cap. 289 of Singapore) (“SFA”). UK: This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product.
SEBA is not an authorised person for purposes of the Financial Services and Markets Act (FSMA), and accordingly, any information if deemed a financial promotion is provided only to persons in the UK reasonably believed to be of a kind to whom promotions may be communicated by an unauthorised person pursuant to an exemption under the FSMA (Financial Promotion) Order 2005 (the “FPO”). Such persons include: (a) persons having professional experience in matters relating to investments (“Investment Professionals”) and (b) high net worth bodies corporate, partnerships, unincorporated associations, trusts, etc. falling within Article 49 of the FPO (“High Net Worth Businesses”). High Net Worth Businesses include: (i) a corporation which has called-up share capital or net assets of at least £5 million or is a member of a group in which includes a company with called-up share capital or net assets of at least £5 million (but where the corporation has more than 20 shareholders or it is a subsidiary of a company with more than 20 shareholders, the £5 million share capital / net assets requirement is reduced to £500,000); (ii) a partnership or unincorporated association with net assets of at least £5 million and (iii) a trustee of a trust which has had gross assets (i.e. total assets held before deduction of any liabilities) of at least £10 million at any time within the year preceding the promotion. Any financial promotion information is available only to such persons, and persons of any other description in the UK may not rely on the information in it. Most of the protections provided by the UK regulatory system, and compensation under the UK Financial Services Compensation Scheme, will not be available.
© SEBA / Grafenauweg 6, 6300 Zug, Switzerland