In the chaotic world that is the novel coronavirus-fueled investment markets, one sector has been steadily rising in prominence. An alluring yet frustrating asset, bitcoin is at time of writing on the cusp of breaching the psychologically important $10,000 level. Yet outside of ardent cryptocurrency supporters, the blockchain reward token has its detractors. After all, when the U.S. was gripped in coronavirus panic in March, prices dipped well below $5,000.
At the same time, proponents argue that this time is different. Yes, it’s one of the most dangerous four-word phrases you’ll ever come across. Yet it also has a compelling allure today. This is due to a concept called halving. Very roughly, halving correlates to a reverse stock split or share buybacks. As Coindesk.com contributor Alyssa Hertig explains:
Sometime in May, the number of bitcoins (BTC) entering circulation every 10 minutes (known as block rewards) will drop by half, to 6.25 from 12.5. It’s a milestone that’s easy to see coming because it happens every four years and has happened twice before.
In practical terms, this event reduces the supply of circulated bitcoin. Based on economic principles, lower supply should increase demand. But it’s a bit more complicated than that. And no one reasonably sized article can fully articulate the processes involved.
Instead, I’ll provide a basic background and focus on the possible implications of the halving.
What Is Bitcoin Halving
To understand the bitcoin halving event, one must appreciate the concept of the blockchain. Using technical terms, a blockchain is a distributed, decentralized, public ledger. In human terms, it’s a transactional record-keeping system.
But instead of a centralized source inputting and verifying the transaction data – such as a corporation’s accounting department – the process of verification occurs by multiple operators called miners; hence, the process is decentralized.
Utilizing advanced computer hardware to run complex algorithms, miners verify the transaction data that goes into every block of data in a blockchain. Running these algorithms is energy intensive and therefore costly. For their efforts, miners receive a reward token for their troubles, in this case bitcoin.
The halving, then, is exactly what it sounds like. As Hertig explains, “Every 210,000 blocks, or roughly every four years, the total number of bitcoin that miners can potentially win is halved.”
It’s important to note that halving will end when bitcoin reaches its total maximum supply of 21 million coins. That’s scheduled to occur around the year 2140.
Will Prices Move Up?
Now, for the million-dollar question: will the bitcoin price move higher because of the halving? It could but it’s also complicated.
First, we must understand that for all intents and purposes, the halving process is set in stone. The creator of the cryptocurrency, a person or entity named Satoshi Nakamoto, designed the architecture this way. Yes, it’s possible to change this setup but would require a consensus among the cryptocurrency’s mining community. In short, it’s probably not going to happen.
This brings me to a second point. Because halving is set in stone, it’s a well-known factor. And when everyone bets on the same horse, the potential reward is minimal.
True, the bitcoin price has skyrocketed following prior halving events. But correlation doesn’t always mean causation. With the virtual currency, it’s possible that investors are conflating its dramatic rise with the halving process. In my opinion, it’s more likely that the newness of this investment class excited buyers into a frenzy.
Let’s face it – in the early 2010s, very few people knew about cryptocurrencies. When bitcoin first breached four-digit prices, it piqued broader interest before the digital markets crashed. A few years later when bitcoin surged toward – and passed – five-digit territory, mainstream investors bought in en masse. Again, the markets crashed.
That said, I believe that cryptocurrencies will do very well for the same reason that a disconnect exists between a rising stock market and terrible economic metrics. Namely, in a subterranean interest-rate environment, people need a platform to grow their money. One avenue is the equity market. The other avenue is cryptocurrencies.
A Fascinating Social Experiment
During this coronavirus-fueled quarantine, I’ve had much time to reflect on the financial markets. As such, my opinion on bitcoin and many other cryptocurrencies, such as ethereum and litecoin, have evolved.
What’s particularly interesting about virtual currencies is that they represent a fascinating social and economic experiment. During the Great Depression, the Federal Reserve was reluctant to increase the money supply, which economists argued exacerbated the crisis. Indeed, this one event has forever changed how the Fed responds to economic shocks.
When the Great Recession struck, the Fed wasted no time in expanding the monetary base. With the Covid-19 pandemic, we see the same thing happening today. But in terms of supply, bitcoin is different. Rather than expanding supply, it’s on a predetermined path to slow exponentially to a crawl.
Of course, it’s not an exact parallel. But the restriction or deceleration of supply runs counter to modern economic theory. Will this lack of supply drive a surge in demand? Or will cryptocurrencies fail as investors look for better alternatives?
Fundamentally, it’s fair to point out that cryptocurrencies have no inherent value. When you invest in a stock, you’re buying equity in a business. That business hires people, injects money into its industry’s supply chain, and invests in platforms and solutions to better serve their customers.
With cryptocurrencies, you’re paying money so that some nerd can burn ungodly amounts of energy, energy that arguably could have been put to better use. That’s not exactly a heartening outlook.
Be Bold but Be Careful
Ultimately, you’re buying bitcoin because you believe other people will value it more than you do. On the surface, that sounds like a classic case for a bubble. And in many ways, that’s exactly what this racket is.
But that doesn’t necessarily mean that cryptocurrencies don’t have a long pathway ahead. Because the coronavirus disrupted everything, there’s arguably greater demand for digital (read flexible) investment platforms. Plus, you must also consider that Generation Z and future generations are exclusively digital. To them, virtual currencies have greater sway than the Dow Jones Industrial Average.
So yes, I believe that you’ll see incredible gains in the digital markets. Just don’t get carried away. Like I said, you’re buying into a consumptive, not accretive investment.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare. As of this writing, he is long the cryptocurrencies mentioned in this article.