If you’re not a bitcoin enthusiast, you probably haven’t heard what’s happening next year: It’s called the “halving”, and it will cut production of the cryptocurrency by 50%
No one’s in control of this process. It’s a rule written into bitcoin’s underlying code by its pseudonymous creator Satoshi Nakamoto more than a decade ago. The event, expected in May 2020, slashes by half the number of new coins awarded to bitcoin miners who provide global supply of the cryptocurrency by solving complex maths puzzles.
That’s a big change in a market worth about $120 billion where bitcoin worth several billions dollars are created every year. Players in the know are preparing for the sharp price gains and volatility that have accompanied previous halvings, which happen roughly every four years and act to both ensure the scarcity of bitcoin and keep a cap on price inflation.
There are likely to be winners and losers. So market participants, from bitcoin miners and traders, are trying to fathom how the next halving might play out to gain an edge. “This is the biggest question right now for most of the industry,” said Eyal Avramovich, chief executive of MineBest, a Warsaw-based company that mines bitcoin. The fracture to the production of bitcoin provides a reminder of one reason why the decentralized digital currency has confounded regulation and acceptance by mainstream finance: Its fate remains tied to arcane technological factors.
In theory, if supply is cut and demand stays constant, prices rise. This time around, seven crypto traders and miners interviewed by Reuters said the May halving would probably lead to greater volatility and trading volumes. However the cut to supply is liked to be more priced in than previously, they said, with many traders already geared up for the upcoming event.
MAKING MONEY FROM SWINGS
Bitcoin miners use high-spec computers to compete against other machines in the crypto network, racing to add new “blocks” to the blockchain ledger that underpins the cryptocurrency. They are rewarded with a set number of bitcoin, currently 12.5. At current rates of block creation, the next halving will take place in May, when the number will drop to 6.25.
In the one-year periods after the two previous halvings, in November 2012 and July 2016, bitcoin rose around by 80 times and four times respectively. It is not clear how much of these price gains was down to the halving, versus with other factors. This time around, bitcoin derivatives markets – still nascent – point to higher volatility around the time of the halving, said Jeff Dorman of Arca, a U.S. crypto investment firm.
Such volatility in bitcoin markets tends to benefit quantitative hedge funds and high-frequency traders that seek to make money from swinging crypto prices. “For us, the event will be positive because it cause activity in the market,” said Ha Duong of Cambrial, an cryptocurrency investor in Berlin.
But for miners that hold large inventories of bitcoin, volatility can also be a hindrance. For them, stability of price gives greater predictability for investment in new gear. While bitcoin futures contracts allow miners to hedge the risk of their inventories, there are currently few tools for them to properly hedge against volatility, said Ricky Li, co-founder of crypto trader Altonomy.
“If you want to long volatility, the options contracts available for the market right now really do not have the tenor (length),” he said. “Right now all you can do is to just make sure your holdings risk, your inventory risk, is hedged.”