The third Bitcoin “halving” took place Monday afternoon, putting the inflation rate of this populist Internet money below the targeted annual inflation of the U.S. dollar.
I know what you’re thinking. Bitcoin? Halving? Inflation? What language is this? But you’ll want to understand this, as it may become a crucial fact to know, should the U.S. economy continue on its current trajectory.
What Is Bitcoin, and Why Does It Have Value?
Simply put, Bitcoin is digital scarcity. The Internet made it easy to transfer information — but not currency. If I email a photo to a friend, the file doesn’t leave my computer; now there are two copies of that file on two computers. That’s not a problem with a photo, but it is a problem with cash. If every purchase ended up doubling the amount of cash in circulation, it would quickly lead to hyperinflation and would crash the value of a dollar.
Bitcoin fixes this. What it does is create a digital ledger that assigns credits to “addresses,” or strings of numbers and letters that function as a destination for said credits. People who use the software can control that address with a private password that allows them to charge a debit to their address and add a corresponding credit to another address, presumably to pay someone else for a good or service. In layman’s terms, when I send my Bitcoin to someone else, I’m really sending it. I can’t send it to five other people, like a PDF over email or text. It’s out of my possession. And tens of thousands of computers around the world are checking 24/7 to prevent fraudulent accounting — for instance, if I try to spend my Bitcoin in two different places, only one of those transactions will be recognized as valid in the history of the ledger.
The second problem that Bitcoin fixes is monetary policy. Do you know how many U.S. dollars are in circulation around the world? Can you audit their provenance? Can you do anything to prevent hyperinflation? Do you know why the Federal Reserve pumped trillions into the repo market from September to January — before the coronavirus crisis made it pump even more? Do you know how it decides which banks and businesses get this money?
You obviously don’t, because there is no transparency, and there is no predictable monetary policy in the western world — aside from ever-greater federal debt, ever-greater unfunded entitlements, and ever-greater money printing. Bitcoin, on the other hand, has simple, predictable monetary rules, and it’s designed to be deflationary — that is, unlike physical gold, it suffers no drop in usability if the value of its lowest denomination becomes too high and it needs to be split into smaller fractions. As the population grows, the value of a fixed money supply slowly rises. Purchasing power goes up over time, giving people a greater incentive to save.
These days, you cannot save cash; if you don’t want your money to lose its value, you must hand it over to a bank, a fund, or some other third party who will take their cut and penalize you for spending it before their arbitrary waiting periods. Regularly tithing a tenth of your paycheck to the stock market, decade after decade just to outpace inflation, is a wealth transfer from ordinary people to major corporations; is it any wonder small businesses struggle to stay afloat in this system? Is it any wonder the working class is saving for retirement rather than property and entrepreneurship?
And this facet of Bitcoin is possibly the answer to that broken system.
What Is the Bitcoin Halving?
One important point to note is that Bitcoin’s supply is not fixed — not yet. New Bitcoins are added to the circulating supply all the time — but baked into Bitcoin’s software is a “halving” of its issuance of new credits. I have explained this system in the past in a discussion of the process of Bitcoin mining:
Bitcoin employs a system called “proof of work” where, approximately every ten minutes, the software saves the most recent state of the ledger in a “block” of transaction information. People running the Bitcoin software use their computers to encrypt the newest valid block in a process called “hashing” or, more commonly, “mining.”
For the time being, Bitcoin does have a programmed inflation rate, or what is called a “block reward.” Any time a new block is confirmed, the software gives out a number of new Bitcoins to the miner that found it, increasing the ledger’s total balance. When the program first began in 2009, the ledger started with 50 Bitcoins, adding 50 more to the balance with each new block. That reward decreases by 50% periodically until it becomes so small (circa 2140) that no new Bitcoins will be added to the ledger, capping the total balance at 21 million.
There have been two previous “halvings,” one in 2012 and one in 2016. Since 2016, Bitcoin’s supply increased by 12.5 new BTC every ten minutes, which meant an annual inflation rate of around 4%. Once it hit the 630,000th block of transactions on Monday, that subsidy decreased to 6.25 new BTC every ten minutes, setting the annual inflation rate now at 1.8%. The Federal Reserve has an inflation target of 2% annually; while some years may fall below that average, a loss of purchasing power is certain over time — again, unless you regularly hand over your cash for stocks, funding Coca-Cola et al.’s operations while you wait for your mid-60s.
[Update: To clarify the terms used here, the “inflation” of Bitcoin here is referring to the increase in its monetary supply, while the “inflation” of the U.S. dollar is referring to prices and purchasing power, since it is impossible to track the supply of U.S. dollars around the world, as I mentioned earlier. The purchasing power of Bitcoin has undergone massive deflation since its first trading against USD in 2010.]
Bitcoin is now entering the season where its primary value proposition gets tested: a monetary system without bailouts, without centralized control. People can choose whether they trust this software or whether they trust their government with their wealth, now that the software has matured beyond its high early supply growth.
Will BTC soon rocket to “the moon,” like it did with its big 2017 breakout to $20,000+? That’s not very likely; looking back, it seems much of the demand for that rally — which began more than a year after the July 2016 halving — came from a Ponzi scheme called BitConnect, not an organic rise in the number of people seeking financial autonomy. It seems Bitcoin is best suited for long-term speculation — a hedge against hyperinflation or another black-swan economic disaster — with the understanding that widespread adoption could one day flatten out its volatility, and scalable payment systems could one day make it suitable for everyday use.
A couple necessary disclaimers: this is not financial or investment advice. Exchanging your time or resources for any of these digital assets could result in a total loss, and you should be extremely skeptical of any pie-in-the-sky promises. Consider my biases: I own a small fraction of BTC and stand to gain financially if it increases in value.