An explainer on the Bitcoin Halving event
In today's newsletter, we tell you exactly why everybody's talking about bitcoin and what this means for the ecosystem.
The Story
Bitcoin isn’t like your regular currency. It’s a digital currency that runs on a blockchain.
Meaning
1. Nobody controls the currency (no central bank that prints the notes)
2. Nobody decides who gets to transact with the currency (theoretically available to everyone irrespective of your nationality)
3. It provides an unalterable record of all transactions ever committed on the network (nobody can sneak into the network and alter records)
4. And these transactions are anonymous
So it is imperative to know that the parties involved in the transaction are playing fair. Ergo, it’s imperative to verify these transactions.
Thankfully, the system can accommodate this. But verifying a transaction in the crypto world isn’t like verifying a transaction at your departmental store. Here, you’ll have to solve complex mathematical problems to vet new transactions. And if you successfully manage to get through the problem solving, you get a reward.
Actually, that’s not true. You have to verify a bunch of transactions. Which then culminates in a big block of sorts. Then you put the blocks together in a chain and you get ….
Wait for it…..
BLOCKCHAIN!!!
Only then you get your reward. The cool thing, however, is that the reward isn’t a certificate with a cash prize on top. Oh no!!!
You actually get new bitcoins every time you create a block. And these Bitcoins are whipped out of thin air just for you — for the stellar job that you did.
A job that’s called mining. With you as the miner.
But what happens when you try and create these blocks but somebody else beats you to it?
Well, in that case, you go empty-handed. So you’ve got to do it fast. Meaning you need fast computers, stable electricity, and a lot of cooling to run these systems. For context, Bitcoin used an estimated 191 million kilowatt-hour of electricity the day before yesterday. Extrapolate it for a year and you get 70 terawatt-hour. That’s the amount of electricity the entire country of Colombia uses to tend to the entire population.
And as more people with swanky computers keep entering the fray, creating new blocks gets harder. And the problem solving —computationally intensive.
Because if it doesn’t, miners will keep updating their computing hardware and you’ll have a wave of new bitcoins entering the system too fast, too soon. And that doesn’t bode well for bitcoins in general.
You see, the value of each bitcoin is ultimately governed by the immutable laws of demand and supply. Increase the supply and the value of said commodity decreases. And as the value of each bitcoin keeps diminishing, the value of the reward (assigned to miners) tumbles alongside it. That’ll push a few miners out the ecosystem and with less competition, the verification and the problem solving becomes less intensive (computationally).
The balance will be restored.
If you don’t limit the supply, however, you will most likely have chaos.
Also, the system limits the supply of bitcoins in another more intrusive fashion.
You see, when bitcoin first launched, the reward for successfully creating a block was 50 bitcoins. A few years later, in 2012, it halved to 25 bitcoins. In 2016 it halved again to 12.5 bitcoins.
And 2 days ago, when people reported on the great Bitcoin Halving event, they were referring to this reward system. So for the next 4 years, miners will be rewarded 6.25 bitcoins for every block they create and the process of halving will continue until the final bitcoin is mined.
Which should happen sometime during the year 2140. And the hope is that bitcoins will become so ubiquitous by then, that miners will no longer need to be compensated using new bitcoins. Instead, a transaction charge for facilitating the exchange will be ploughed to the miner as compensation.
Whether that will be incentive enough for people to still verify transactions is a matter of much debate. But it is what it is.