The bitcoin conundrum: cracking the code on decentralised digital currency

Let us face the facts. It’s undeniable that 2020 has been one of the most astonishing and cataclysmic years to date. Although our global economic outlook is seeing some light at the end of the tunnel, much of the future is frankly still up in the air. Markets, in particular, have been highly volatile, and the question is when society will holistically resume remains ambiguous. Yet despite a year that has been full of surprises, cryptocurrency underwent one of its most pivotal events that had people buzzing with anticipation.

What happened was the halving of Bitcoin, or BTC; one of the most recognised, decentralised digital currencies existing today. The halving is an event that only transpires every four years and was always known to take place with complete certainty. This important moment for the Bitcoin market was definitely no surprise and had the attention of many over the past several months.   

Bitcoin has been floating around in financial markets and open discussions for over a decade, and this month marked its third halving since its establishment by pseudonymous creator Satoshi Nakamoto. A caveat, however, is that the system is finite. Satoshi Nakamoto founded the Bitcoin ecosystem upon a limited supply of exactly 21 million Bitcoins from the very start. When the final bitcoin is mined, the supply will be depleted. Every four years, 210,000 blocks are mined by people solving complex maths problems with computers that require an immense level of energy. Quadrennially, miners have their rewards cut in half, giving the halving its eponymy.

Beyond this, what we are all used to is fiat currency, referring to the physical currency that is commonly used today, printed and distributed by central banks, flowing through the economy via a diverse range of transactions. Bitcoin is produced in a similar way, through ‘bitcoin mining’, a very expensive, arduous and technical process of creating ‘blocks’ of verified transactions that are added to the blockchain system. Mining is essentially like auditing; making sure bitcoin transactions are honest, secure and helping to support and legitimise the Bitcoin network [4]. As a result, miners are rewarded for their work, earning bitcoin as compensation in exchange for running the system.

But, I’m sure there are a lot of thoughts running through your mind, such as ‘Alright, I don’t know what that means,’ or ‘I don’t even know what Bitcoin really is,’ or ‘Sure, but I have nothing to do with Bitcoin and so this doesn’t really matter to me.’ These are all highly justified, but give me a chance to argue why it would be great to know what the halving meant, how Bitcoin works, and why it matters to not only you and I, but the way we can understand contemporary monetary supply, policy and the nuances of the halving on our economy.

Cryptocurrency is essentially virtual money in the form of digital files, built upon encryptions and public distribution ledgers, such as blockchain, for secure online transactions [1]. Cryptocurrency is decentralised, meaning that it’s not controlled by any person or financial institutions. It is easy to transport, secure and is unaffected by inflation, but it is highly volatile and supply is relatively scarce compared to conventional fiat currency and financial instruments [2]. Bitcoin is a form of cryptocurrency, commonly considered one of the first, and is now one among over 4,000 cryptocurrencies in the market. However, Bitcoin remains one of the most popular, with over 76% of surveyed millennials saying they would invest $10,000 into the digital currency [3].

On 11 May 2020, the mining block reward for Bitcoin reduced from 12.5 BTC per block to 6.25 BTC per block. This will be reduced again in 2024, halving once more to 3.125 BTC per block.

So, we know now what the halving is, and how it works. However, what’s interesting about the halving is that it has reminded us about the incredibly brilliant and intricate system Bitcoin is founded upon, notably how it differs from our global monetary system: limited money supply and deflationary economics [5]. Over time, the Bitcoin currency will completely run out; a stark contrast to fiat currency, which is unlimited and controlled to either stimulate or sedate the economy depending on feasibility and necessity. With a limited money supply, Bitcoin’s ecosystem is far more predictable, and without a central bank playing god, Bitcoin algorithms will continue to run until none are left to produce, which raises speculation that BTC will become increasingly rare and valuable in the long-term [6]. Furthermore, unlike inflation-prone fiat currencies, Bitcoin’s buying power increases over time, which might have Keynesian economists throwing fits due to the detrimental implications that has on consumer spending.

However, what’s more intriguing is Bitcoin’s role right now in this global pandemic. When indices and stocks began their journey down into bear market, Bitcoin was a ‘virtual commodity’ that many trusted in as a safe escape once the halving happens. This is because historically, halving events have appreciated Bitcoin value into rallies every time. Legendary hedge fund manager Paul Tudor Jones believes Bitcoin is the ‘fastest horse’ in this environment, reminding him of gold in the 1970s [7], another asset that has been a timeless commodity investment in times of economic distress. However, gold is far more liquid, far more widely understood, and is relatively far less volatile.

Whilst the previous events saw bullish movements, this time won’t necessarily be the same; we may not see an immediate rally any time soon [8]. Interestingly enough, Bitcoin plummeted last week, after rumours surfaced about an inactive account from the early days of Bitcoins establishment that sold 50 BTC (approximately A$700,000) [9]. For perspective, if Satoshi Nakamoto were to sell his/her/their coins, the entire Bitcoin price would literally tank due to a highly sacrilegious dumping scheme. As you can see, bitcoin and crypto markets remain volatile regardless of the hype, and many investors have turned away to other safer commodities and securities [7]. Moreover, the previous two events didn’t have a global health crisis disrupting major economic activity, so this year’s halving remains a wildcard for many [10].

So what is the verdict on Bitcoin? Investors and analysts believe it could act as a hedge, or safeguard, against inflation [11]. Some economists arguably view and fear inflation, without intervention, will be a ‘virus’ of its own accord, as central banks have begun executing mass money creation, QE expansion and other fiscal stimuli to grapple with rising national debts. On the other hand, sceptics hold onto the belief that Bitcoin is simply an impending speculative bubble, with zero intrinsic value due to its intangibility [12]. When will we run out of Bitcoin? It probably won’t happen for over another 100 years. When this happens, however, Bitcoin will continue to circulate the system, as miners will continue to receive transaction fees through blockchain transfers. However, the journey to that point and the relevant repercussions are still open-ended right now [13]. No one can be absolutely certain about how significant Bitcoin will become in the short-term, let alone the next several decades. Regardless, at least the majority of crypto investors and researchers have had something to be excited about in this tumultuous year. It’s going to be a fascinating journey, bearing witness to finance and technology intertwining and evolving within this unpredictable world economy.

[1] Greenberg, A. (2011). Crypto Currency. Retrieved from https://www.forbes.com/forbes/2011/0509/technology-psilocybin-bitcoins-gavin-andresen-crypto-currency.html#5d854adf353e  

[2] Frankenfield, J. (2020). Cryptocurrency. Retrieved from https://www.investopedia.com/terms/c/cryptocurrency.asp

[3] Mourdoukoutas, P. (2018). Bitcoin, Ethereum And Litecoin Are The Most Popular Cryptocurrency Investments Among Millennials. Retrieved from https://www.forbes.com/sites/panosmourdoukoutas/2018/03/25/bitcoin-ethereum-and-litecoin-are-the-most-popular-cryptocurrency-investments-among-millennials/#64b3262e76dd  

[4] Hong, E. (2020). How Does Bitcoin Mining Work?. Retrieved from https://www.investopedia.com/tech/how-does-bitcoin-mining-work/

[5] Huang, R. (2020). Seven Key Things You Should Know About The Halving Of Bitcoin. Retrieved from https://www.forbes.com/sites/rogerhuang/2020/05/11/seven-key-things-you-should-know-about-the-halving-of-bitcoin/#63251e6c7b93  

[6] The Deflationary Economics of the Bitcoin Money Supply. (2020). Retrieved from https://www.skalex.io/deflationary-economics-bitcoin/  

[7] Ossinger, J., & Hajric, V. (2020). Bitcoin Crashes as Halving Hype Loses Impetus Over the Weekend. Retrieved from https://www.bloomberg.com/news/articles/2020-05-11/bitcoin-has-rough-weekend-as-price-slumps-back-below-10-000?sref=rOyhIHD5  

[8] Chong, N. (2020). The Bitcoin Halving Just Happened: Here Is What Analysts Think Comes Next. Retrieved from https://www.forbes.com/sites/nickchong/2020/05/11/the-bitcoin-halving-just-happened-here-is-what-analysts-think-comes-next/#56860c06419e  

[9] Hajric, V., & Kharif, O. (2020). Crypto Faithful Flip Out on Speculation Satoshi Sold Bitcoin. Retrieved from https://www.bloomberg.com/news/articles/2020-05-20/crypto-faithful-freak-out-amid-speculation-satoshi-sold-bitcoin?sref=rOyhIHD5  

[10] Chavez-Dreyfuss, G. (2020). RPT-UPDATE 1-Coronavirus sows doubt over bitcoin’s rally after third ‘halving’. Retrieved from https://www.reuters.com/article/crypto-currencies-bitcoin/rpt-update-1-coronavirus-sows-doubt-over-bitcoins-rally-after-third-halving-idUSL4N2CT1IH

[11] Schatzker, E. (2020). Paul Tudor Jones Buys Bitcoin as a Hedge Against Inflation. Retrieved from https://www.bloomberg.com/news/articles/2020-05-07/paul-tudor-jones-buys-bitcoin-says-he-s-reminded-of-gold-in-70s

[12] Zigah, X. (2020). Is Bitcoin Really Digital Gold?. Retrieved from https://www.forbes.com/sites/forbesfinancecouncil/2020/05/11/is-bitcoin-really-digital-gold/#3e6f586f2a84

[13] Kim, C. (2019). With 18 Million Bitcoins Mined, How Hard Is That 21 Million Limit?. Retrieved from https://finance.yahoo.com/news/18-million-bitcoins-mined-hard-210009973.html