Invented in order to deal with fiat's inflation problem due to the fact that currency could be printed anytime at will causing inflation, Bitcoin has an internal mechanism to control inflation. Thus as per Satoshi Nakamoto's design, the number of blocks added to the Bitcoin blockchain, which keeps growing as people continue to mint, reduces to half every four years.
What's Bitcoin Halving?
Halving is the reduction in the number of Bitcoins mined per given time into half. The newly mined Bitcoins are reward to miners -- remember mining is an activity designed to first decentralize the network of participants and two to secure the network. The reward to miners for playing these roles, which is the newly mined Bitcoins, is set to decrease every 210,000 blocks.
Based on the Bitcoin protocol, the supply of Bitcoin is limited to 21 Million with the number of Bitcoins generated per block remaining constant and every block being mined per each 10 minutes. Since 6 blocks are found every hour on average and halving happens every 210,000 blocks then the halving takes about 4 years. When Bitcoin started, 50 bitcoin would be mined every 10 minutes and after the last two halvings, this year's halving will be reducing rewards to 6.25.
Halving is expected to cause some jump in price since the major effect of the halving event is to cut supply of Bitcoins mined, which could cause a higher demand.
As mentioned, the intention of halving is to cut down supply of btc or to slow the process of producing new Bitcoins. Based on Satoshi Nakamoto's design of the protocol, the reducing of supply is meant to keep inflation in check as previously said.
Bitcoin was inspired by need to ending the problems of fiat currencies such as inflation with the understanding that the flaws in the politically-motivated decisions, decisions and factors that control supply and demand affect the value of a currency such that printing of too much currency leads to dropping of its value. Limited supply of Bitcoin is also meant to keep the value more of constant.
According to Nakamoto, the steady addition of a constant amount of new coins would be analogous to gold miners who expend resources to add more gold into circulation. Those resources spent to add more Bitcoins into circulation is CPU time and electricity.
What halving could actually do to market?
1. Extending the life of reward system: Since the maximum number of Bitcoin to be released is 21 million, releasing 50 Bitcoin every 10 minutes would mean reaching that supply cap rather quickly in about eight years. Although releasing lesser and lesser Bitcoins as reward over the years reduces the rewards for miners, it does extend the rewards over a longer time.
As rewards are important to miners for the continuity of the network. Although the final block would be mined sometime in the year 2140 meaning after that there wouldn't be any mining rewards to miners, there still would be transaction fees. Hence, depending on cryptocurrency economics then, it could still be possible that mining purely for transaction fees could be profitable for miners too. According to Satoshi Nakamoto, once a predetermined number of coins have entered circulation, the incentive can transition entirely to transaction fees and be completely inflation free.
It is also possible that miners could not only earn transaction fees from Bitcoin network alone but also transaction fees from additional layer networks that would exist on top of Bitcoin network such as RSK.
2. Help see steady price increases over time: Halving, as explained over and over, does reduce the supply of Bitcoins to the system. This, based on the law of supply and demand, would have the price increase since scarcity would increase proportionally.
Most of the people expect Bitcoin price to go up after May 2020 halving. Mostly because previous halvings have triggered bull runs. But more importantly that's because the supply is expected by about 2.5 percent in 2020, which would be an all-time low due to halving of the block reward from 12.5 to 6.25 BTC. Further, the supply could fall below 2 percent.
Part of what is expected to drive the demand is also the derivatives market which is expected to grow as a sign of further integration of cryptocurrency into mainstream markets according to Peter Johnson is a Principal at Jump Capital. He expects volumes on U.S. regulated crypto derivatives exchanges such as CME and Bakkt and the rest to "grow strongly" although the center of activity for this will continue to come from exchanges that cater to non-U.S. retail traders.
Tuur Demeester, an investor, also recently predicted that in order for Bitcoin to maintain $8,000 until the next halving, the market would need to see $2.9 billion of investment inflow before then in order to offset the deflationary effect of new bitcoins entering the system. $2.88B would be required to buy up all newly minted BTC at $8k in next 200 days. The reduction in selling pressure after halving would lead to price increase even assuming that growth in investment was constant.
A Bitcoin trader has also derived possibility of the Bitcoin price going to $60,000 after this year's halving using the stock-to-flow (S2F) ratio. The stock-to-flow (S2F) ratio divides current inventory by annual production to create a model to predict past price movements for Bitcoin price with a high degree of accuracy using gold and silver as benchmarks.
It is likely certain that the hype about halving could start some bull run before May halving. Hype usually causes price pumps before the actual events although effects of price pumps are always extended as the pump dwindles towards the actual event time.
However, it is not likely that this year's halving will cause a bigger or equal pumping than previous halving events. First, the price hasn't responded to market movements as was expected, within the last one year. That could be due to a number of factors including manipulation and the fact that the market is more information efficient now than it was -- that a more efficient information distribution would mean smart investors would have incorporated the supply adjustment into their models and taken positions.
The other factor is that the cryptocurrency market is very different today than it was during the previous halvings: four years ago, cryptocurrency derivatives markets and institutional involvement was nowhere then but they are now something to consider when predicting price dynamics. The stock-to-flow (S2F) ratio model has been criticized since it does not take into account demand when predicting price of Bitcoin, yet in traditional markets, price is rarely a function of supply. Also, the altcoins markets are more mature now than they were four years ago. In fact, although this would be extravagant, some have claimed that halving could be negative if it reduces miners’ profitability and forces many of the smaller ones out of the market.
3. Each halving increases the cost of mining each Bitcoin. In mining, since it must be able to mine a certain number of Bitcoin per ten minutes, the Bitcoin network difficulty will have to update after some time (every two weeks) as more miners and people and powerful machines join the mining race. Hence the difficulty of finding Bitcoin is what the network uses to keep amount of Bitcoins added regular. If difficulty remains the same, it would take less time to add more new blocks to the blockchain as more miners join the network.
The difficulty increases every 2016 blocks (every 2 weeks). After every 2016 blocks, which takes 2016 x 10 minutes, each node will divide the number 20160 by the actual time it takes and uses the result to adjust the difficulty for the next 2016 blocks. This is done by multiplying the result with the current difficulty to acquire the new difficulty. If the result acquired by dividing total time to mine 2016 blocks by the total time spent is greater than one, then the new difficulty is to be greater than the current because it means that the previous 2016 blocks were mined quickly in less than 10 minutes each on average. The new difficulty would decrease if the number result was lesser than 1.
Given that the difficulty is increasing, the actual cost of mining increases after each Bitcoin is mined given that the rewards are lesser.