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CryptoCompare Analysis - The Bitcoin Halving Is Coming: Why this Time Will be Different

Date 29/04/2020

A major event is set to happen in the world of Bitcoin and cryptocurrencies. With the Bitcoin halving less than two weeks away, CryptoCompare, the leading provider of digital assets market data, has provided some original data and insights to explaini what the halving is, why it's important and what this data says may happen to the bitcoin price. 

Key Takeaways:

  • What is the Bitcoin halving and why is it important?
  • Social data indicates that there is substantially more interest in the Bitcoin halving in 2020 than in 2016.
  • The options market suggests however, that we will not see a bullish period in the months following the halving.
  • The crypto market in 2020 is very different from previous halvings, and the impact of miners selling their bitcoins differs substantially this time around. This will likely dampen the post-halving impacts from miner selling. 
  • The impact of Covid-19 so close to the halving and Bitcoin’s correlation to equity markets means we may not see significant surges in price due to the halving.  

What is the Bitcoin Halving?

Bitcoin is a revolutionary kind of money. Entirely digital, and with no central authority in charge, it relies on consensus between everyone on the network to keep it running. Every 4 years, the Bitcoin network undergoes a momentous event known as the “halving.” When the pseudonymous creator of Bitcoin, Satoshi Nakomoto, constructed the Bitcoin network and protocol, he or she (or they) pre-programmed it to include an ever-decreasing rate of new Bitcoins being supplied, with the total amount capped at 21 million bitcoins.

Bitcoin relies on “miners” to maintain and secure the network, who process blocks and add them to the shared record of all transactions (the “distributed ledger”) which form the blockchain. As a reward for this energy-intensive task, miners are compensated with bitcoins. Every 4 years, this reward for adding a new block is cut in half. The last time this happened, in July 2016, the Bitcoin block reward was slashed from 25 to 12.5 bitcoins, and the same is due to happen this May (estimated to be on May 12), with miners set to receive only 6.25 bitcoins from then onwards.

The countdown to the halving

Bitcoin is set to reduce its block reward by half around May 12th and Google searches for "Bitcoin halving" are skyrocketing. The chart below shows searches for the term over the last 5 years against the Bitcoin price. We can see how recent searches substantially eclipse the search volumes for the last halving in July 2016, pointing to increased investor interest in the event.

MV_CC_Bitcoin_Halving_Fig_1

What is particularly significant about this halving cycle is its timing. With bitcoin set to reduce its rate of supply at the time that central banks around the world are conducting one of the greatest money supply experiments in history, many eyes are turning to the nascent digital asset as a hard, digital store of value. But will this increased interest lead to a price rise?

The case for a price surge

Previous halvings have heralded significant surges in the Bitcoin price around the halving event and in the months and year following. Why did this happen? Will it happen again?

Simple economics would dictate that if there is a decreasing rate of supply of an asset and demand remains the same or increases, then all things being equal, the price of the asset will go up.

What’s more, many Bitcoin proponents point to a model known as Stock to Flow, to argue in favour of dramatic price rises around halving events - and with Bitcoin’s Stock to Flow ratio set to increase with a decrease in supply, they are expecting a surge in price following the halving. 

But history does not always repeat itself, and a far larger, more established crypto market may not produce the same results in 2020.

What does the data say?

The market in 2020 is very different from 2016. 

MV_CC_Bitcoin_Halving_Fig_2

In 2016, the total daily Bitcoin volume on spot exchanges rarely exceeded $1 billion USD, peaking at close to $1.5bn roughly 2 weeks before the halving. In 2020, in contrast, total daily volumes are regularly ten times this number, with daily spot volumes on Top-Tier exchanges hitting $21.6 bn on March 13th.

MV_CC_Bitcoin_Halving_Fig_3

Furthermore, it is crucial to acknowledge that in 2020 we have a much broader array of market participants, larger market players, more established exchanges and a far more developed derivatives market. All of this means that we may see less of a price increase in the year following the halving.

Miners are smaller players in 2020

During previous halving cycles, miner selling was a bigger determinant of the sell pressure in bitcoin markets. In 2016, miners likely had a far bigger impact on the bitcoin price, as miners selling their bitcoins represented a larger and more impactful component of bitcoin sell pressure. 

Some have argued that this halving of sell pressure contributed to the rise in bitcoin price in the months after the halving event in 2016 and 2017. 

MV_CC_Bitcoin_Halving_Fig_4

Now however, with far higher spot and derivatives volumes, and more market participants, the drop in sell pressure from miners selling half the number of bitcoins will have less of an impact on the total sell pressure. We might therefore expect less of an impact in the months following this year’s May halving, and therefore less of a surge in price.

Options: the market does not expect a surge

Options market makers are often considered the most knowledgeable market participants, and many look to their pricing for indicators of where prices are heading.

The more mature derivatives market of 2020 gives us a better picture than in 2016 of what the market thinks. Specifically, the bitcoin options market gives us some insight into what the market believes will happen.

Implied volatility is a derived metric which measures the expected volatility of an asset, and is  used by traders to gauge the forward-looking sentiment of a market: higher implied volatility is associated with higher premiums for options, meaning there is greater demand for those options. 

If we look at the skew at the moment of the implied volatility for bitcoin options we can see that the market is more concerned about the downside of bitcoin dropping in price, than the potential upside. 

MV_CC_Bitcoin_Halving_Fig_5

Looking at the chart above for Deribit, we can see that the curve to the left is far steeper than the curve to the right. What this means is that sellers of options (such as market makers) at these lower strike prices on the left are commanding higher premiums for these options, as they believe there is more downside risk to the bitcoin price, and buyers of options at these low strike prices are more willing to pay a premium to express their views, as they also believe there are more downside movements to come. 

In short, the options market does not expect the bitcoin price to rise much, and is more concerned about the price dropping. This also currently holds for contracts expiring in June, September and even December, as we can see below for OKEx and Deribit for options expiring in September:

MV_CC_Bitcoin_Halving_Fig_6

While it’s possible that this chart just points to a risk-averse options market, (particularly if it primarily comprises miners who are already long bitcoin through mining), it does add weight to the argument that markets are not expecting much of a price surge in the aftermath of the upcoming Bitcoin halving.

The elephant in the room: Covid-19 and Bitcoin’s ‘Black Thursday’

Finally, we cannot ignore the impact of Covid-19 and the massive effect it has had on financial markets. With crypto markets by and large tracking equities throughout the financial turmoil of recent months, bitcoin saw one of its biggest single day drops on March 12-13th, plunging over 40% to trade below $4,000 on some venues, as stock markets took a beating. 

Comparisons with previous halving cycles therefore, cannot ignore the impact of enormous macro events like the coronavirus crisis, the fact that bitcoin now seems to track equities quite closely, and that such dramatic external shocks to the bitcoin price so close to the halving may negate much of the supposed impact of these events. 

What does this all mean?

Predicting the bitcoin price is notoriously difficult. While in theory a decreasing supply, and stock-to-flow models may suggest a surge in price, the reality is a lot more complicated. A far larger, broader spot and derivatives market means that miner selling is simply less impactful. Options markets do not point to a bullish period following the halving, and the impact of Covid-19 and equity market volatility on the Bitcoin price could be a bigger determinant of the price movement than the halving itself.