Why mining rewards are being halved

Why mining rewards are being halved

On the 5th of August, 2019, the mining rewards for Litecoin miners were halved. In 2020 Bitcoin miners will face the same fate. For cryptocurrency miners this might sound like bad news but a halving actually happens for a good reason! Keep reading to find out why.

Satoshi Nakamoto

Satoshi Nakamoto is the creator and developer of the Bitcoin protocol. This protocol consists of all the coding that is needed to run the Bitcoin network. In this protocol Satoshi implemented certain rules to make sure the Bitcoin network will retain its value for a long time to come. Popular believe is that Satoshi tried to create a digital version of gold. One way Satoshi tried to realize this was by setting a total supply of bitcoins that can be created (21 million), just like there is a finite amount of gold in the ground. 

Another rule he or she (we don’t know who Satoshi really is) wrote is that mining rewards will be cut in half after every 210.000 blocks that are mined. This halving will benefit bitcoin owners as well as miners that mine bitcoin. 

Gold

In traditional markets, let’s say with fiat currencies such as the euro, there is agreement on the value of one euro. The same applies to bitcoin, litecoin or most other cryptocurrencies. But since these fiat currencies don’t have a fixed total supply, creating more and more of the currency can cause problems. When the central bank decides to print more euros, the actual value of that one euro decreases as there are now more euros in circulation. This is called inflation. Halvings occur as a means to prevent inflation. Vitalik Buterin, the creator of Ethereum, wrote in 2012:

“One of the major faults of traditional, “fiat”, currencies controlled by central banks is that the banks can print as much of the currency as they want, and if they print too much, the laws of supply and demand ensure that the value of the currency starts dropping quickly.

Bitcoin, on the other hand, is intended to simulate a commodity, like gold. There is only a limited amount of gold in the world, and with every gram of gold that is mined, the gold that still remains becomes harder and harder to extract.”

Satoshi prevents bitcoin from inflating by making sure both the total supply that will eventually will be in circulation, and the rate of newly mined bitcoins are limited. By making sure the rate of newly arriving bitcoins slows down over time (by means of halving events), even deflation might occur. This makes cryptocurrencies such as bitcoin a better store of value than traditional fiat currencies as these do not have a predetermined supply and thus can be printed without any limits.

When do halvings happen and what can happen?

Every cryptocurrency that has the halving mechanism implemented has its own set of rules. In the case of Bitcoin, every 210.000 mined blocks the rewards are being halved. For Litecoin this is after every 840.000 blocks. 

The value of cryptocurrencies of which the mining rewards are halved often rises after a halving event. Reason for this being that investors know when the halving will happen and thus can anticipate the increased scarcity of a cryptocurrency. The result is often a rising value already months before the actual halving happens. Another reason why halvings causes cryptocurrency prices to rise is that the production costs of cryptocurrencies rise (e.g. a miner receives less cryptocurrency for the same amount of work). And since miners are the market makers, they are a big factor in determining the value of the cryptocurrency they mined.