As the world gets into a frenzy around the coming Bitcoin halving – and the price of bitcoin (BTC) as a result – it’s important to take a moment for a reality check.
The halving is a non-event for the vast majority of the world. At its core, it’s a simple evolution in how much the people who process bitcoin transactions get paid. All electronic payments, whether made via credit card, Venmo or the tap of a phone, require some kind of processing.
Bitcoin transactions are no exception.
On-chain bitcoin transactions are processed by the vast network of so-called “miners,” who validate and record transactions on the blockchain. To date, these miners receive two types of rewards: a block reward, paid by the bitcoin network, and a network transaction fee, also paid in bitcoin by the person making the transaction.
The coming “halving” reduces the first reward by half. There’s nothing surprising in this. Rather, the halving is a predetermined part of the system, designed to regulate the supply of new bitcoins in a predictable manner until the maximum of 21 million bitcoins have been issued. Sometime in the next century, given current trends, the block reward for processing bitcoin payments will halve until it goes toward zero.
But the result of the decrease in the block reward has a substantial impact on the second, the network transaction fee. The increase in transaction fees is a stark reminder that the supply of bitcoin is, by design, limited. Once 21 million bitcoins have been issued (as block rewards), there’s no way for anyone to create more bitcoins or alter the supply, as governments often do with their own fiat currencies.
This is why some people liken bitcoin to “digital gold.” It’s not a bad comparison but there are two important differences to remember: First, the supply of bitcoin is fixed at 21 million bitcoins. The supply of gold is finite, but it’s not fixed and known. After all, who knows what vast gold reserves might be discovered tomorrow?
Second, bitcoin is infinitely divisible. As bitcoin gets more valuable, people will transact subdivisions of value (for example, there are 100 million satoshis in one bitcoin). Gold is physical and you can’t subdivide it infinitely as it gets more valuable, though new digital gold entrants are attempting to make gold act more like, well, bitcoin.
The halving reminds people that the supply of bitcoin is truly limited and that demand is increasing, driving up the price of bitcoin in the long term. As something becomes more valuable, more people will want to use it, and so the cycle continues.
In the near term, the largest everyday impact of the halving will be a broader consumer shift to processors with lower-cost transaction fees. Enter the Lightning Network, a second-layer network that bitcoin transactions outside of the main blockchain. The Lightning Network processes peer-to-peer bitcoin transactions almost instantaneously, just like on the main blockchain.
The difference? The Lightning Network’s transaction fee is just a few cents. For regular people – those making small transfers or using a bit of bitcoin to purchase goods and services – this will become the preferred mode of transacting; it’s fast and it’s cheap. The relative ease of transacting with the Lightning Network may also accelerate consumer adoption.
On-chain transactions won’t go away, of course. People will continue to use the blockchain to document large transactions – the same way that you’d use a wire payment, not a debit card, to purchase a car or house.
As on-chain network transaction fees continue to increase, network congestion will be offset by the shift to second-layer networks, which will in turn encourage a greater volume of transactions, some of which will happen on the main blockchain, which will push up processing fees. Ultimately, even with the rise of second-layer networks like Lightning, the net result will most likely be a steady increase in network fees as bitcoin becomes more widely adopted.
And that’s a good thing.
The more bitcoin acts like other currencies, the more comfortable people will be using it. While most of us are not miners, many of us are currently financially disenfranchised: Today there are more than a billion adults in the world who have a smartphone but no bank account. These people are digitally connected to the rest of the world, but lack the benefits of participating in a global financial system.
For them, bitcoin is a strong solution for their daily spending or personal savings – but only if it’s fast, reliable, inexpensive and accessible. The halving, by spurring the adoption of second-layer networks like Lightning, makes bitcoin just that.
