The halvening is a momentous event in the Bitcoin world. It is also something exceedingly new. The world simply has not yet experienced many halvening events and the ones that have happened were minute in size compared to the one we just experienced.
Before the event, Bitcoin experienced extreme volatility. After a fairly steady rise for most of the year, Bitcoin shot up in price in late June and then dropped quickly the day of the halvening. After the halvening, most of those losses were gained back and Bitcoin has seemed relatively stable since.
I am here to tell you that this stability is not likely to stick around. We will be seeing more volatility. Long term, anyone involved in bitcoin likely thinks the prospects are good (otherwise, why be involved?) but what can other halvening events tell us about the short and medium-term prospects for the digital currency?
It is worth taking a look at two other major halvening events in the cryptocurrency world. The first is the previous Bitcoin halvening and the other is Litecoin’s first halvening last year. Both have similarities to the halvening we just experienced but neither is a direct analog.
During Bitcoin’s first halvening, things were relatively stable. Three months after the halvening, Bitcoin saw a huge increase. While Bitcoin had jumps in price before, and had an even larger one later, at the time it was the largest bitcoin price increase. Unlike the later increase that happened in 2013, this one was organic. It lacked the artificial price pumping that originated from Mt. Gox and its infamous trading bots. On the surface, that event showcases the best example of a major cryptocurrency halvening in an open market and the affect that can have on the price of an asset like Bitcoin.
Chart Provided By Bitcoincharts.com
However, the difference between that event and what we just experienced are large enough that it wouldn’t be prudent to assume everything will go the same way. Bitcoin is infinitely more popular today than it was in 2012. Speculative investors have been factoring in the halvening for years and there is now significant competition for Bitcoin in the form of Ethereum. There are also thousands of new services built around bitcoin and the blocksize debate currently hovers over the entire ecosystem like a dark cloud. The point is: the world is different in 2016 than it was in 2012.
Litecoin’s halvening took place in a world much more like our own. When it happened in 2015, the world was already aware of cryptocurrencies. Forward looking technology companies and banks were getting into digital currencies at a break neck pace. While Litecoin was largely excluded from that, there was a lot less mystery behind what exactly a halvening would mean.
Litecoin saw a price increase about a month before its halvening, similar to how bitcoin saw a price increase before this halvening (and dissimilar in that way to bitcoin’s first halvening) But before the Litecoin halvening happened, its hype had worn off and most of its gains were wiped out.
Chart Provided by CoinMarketCap.com
Despite the initial similarities of the price charts, there are massive differences in the situation. While Litecoin was long considered the undisputed king of Altcoins, its halvening took place during a time of decreasing interest in the coin often called silver to Bitcoin’s gold. There was increased competition and all the hype in the altcoin world was behind Ethereum rather than litecoin. If a company was working with a digital currency it was likely either Bitcoin or Ethereum (with an occasional project focused on Ripple) but never Litecoin.
What this means is that Litecoin lacked the network affect. The “network effect” describes a phenomenon that affects all networks from Social Media sites to the Internet itself. Essentially, it describes how a network grows organically. As a network becomes more popular, its inherently has more advocates who bring in new people who themselves become advocates, growing the network until we have something the size of Facebook or Bitcoin.
Litecoin experienced this near its birth, but by 2015, its network has begun to detract, due to the aforementioned increased competition and development that had, at least to outwardly appearances, gone stagnant.
So perhaps it shouldn’t be a surprise that Litecoin’s initial gains didn’t hold. Bitcoin, by contrast, has seen an increase in mainstream media articles due to the halvening, undoubtedly increasing its number of users. It clearly isn’t a one to one comparison, Bitcoin is rising in popularity and visibility, while Litecoin was falling in both during its halvening. Still, it showcases that the simplistic equation of a lowering supply resulting in a higher price doesn’t always play itself out.
The Halvening and Deflationary Spirals
Where does that leave us with Bitcoin and what to expect going forward? I spoke with Blake Anderson, a cryptrographic security expert and bitcoin consultant who has been around since before the last halvening.
“If Gold demand skyrockets, gold mines can increase output and this has a stabilizing affect that certain elements of the market find desirable. Bitcoin doesn’t have that elasticity property and in fact the opposite is happening, its supply is decreasing. This is similar to a deflationary spiral feared in traditional economics.”
A deflationary spiral is an economic term referring to when demand for products have dropped, causing less spending, which lowers prices. With prices going down, consumers often see little reason to spend, since their dollar may be more valuable in the future. This lack of spending causes further declines in profits, causing more economic turmoil, leading more people to hold on to their money, further decreasing prices and causing the cycle to continue.
In the bitcoin world, most of these issues aren’t present, so the economy is able to enjoy the advantages of deflation, without the economic side-effects present when it happens to the economy as a whole. For one, the price of bitcoin doesn’t affect the price of goods in relation to fiat. While an increase in bitcoin’s price does, in theory, mean that product X now costs less bitcoin than it did before, most people don’t think of it in those terms. A user may be put off from spending bitcoin on a particular product if he or she thinks it is about to rise in price, but they are still likely to buy that product using fiat, so that business (and by proxy the economy) is not hurt by that user’s decision to hoard their bitcoins.
That does mean less use for bitcoin as a currency spent on consumer goods, but that is more than made up by speculative investors who trade bitcoin more often after price spikes. Speculative investment thrives in deflationary spirals, and for good or ill that is still the most common use for bitcoin.
Bitcoin can have deflationary spirals without suffering the negative consequences that has on the economy because Bitcoin is still largely separate from the economy. While the affect doesn’t have the same collateral damage as they do in the fiat world, Bitcoin’s deflationary spiral still has a lot of the same driving forces.
“HODL” an intentional misspelling of “hold” is a bitcoin axiom if there ever was one. The best and only investment advise I give is simply “buy and hold bitcoin for as long as you can” and I’m not alone in offering that sage wisdom. On May 22nd, 2010, Laszlo Hanyecz initiated what is now considered the first bitcoin transaction that paid for a legitimate, physical object. He paid 10,000 bitcoins to another Bitcointalk user for $25 worth of Papa John’s Pizza. At the time, this was a reasonable exchange rate. At bitcoin’s height, according to CoinDesk, the 10,000 bitcoins would have been worth a whopping $11.47 million. Today, May 22nd is celebrated by Bitcoin users as “Pizza Day.”
The message of Pizza Day is clear: Don’t spend your bitcoins, they will be more valuable in the future and you will regret it. This advice would be suicidal in an capitalistic economy that depends on infinite growth and an inflationary currency, but with bitcoin it only increases the network affect. People hold on to their bitcoins, causing the price to go up, which brings more attention to the digital currency, which draws in new people who hold their bitcoin, causing the price rise even higher.
Whereas in a normal deflationary spiral the affect would be people spending less, the rise in bitcoin’s price actually makes people feel like they are flush with cash and more willing to spend money, either fiat or bitcoin. Bitcoin is a currency but it is also a commodity and commodities like gold and bitcoin see increases in investment when deflation occurs, rather than the decrease in investment that we see in a deflationary spiral due to a slowing economy.
Speculative trading does put a ceiling on the price short term. Some traders will want to cash out their bitcoins as soon as it becomes profitable for them to do so, so their sells will slow Bitcoin’s rise. However, those forces pale in comparison to Bitcoin’s growing network affect. Assuming that will continue might be dangerous, but with increasing interest and investment, it is hard to imagine it slowing any time soon.
What all this means is that, without a significant decrease in demand, the bitcoin halvening is more likely to have the affect that the first bitcoin halvening had than the Litecoin halvening, despite the early similarities between this halvening and the Litecoin one. If momentum continues, the forces behind Bitcoin’s rise are simply too great. Speculative trading can only act as a release valve for so long before the basics of economics take over. Bitcoin is now significantly more expensive to produce in terms of kW to Bitcoin. The only way this becomes accounted for is for the price to rise and that increase in price inevitably leads to more investment and an even higher price.
Hype and Bitcoin go hand in hand, often to Bitcoin’s determent, but when it comes to the currency’s long term prospects, it is impossible not to become excited. Unlike traditional deflationary spirals, Bitcoin’s has a positive flip side: an avalanche of excitement. Just like a real avalanche, when it is over and the snow has settled, the resulting landscape will have changed significantly.