Supply Impact: Bitcoin issuance will halve around April 2024. While miners face revenue challenges in the short term, underlying on-chain activity and positive market structure updates make this halving fundamentally different from previous ones.
Miners’ situation: Faced with reduced block reward income and high production costs, miners are trying to ease short-term financial pressure by raising funds through issuing equity/debt and selling reserves.
On-chain activity continues to grow: The advent of inscriptions has led to a new surge in on-chain activity, with over 59 million NFT-like collectibles having been inscribed as of February 2024, generating over $200 million in transaction fees for miners. This trend is expected to continue, fueled by renewed developer attention and continued innovation on the Bitcoin blockchain.
Impact of Bitcoin ETFs on the Market: Continued adoption of Bitcoin ETFs could significantly absorb selling pressure, potentially reshaping Bitcoin’s market structure and providing a new source of stable demand, which would be positive for price.
As we get closer to the 2024 halving, Bitcoin isn’t just alive, it’s evolving. With the historic approval of a spot Bitcoin ETF in the U.S. and changes in fund flows, the structure of the Bitcoin market is changing. In this post, we’ll dive into what the halving means, its importance, and its historical impact on Bitcoin’s performance. We’ll then examine Bitcoin’s current landscape and why things look very different than they did just a year ago.
What is halving?
New bitcoins are generated through a process called "mining," where computers solve computationally intensive problems to earn block rewards of new bitcoins. The issuance of bitcoins is limited by design—roughly every four years, the mining reward is "halved," effectively halving the number of new coins issued.
This deflationary property is a fundamental attraction for many Bitcoin holders. While fiat currency supply is dependent on central banks and precious metal supply is subject to natural forces, Bitcoin’s issuance rate and total supply have been dictated by its underlying protocol since its inception. The combination of a fixed total supply and a gradually decreasing inflation rate not only creates scarcity, but also builds deflationary properties into Bitcoin.
Aside from the obvious supply implications, the compelling excitement and anticipation surrounding the Bitcoin halving stems from its historical correlation with Bitcoin price increases:
However, it is important to understand that a post-halving Bitcoin price surge is not a given. Given that these events are highly anticipated, if a price surge was certain, rational investors would likely buy in advance, leading to a price surge prior to the halving. This brings us to frameworks like the Stock-to-Flow model. While it creates visually appealing charts by correlating scarcity with price increases, the model ignores the fact that this scarcity is not only predictable, but widely known in advance. We can conclude this by observing other cryptocurrencies that employ similar halving mechanisms, such as Litecoin, which has not consistently seen price increases post-halving. This suggests that while scarcity can sometimes influence price, other factors also play an important role.
Rather than attributing post-halving price increases to the halving itself, it appears that these periods coincide with significant macroeconomic events. For example, in 2012, the European debt crisis highlighted Bitcoin’s potential as an alternative store of value amid economic turmoil, causing its price to rise from $12 to $1,100 in November 2013. Similarly, the 2016 initial coin offering boom—which pumped more than $5.6 billion into altcoins—indirectly benefited Bitcoin, boosting its price from $650 to $20,000 in December 2017. Of particular note, during the 2020 COVID-19 pandemic, massive stimulus measures have heightened inflation concerns, potentially pushing investors toward Bitcoin as a safe haven, causing its price to rise from $8,600 to $68,000 in November 2021. These macroeconomic uncertainties and explorations of alternative investment options appear to coincide with periods of increased interest in Bitcoin, which coincidentally occur around the time of the halving. This pattern suggests that while the halving helps reinforce Bitcoin’s scarcity narrative, the broader economic context and its impact on investor behavior can also have a significant impact on Bitcoin’s price.
While the future macroeconomic environment remains uncertain, the impact of the halving on Bitcoin’s supply structure is certain. Let’s take a deeper look.
Miner threats
The halving poses challenges for Bitcoin miners. With Bitcoin issuance reduced from 6.25 BTC per block to 3.125 BTC, the revenue miners receive from block rewards has effectively been cut in half. In addition, expenses are increasing. Hash rate, a measure of the total computing power used to mine and process transactions on the Bitcoin network, is a key input in calculating miner expenses. In 2023, the 7-day average hash rate surged from 255 EH/s to 516 EH/s, an increase of 102%, significantly outpacing the 41% growth rate in 2022. This surge is due in part to Bitcoin's price increase throughout 2023 and companies' acquisition of more efficient mining equipment in response to favorable market conditions, highlighting the growing challenges facing miners. The combination of falling revenue and increasing costs could put many miners on edge in the short term.
While the situation may seem grim, there is evidence that miners have long been prepared for the financial consequences of the halving. In the fourth quarter of 2023, miners notably sold their Bitcoin on-chain holdings, possibly to build liquidity ahead of the block reward reduction. In addition, major fundraising events such as Core Scientific's $55 million equity offering, Stronghold's $15 million equity financing, and Marathon Digital's ambitious $750 million hybrid equity financing highlight the industry's proactive attitude in strengthening reserves. Together, these moves suggest that Bitcoin miners are well-positioned to cope with the upcoming challenges, at least in the short term. Even if some miners exit the market completely, causing the hash rate to drop, it could lead to a mining difficulty adjustment, potentially reducing the cost per coin for the remaining miners and keeping the network balanced.
Despite the challenges posed by the reduction in block rewards, the growing role of inscriptions and L2 within the Bitcoin ecosystem have recently emerged as promising use cases. These innovations may provide a glimmer of hope for miners, potentially increasing transaction throughput and increasing transaction fees on the network.
Inscription
As we’ve explored before, inscriptions (“ordinals”) represent a groundbreaking innovation within the Bitcoin ecosystem. From simple images to custom “BRC-20” tokens, digital collectibles can be uniquely “imprinted” to a specific Satoshi (the smallest unit of Bitcoin, as each Bitcoin is divisible into 100 million Satoshis). This new dimension of Bitcoin utility has spurred significant growth: over 59 million assets have been imprinted to date, generating over $200 million in transaction fees for miners (Exhibit 5).
The surge in network fees has had far-reaching consequences, particularly as on November 20, 2023, the Bitcoin network’s transaction fees surpassed those of the Ethereum network for the first time, setting a new record in recent history. Since the advent of ordinal inscriptions, there have been multiple times when miners have earned more than 20% of total transaction fees from inscription fees. Even compared to the total volume of NFTs on other chains, Bitcoin dominated NFT transaction volume in November and December 2023, a development that few could have predicted at the end of 2022.
The success of inscription has implications for the Bitcoin network. As block rewards decrease over time, the question of how miners are incentivized to secure the network becomes more pressing. Since transaction fees from ordinals already account for approximately 20% of total miner revenue, this emerging trend in inscription activity offers a new path to maintaining network security through increased transaction fees, at least for now.
However, this success also highlights scalability challenges as users will have to bear higher transaction fees. This may hinder users from conducting basic transactions like transferring money. In addition, Bitcoin’s architecture limits programmability, which further limits the barriers to developing complex applications that can use these inscriptions. This situation highlights the need for scaling solutions that can both increase throughput for efficient transactions and expand use cases, such as trading NFTs and BRC 20 tokens.
In response, the community is exploring avenues such as Layer 2 Rollups, similar to what Ethereum has done, to enhance scalability and usability. Growing interest in Taproot-enabled wallets, which offer greater programmability with enhanced privacy and efficiency features, indicates a move toward addressing these challenges together. As transaction fees on the Bitcoin mainchain increase, the development of L2 networks becomes a possible step forward.
As we discussed in our previous article on Inscription, the resurgence of Inscription and the introduction of the BRC-20 token has sparked a cultural shift within the Bitcoin community, attracting a new group of developers excited about the possibilities of network expansion. This shift is arguably one of the most important developments for Bitcoin, as it not only diversifies the ecosystem, but also infuses the community with new perspectives and innovative projects, driving future development.
Among existing second-layer (L2) solutions, some have been quietly laying the foundation for this evolution for years. Stacks is a platform that introduces fully expressive smart contracts to Bitcoin. It facilitates the development of a variety of decentralized applications (dApps) that leverage Bitcoin's security, enabling functionality ranging from DeFi to NFTs. These dApps represent the forefront of Bitcoin's transition to a multifaceted ecosystem capable of supporting a variety of blockchain-based applications.
ETF Fund Flow
In addition to the largely positive on-chain fundamentals, Bitcoin’s market structure looks favorable for post-halving prices. Historically, block rewards have created potential selling pressure on the market, potentially causing all newly mined Bitcoin to be sold, thus affecting price. The current 6.25 Bitcoin mined per block equates to about $14 billion per year (assuming a Bitcoin price of $43, 000). To maintain current prices, a corresponding buying pressure of $14 billion per year is required. Post-halving, these demands will be halved: with only 3.125 Bitcoin mined per block, this equates to a reduction to $7 billion per year, effectively reducing selling pressure.
ETFs generally provide a way for a wider range of investors, financial advisors, and capital markets allocators to gain exposure to Bitcoin, which could lead to increased mainstream adoption over time. Following the approval of U.S. spot Bitcoin ETFs, these newly launched products saw net inflows of approximately $1.5 billion in the first 15 trading days, nearly equivalent to three months of potential post-halving selling pressure. While the surge in net inflows in the first few days could be due to initial excitement and pent-up demand, assuming net inflows remain stable amid continued Bitcoin ecosystem adoption and maturity, ETF liquidity could provide some offset to continued selling pressure from mining issuance. Sensitivity analysis of daily net inflows ranging from $1 million to $10 million suggests that at the higher end, reduced selling pressure could reflect the effects of another halving, fundamentally shifting Bitcoin's market structure in a positive way.
in conclusion
Bitcoin has not only weathered the storm of the bear market, but has also challenged outdated perceptions with its developments over the past year. While it has long been hailed as digital gold, recent developments show that Bitcoin is evolving into something more. Fueled by a surge in on-chain activity, supported by the momentum of significant market structure, and backed by its inherent scarcity, Bitcoin has shown its resilience. The Grayscale Research team will be closely monitoring its developments around the April 2024 halving, as we believe Bitcoin has a bright future.
