For the Curious But Perplexed, the Bitcoin 'Halving' Explained

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Four years ago, the last time the supply of new bitcoins added to circulation was cut in half, few if any bankers paid attention. Few had even heard of bitcoin.

On the eve of the next halving, which was expected to occur sometime Saturday, much has changed. The key innovation behind bitcoin — the decentralized record-keeping system known as the blockchain — is a hot topic in financial technology circles. And even though bankers, regulators and consumers remain leery of bitcoin itself, the milestone in the digital currency's history was clearly on the radar of at least one global bank: On Thursday night, Barclays co-hosted a "halving party" in New York with Digital Currency Group, the venture capital firm founded by the bitcoin evangelist Barry Silbert.

The industry's tentative interest goes beyond bitcoin's notoriously volatile exchange rate or the perceived money laundering risks.

"Bitcoin as computer science can teach all of us a lot," said Caitlin Long, a former Morgan Stanley managing director who served on the investment bank's internal blockchain working group. "Its success as software that's fully exposed to the war zone of Internet security, 24/7/365 — without any successful attack on the ledger in seven years — can teach bank IT professionals a great deal about cybersecurity."

For the curious but perplexed, American Banker presents a short explanation of the halving.

The halving is an event built into the original code of the bitcoin blockchain when incentives for bitcoin miners are cut by half. This is scheduled to happen every 210,000 blocks, or about four years.

As a refresher, miners run the machines that do the work necessary to record a new block of transactions and add it to the global ledger, known as the blockchain. The process mainly involves solving what's essentially a very complex math problem, which the miners typically spend about 10 minutes completing.

Miners have two incentives to mine: transaction fees (paid voluntarily by senders for faster settlement) and mining rewards — 25 newly created bitcoins, or about $16,400 as of Friday evening, for being the first to solve the puzzle. Sometime on Saturday, the mining rewards will shrink to 12.5 bitcoins. Initially, the incentive was 50 bitcoins; it dropped to 25 in late 2012.

Years from now, the number of bitcoins in circulation will cap at 21 million, according to the original bitcoin code. The halving is designed to control the supply, helping maintain the idea of bitcoin as digital gold — whose fixed supply helps determine its value — unlike paper currencies that can be printed endlessly by governments and inflate away holders' purchasing power.

"After the halving, bitcoin will work as advertised, basically," said Sid Kalla, an early bitcoin adopter and the chief technology officer of Acupay, a New York-based technology provider specializing in cross-border finance. "The scheduled setup eight years ago shows the strength of the network and should give people confidence in bitcoin's long-term ability to perform."

One issue to be aware of, however, is whether miners have enough incentive to continue mining when block subsidies are reduced. If not, the bitcoin network's hash rate — the amount of processing power devoted to protecting the network — could drop, potentially making bitcoin less secure in the long term, Kalla said. However this is less of an issue with bitcoin than with other cryptocurrencies, he said. (Permissioned blockchains like the ones the banking industry has been experimenting with for the last year usually don't have a native currency, and therefore don't need mining incentives to confirm transactions.)

Unless bitcoin transaction fees rise, they are unlikely to cover the shortfall, Kalla said, but miners could start charging higher transaction fees if they can't break even because their main source of revenue has dropped by half.

"No one knows what will happen," Kalla said. "One thing we definitely know is the new supply of bitcoin is going to halve, which means it's likely there will be less sell pressure because miners don't generate as many bitcoin to sell on the open market now."

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