The next halving of bitcoin’s mining reward will occur around the week of May 18, 2020. The mining reward halves every four years. A designed algorithm creates the supply of bitcoin on a schedule coded into the Bitcoin protocol. After 140 years, bitcoin will reach its total supply of 21 million bitcoins (less a few million lost forever). How did this fixed supply come about, and what is the rationale behind it?
I explored the economics behind Bitcoin’s fixed supply in The Flawed Monetary Theory of Craig Wright. Creating the Bitcoin protocol under the pseudonym Satoshi Nakamoto, Wright misinterpreted the historical stability of gold. He believes gold is inflationary and cites a few decades during the 15th-century Spanish mercantilist era of South American gold plunder as causation. One has to observe gold and its unique properties over millennia to understand its historical stability of value. Minor periods of large gold finds are a mere blip over gold’s thousands year history of stability.
Wright’s solution for his muddled monetary theory is a fixed supply of bitcoin. Fixed supply closely follows the Austrian-Rothbardian theory that the only real money is money that is backed 100 percent by gold. No developed economy has ever backed its money with 100% gold reserves. There is not enough gold. A global economy based on 100 percent gold money would be deflationary and unworkable.
Wealth is knowledge, and growth is learning. This is the bedrock principle that defines George Gilder’s information theory of economics that he developed in his book Knowledge and Power. The trial and error advance of knowledge and learning led mankind in the late 1700s to adopt the gold standard as the most stable monetary system. Great Britain and the United States built empires during their two centuries of stable money under gold standards. The world experienced its most rapid periods of growth and industrialization during global gold standard years. Attempting to move an economy into a deflationary fixed supply cryptocurrency monetary system is economic regression. Our inflationary global fiat system that began in 1971 is also an exercise in economic regression. Sustained growth and progress require stable money.
Wright’s explanation for the fixed supply of 21 million bitcoins is related to a mathematical function and ignores the traditional role of the supply of money in an economy. The IEEE 754 standard limits how accurately you can transmit digits without loss or error. Wright states that 6 quadrillion digital units are the limit. Wright’s total supply of 2.1 quadrillion satoshi—or 21 million bitcoin—is below the 6 quadrillion limit but large enough for his theoretical design usage. A satoshi is 1/100,000,000th of a bitcoin. (A currency whose value is defined relative to the transactional costs of everyday goods and services and that maintained a stable value purchasing power would never need a unit that is 1/100,000,000th of the currency’s value. What could you buy with 1/100,000,000th of a dollar?)
More importantly, the 21 million quantity defines a mathematical percentage in the Bitcoin protocol halving formula. Starting with a 50 bitcoin per block reward that halves every four years, Wright arrives at a total of 21 million bitcoins in 140 years. The 21 million total supply defines a nice mathematical ratio. After the first halving of 50 to 25, 50% of the total supply of bitcoins are mined. At the second halving from 25 to 12.5, 75% are mined. At the May 2020 halving, 87.5% are mined. The sum of each halving defines the total number of bitcoins that have been mined. This formula continues until the 21 million total is reached in the year 2140.
In other words, because of a limiting IEEE standard that justifies a needless satoshi unit and a nice mathematical formula, Satoshi pulled the fixed supply number of 21 million bitcoins out of his oshiri. The majority of cryptocurrency has copied the Bitcoin fixed supply protocol.
The Halving Conundrum
Bitcoin’s present utility is primarily a means to quickly and cheaply move money on a global platform. It also has utility as a store of value—or speculative asset—based on the hodl belief that its price will increase exponentially. Hodlers expect bitcoin, based on its limited supply, to act like a collectible. But bitcoin is not a physical collectible. It is ether. Its only sustained value is from its ability to act as traditional currency and transact for goods and services. Its ability to act as an alternative money transfer system remains intact largely due to its novelty and the hands-off approach governments have taken with regulation thus far.
A cryptocurrency can’t be both a currency and a speculative asset that acts as a collectible. These goals are opposing and represent a crypto conundrum. Hodling bitcoin negates its use as a transactional currency, and its use as a transactional currency negates its reason to hodl. Every halving makes this conundrum more pernicious and the competing goals more pronounced.
With each halving, the value of bitcoin needs to increase to support its miners. Consolidation of the bitcoin mining industry is the result. Only the most efficient miners can continue to support themselves on the decreased reward. Wright understands that transaction fees have to make up the difference. As I noted in The State of Crypto, Wright pointed out this problem in August 2018.
If we do not scale in the next couple of years, it’s over. That simple. All your investment, piss it away in the wind. We either scale or you may as well go home now.
Scale doesn’t mean the ability to scale, which BSV enabled with its Genesis upgrade. It means a massive increase in the number of transactions for goods and services that begin to compete with traditional currency and payment platforms. But transactions are not happening due to the hodling conundrum. Cryptocurrency remains a speculative asset with no movement toward a transactional currency. The problem is well defined. It’s the fixed supply flaw.
What happens if the transactions don’t happen? Will Wright be prescient with his comment, “All your investment, piss it away in the wind. We either scale or you may as well go home now.”? The irony shouldn’t be lost on anyone. Wright is warning of the consequences of his own protocol design.
The entire crypto space is defined off of bitcoin’s value, and they all rise and fall together in a sort of weird equilibrium. This doesn’t indicate true price discovery or true value. (See The State of Crypto that discusses the underlying crypto space in detail.)
Bitcoin’s utility to transfer money determines its value, which creates the demand that determines its price. These conflicting goals do not define a traditional currency and are not the foundation for a disruptive financial system.
Cryptocurrency has to transact as a currency for goods and services. Halving rewards that require an increase in the underlying price to support mining, conflicts with its limited utility. This impacts demand which determines its price. It requires a huge stretch to justify a reason for why hundreds of cryptos even exist. There is nothing they provide in utility that a few cryptos can’t provide with more stability.
Cryptocurrency is reaching a denouement with this halving. The lack of true price discovery, the halving reward which can’t support its limited utility, and limited utility which can’t justify an ever-increasing price portends an inflection point for the crypto space.