Cryptocurrency Halving

2019.12.05 2019.12.05 Cryptocurrency Halving

Oleg Tkachenkohttps://www.litefinance.org/blog/authors/oleg-tkachenko/

Cryptocurrency Halving

Why do we need miners' reward reduction and when does it happen?

Halving is a reduction in the reward for mining by half that is designed in the blockchain structure. Halving frequency depends on the rate of block generation. For example, for LTC and VTS, whose halving will be in August 2019 and May 2020, respectively, it happens every 4 years. In theory, halving should reduce the number of miners and so, reducing the total supply, increase the price of bitcoin, for example. But in practice, everyone who is trading crypto knows that the price starts growing a few months before the event and it may either continue rising or drop after it. This article explains on the example of practical analysis of ВТС, ЕТН and LTC halving what a cryptocurrency trend depends on before and after halving, and how you can make profit from it.

Halving: basics, results and whether you can make profit from it.

Spring brought success to cryptocurrency market. After a long trading flat in winter, there was the long-awaited breakthrough. The cryptocurrency market capitalization, being in the range of $110 billion -$130 billion for a long time, at last broke through the resistance level and by the end of the spring, slowly but surely, without strong pullbacks, reached up to $250 billion.

A remarkable fact. Analysts do not have a single informed opinion to explain why this breakthrough happened. According to one version, the BTC became the driver, pulling the rest of cryptocurrencies up with it. It is a controversial issue. For example, in April, there was an opposite trend, when many of the TOP-20 alt coins showed a decline, and the share of the BTC in capitalization rose to 59.5%. There is another opinion: each cryptocurrency should be studied separately. It turned out that a small impulse sent by several cryptocurrencies was enough for the whole market to start trading up. Some statistics.

Cryptocurrency price increases from January 1 to May 24 (USD):

The total capitalization is 97.97% (from 125.7 billion up to 248.85 billion). Growth is smooth, the high for the digital currency price was recorded near the end of the study period at a level of about 260 billion, after which there was a rollback.

ВТС - 112,24% (from 3 746.7 up to 7 951.98). The growth is gradual, the price is close to the highs of 2019.

ЕТН — 88.07% (from 133.42 to 250.92). Price chart is similar to ВТС.

ВСН — 174.18% (from 150.9 to 413.75). Sharp price surge of bitcoin cash in April is thought to be of manipulative nature.

XRP – 9.28% (from 0.3525 to 0.3852). The rate is not stable, the local surge was followed by a sharp drop.

EOS — 143.57% (from 2.57 to 6.26). It is one of the most high-growth cryptocurrencies, which is associated with investors’ interest in high tech activities

LTC — 209.44% (from 30.5 to 94,38). The litecoin ltc  price surge was in early April. Despite the corrections, the coin is close to the highs of 2019

XLM (Stellar) — 12.5% (from 0.112 to 0.126). The price chart is not smooth; there are deep drawdowns despite the general traders’ optimism.

DASH — 103.58% (from 79.16 to 161.15). The price chart follows the general cryptomarket trend.

ZCash — 30.1% (from 56.43 to 73.42). There were hardly any sharp price swings

NEO – 55.36 (from 7.55 to 11.73). The price chart is wave-like, it is not straight.

NEM – 33.75% (from 0.064 to 0.0856). The price hit its high at 0.93 at the end of the studied period.

IOTA – 10.63% (from 0.3567 to 0.3946). The price chart is not steady. Cooperation with corporations was pushing the price up, but the platform doesn’t yet perform any positive results, and  investors do not trust it much.

Against the background of a moderate market cap increase, the price surge of three cryptocurrencies stands out: BCH, EOS and LTC (bitcoin, ethereum, litecoin). The April surge of BTC is associated with transactions from the same wallet in the bitcoin network, which accounted for 49% of the total number of transfers per month. Analysts suggest that it is one of the results of the rivalry between supporters of the original BCH and its fork, Bitcoin SV. According to another version, this is an attack of reorganization in bitcoin blockchain. In any case, for ordinary traders this is a vivid local example of the fact that big capital and personal ambitions of developers rule the market and determine cryptocurrency trading.

EOS is growing in price due to objective reasons and that is the topic of another article. I will rather deal with LTC in more detail. The community expects LTC halving in August 2019, which has become one of its main growth drivers. From this overview, you will learn:

·         What halving is and how it affects the cryptocurrency price

·         Whether the price should be growing after halving

·         Why the common strategy of making money on halving doesn’t work and how the price was moving in similar situations previously

Meaning of halving and hash rate

Halving is a reduction in the block mining reward by half. The idea of BTC and similar PoW altcoins suggests that miners use their computer capacities, time and electricity to perform tasks (computations), and receive a reward for this (you can learn more about generation of cryptocurrency blocks here)

Halving aims at creating a kind of deficit for the coin. In theory, halving should encourage a part of miners to quit mining, thereby reducing the token supply in the market. A decline in supply with a continuing increase in demand will automatically raise the price for the token.

The common strategy of earning on halving is like this: you invest in the cryptocurrency at the moment of its price growth 2 or 3 months before the event; then, you make more profits as there are less miners because of a lower reward, and next, you again enter a long trade, betting that the price should get balanced in the first month, following the event.

Originally, halving was applied only to BTC, which has become the pioneer in this technology. But, as it is about miner reward, halving can be applied to all cryptocurrencies with the Proof-of-Work consensus algorithm, where mining is possible. Let us see on particular examples how investors respond to the upcoming reduction in the mining reward.

1. Litecoin halving

The platform development started in 2011, the total number of Litecoins to ever be produced is 84,000,000 coins, four times more than for the BTC. The Bitcoin block mining reward halves every 210,000 blocks, every four years on average. Although Litecoin supply is more, its halving also occurs at the same approximate interval because miners find Litecoin blocks four times more frequently than BTC blocks (Litecoin block generation time is about 2.5 minutes). The first halving happened in August 2015, when the reward per block was reduced from 50 ltc to 25 ltc.The nearest Litecoin halving is scheduled for the first week of August, the reward for a found block will be reduced from 25 LTC to 12.5 LTC.

Reference. A hash rate can be defined as the speed at which a given mining machine operates. Hash rate is measured in hash per second (H/s). A few theses:

·         If hash rate increases, it means that new participants (new machines) have joined a mining network. The network’s computation capacity increases, the time spent on discovering a block will be less than that at a lower hash rate.

·         The less time is taken by mining, the more difficult it is to discover the next block. The mechanism for making the computation for  coins mining more complicated is a deterrent; otherwise, due to an unlimited increase in capacity, it would be possible to complete total emission much earlier than it is suggested by the Road Map.

On April 4, the Litecoin network hash rate broke through  the previous record  high, recorded at the end of May 2018.  The total network capacity was 359.43TH / s. The previous record 11 months ago was 342.88 TH / s.

The above chart presents how the coin price was moving on that day. At first, there seems to be a clear contradiction. If the network capacity increased, then the number of miners also increased. So, the speed of mining is increasing, and either is growing the supply. But if the supply increases the coin value should be decreasing, in terms of buy and sell on the trading platform.

Even the developers can’t explain this paradox. In Proof-of-Work networks, as a rule, the price follows the hash rate. It means that if the price increases, the hash rate also grows, so, the price increase is the reason, rather than the result. The developers said the coincidence of the hash rate record and a sharp price surge resulted from more efficient mining. However, they did not explain what they meant.

Analysts don’t recommend trying to make profits from halving, they suggest one study the example of 2015. At that time the reward halving was on August 26, but the price reached its highs in July and sharply dropped afterwards.

According to analysts, a similar situation should occur this time. A few months before the halving, the price should be going up, as it is currently doing (a sharp surge in April). However, the price should roll down from its highs and start declining already in July. After the reward halves, investors will be adjusting to the changes in the mining complexity, afterwards, the price is to be corrected up or down. Anyway, there will hardly be a sharp change in price. Miners might refuse to mine the coin at all, but this will lead to a number of consequences. Miners will refuse to mine a coin - the coin will grow in value - miners will again benefit from mining. The price will return to equilibrium.

When analyzing the LTC halving, analysts recommend taking into consideration the following facts:

• No derivatives markets (first of all, futures markets) that will allow traders to insure positions amid uncertainty. That is, miners’ profits almost directly relate to the Litecoin price.
• The remuneration for the found block significantly exceeds the commission to miners for transactions in the network. As there are not many transactions in the network, the commissions won’t yield much profit. For Litecoin miners, the commission fee depends on the market price rather than on the transactions number. The situation with the BTC is different, the reward makes quite a contribution to the miner’s income. For comparison: the share of the commission in the LTC miner’s income from is 0.1%-0.12%, and that for the BTC miner is 4%-8%.

What investors are afraid of. Halving seriously affects the interests of miners in terms of profitability. Theoretically, profitability can be calculated if one knows the number of coins mined, but you cannot say how this will change the complexity indicator. If on the eve of the halving the price does not rise enough to compensate for the future losses of miners, then they will lose their economic interest in LTC. Lower hashrate will automatically increase the risk of a 51% attack. On the other hand, after the attack, the cryptocurrency price will fall, and this is not beneficial for large pool holders, many of which are miners.

Short summary of LTC halving. Based on the experience of 2015, one may assume that the LTC price is now at its highs; it should roll down already by August. The halving itself shouldn’t radically change the cryptocurrency rate, as the market is much more affected by the general cryptocurrency trend (including BCT as well). There can be the short-term price swings because miners will try find a balance between the price and mining profitability. Probably, it is the best time to enter short trades, while one had better wait for about 4-6 weeks for taking long-term investing decisions.

2. Bitcoin halving

It also happens every 4 years. The previous two BTC halvings happened:

• November 28, 2012. The reward was reduced from 50 BTC to 25 BTC
• July 9, 2016. The reward was reduced from 25 BTC to 12.5 BTC

According to Binance Research study, 3 months before the first halving, the BTC price increased by 18%, and it was up by 141% within 90 days after.The decline in profitability was short-term, as it was quickly compensated by the price growth after the halving date. In the media, they often say that the surge in the BTC price in 2013 resulted from halving. It seems doubtful to me as the interval between the events is 1 year.

Three months before the second BTC halving, its price was 54% up, but after it happened, the profitability didn’t meet the previous level. Analysts explain this with the fact that the increased complexity of computation made other cryptocurrencies more popular for miners.

Regarding the next  BTC halving, scheduled for May 2020, investors are not so excited, though, they are rather optimistic. Miners are not so much focused on mining as on the coin price and commission. Therefore, the BTC is likely to increase by 20% and higher, compared to its current value. The BTC behavior during the halving period is different from the behavior of LTC.

Short summary of the BTC halving. Miners drive a relatively large income from the transaction commissions, so a reduction in the reward for mining won’t affect the BTC price much. There are many of BTC supporters, who believe in the network idea itself, rather than are focused on making profit. Therefore, a lower reward for mining won’t result in the price drop, unlike its possibility for the LTC. Analysts assume that the BTC pre-halving rally has already started, and it is the BTC that has pulled the whole market up with it. The price continues growing, but it may decline again in late 2019, like it previously was. So, it is now relevant to open middle-term long positions with a consideration for the possible price decline a few months before halving.

3. ЕТН halving

The case with the ETH halving is even more complex and unusual. Although the ETH also uses the PoW algorithm, Vitalik Buterin has set a goal to transfer to the PoS algorithm. So, the reducing of mining rewards will be controlled manually during the next fork. It is rather not a fork, but an update within the large-scale program, consisting of a few steps: Byzantium, Metropolis, Constantinople.

It is even more difficult to estimate investors’ reaction to the fork than to anticipate the results of halving. At least, much here depends on the innovations’ success (for example, Buterin has once again postponed the Casper update, which doesn’t satisfy investors). You can learn more about how the market responded to the Ethereum forks and see the examples of charts inthis overview .

Conclusion. Can you make profit from cryptocurrency halving? I think the answer is more likely no than yes for a few reasons:

·         It very difficult to predict the cryptocurrency market. Along with halving, one needs to estimate other factors (complexity of mining, the share of commission in the total income of miners) etc. Although the cryptocurrencies use the same PoW algorithm, the developer policy can be completely different (for example, Ethereum, where even the Road Map changes).

·         Halving is the event for a particular cryptocurrency, which can be called local. As long as the BTC is the leader, it will set the trend for the whole crypto market. The LTC halving could just got lost in the general cryptocurrency trend.

·         Developers themselves, as well as the analysts, can’t often explain why the price has changed. For example, the LTC surge in April is only associated with the upcoming halving, but with a reservation that the LTC growth could have resulted from other factors as well.

I’d also like to stress the fact that there are many cryptocurrencies using the PoW algorithm but investors are focused only on the halving of ВТС, BCH and LTC. It seems that halving doesn’t have any influence on the price for other altcoins, or the mechanism of the mining reward halving is not designed in the blockchain irrespective of the consensus algorithm

 So, how you can make cash on cryptocurrency? You need to follow the general cryptocurrency global trend and shouldn’t try to pursue particular local events like halving. You should diversify the risks. LTC and EOS were the leaders in April, but they might become outsiders in a couple of months. Let us discuss the problems of cryptocurrency fundamental analysis in the comments. I am really interested in the ways you analyze the crypto market and the strategies you apply. I wish you successful trading!

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Price chart of BTCUSD in real time mode