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The Bitcoin Halving Beyond the Hype

May 4, 2020·8 min read
The Bitcoin Halving Beyond the Hype

Using the Halving to Your Best Advantage

Much of the talk about the third Bitcoin halving, expected mid-May 2020, hypes it up as a sure-fire cue for a BTC price increase. While we are optimistic about this event’s outcomes, we are wary of the hype glossing over some of the subtleties that would help investors maximize the value of their assets.

In this article, Nexo’s research department explores some possible catalysts for BTC price spikes around this much-anticipated event, covering previous halvings, BTC’s growing resemblance to gold, the efficient market hypothesis, and the mining angle, as well as offering a lender’s perspective.

  1. Some Background

To set the stage, we will begin with an analysis of the last two Bitcoin halvings in 2012 and 2016 as compared to the current context.

a) Previous Halvings:

The state of equity markets and the cryptocurrency investor base are quite different from what we observed during the previous halvings. A common theme between the environments is, however, the risk-averse sentiment and fear of a global recession, particularly in view of the COVID-19 pandemic and its unclear long-term economic effects.

To gain a well-rounded perspective of the upcoming 2020 event, we have compared economic factors surrounding the 2012, 2016 and upcoming Bitcoin halvings in the table below:

In addition to the data presented in the table above, it is worth highlighting that in 2012 and 2016 — the years of both the previous two Bitcoin halvings and of market slumps that spurred currency devaluation — Bitcoin by far outperformed gold, the most stable index and traditional safe-haven during crises. BTC’s price increased 175.2% year-on-year in 2012, while gold jumped 4.7%. A similar scenario occurred in 2016 against 2015: BTC and gold prices surged respectively by 154.5% and 6.97%. Тhis indicates Bitcoin’s superiority as an alternative and emerging investment class. We can also extrapolate that, because of its fixed supply, it can serve as an ideal hedge against currency devaluation during recession periods.

To delve further into the analysis, we look at Bitcoin price movements in the three months before and after each halving, as charted in the graph below, and explore these fluctuations against the economic climate in 2012, 2016 and 2020.

Back in 2012, Bitcoin was a niche asset known to only a handful of IT experts. While BTC’s price was relatively flat before the first halving, an inflow of new investors driven by the existing media coverage following the event fueled a strong rally.

The second halving was a different story. By 2016 Bitcoin had gained a little more popularity and had a more sophisticated investor base. The price action then went with a “buy the rumors, sell the news” behavior that contributed to an increase of over 50% in the three months prior to the event and a relatively flat price afterward.

So what will happen this time? Nowadays BTC is more correlated with other traditional asset classes and is more reliant on macro events, like overall economic strength, monetary policies and investors’ risk appetite. We should, therefore, look at the broader picture.

At the beginning of March, following the COVID-19 outbreak, the US government cut the already low interest rate, slashing it to virtually zero two weeks later. The Fed initially announced a quantitative easing (QE) program of USD 500B in US government bonds and USD 200B in Fannie Mae and Freddie Mac bonds, but plans were quickly extended to remove the QE cap altogether and launch a range of new emergency credit facilities. Likewise, the European Central Bank announced its plans for a USD 812B (EUR 750B) QE program to absorb the economic shock and made junk bonds acceptable collateral for bank loans. In turn, the Bank of Japan removed the previously placed limit of JPY 80T (USD 750B) per annum and increased its capacity to buy corporate bonds and commercial papers.

In the US — the largest economy and one to take the quickest and most aggressive monetary measures — fear among investors, combined with pressure from the purchasing program led to an interest yield capitulation, as demonstrated in the graph below. Rates fell to historic lows and the US treasuries yield curve collapsed across all durations as investors prepared for a prolonged period of economic stimulus.

Data: U.S. Department of the Treasury, Nexo

With yield compression nearing negative levels and unprecedented uncertainty surrounding monetary policy, investors are naturally pushed to search for alternative assets for their wealth. As the recession unfolds, the increase in money supply and pursuit of a balance between capital preservation and risk-adjusted returns will shift investors’ sentiment towards crypto-assets as traditionally cash-generating assets like stocks and real estate become more expensive. With its finite and scheduled supply and decentralized architecture, BTC, in particular, offers the certainty needed in times like these, and will likely become a new safe-haven asset class. In this respect, the upcoming Bitcoin halving is, for all intents and purposes, the antithesis to quantitative easing, and may just as well be dubbed “quantitative hardening”, as recently proposed by Hashcash inventor and Blockstream CEO Dr. Adam Back.

Next, we explore how these underlying forces work in the context of the anticipated halving to drive the BTC price up.

2. Current Context:

While the information from 2012 and 2016 unequivocally points towards a prosperous, prolonged post-halving period, the stark development of the blockchain space and broader economic changes make it unlikely that events will play out quite as they previously did.

Factors like low to negative interest rates, money printing and the shift towards a cashless society currently shape an economic context that may pump BTC prices up.

Governments and banks have been promoting the elimination of cash money for years, and even more so now, as the world prepares for a post-COVID-19 economic crisis. With negative interest rates going hand-in-hand with the elimination of cash, and in turn, contributing to the depletion of people’s bank accounts, a shift to Bitcoin and other decentralized cryptocurrencies would become an increasingly attractive path to financial freedom.

Moreover, BTC can serve as a hedge against inflation due to its fixed monetary policy, with the halving essentially acting as “quantitative hardening” vis-a-vis QE programs implemented by governments across the globe. According to a Bloomberg Economics analysis, the central banks of the seven largest economies purchased $1.4 trillion of financial assets in March alone — nearly five times more than the previous monthly record, set during the April 2019 financial meltdown. This is just the beginning. We may have reached the single peak of the COVID-19 pandemic, or there may be waves of infection, or perhaps even a seasonal recurrence of the disease until eventually a vaccine is discovered, maybe years from now. But despite this uncertainty, what remains perfectly clear is that the COVID-19 pandemic will resonate in the years to come. In light of this, central banks will more than likely continue pumping cash into the economy to keep it afloat.

Analysts from Morgan Stanley estimate that the Federal Reserve, European Central Bank, Bank of Japan and Bank of England will expand their balance sheets by at least a cumulative $6.8 trillion when all is said and done. Once the unprecedented liquidity reaches the end consumer, the result will be inevitable inflation and the devaluation of fiat currencies. Meanwhile, the Bitcoin supply will be cut by 50% over the next month. In such an environment, assets with a limited supply like gold and Bitcoin are likely to stand out as people look for alternative stores of value once the government-backed currencies lose this feature.

Ultimately, this push towards lower cash usage and interest rates, combined with higher money supply will likely lead to the mass adoption of Bitcoin and its peers as an opportunity to escape the already burdensome fiat system.

3. The Case for a BTC Spike Around The Halving

Absolute certainty about the outcome of the third Bitcoin halving is impossible for anyone in the blockchain community, Nexo included. Nonetheless, several arguments support an optimistic forecast for BTC around the 2020 Bitcoin halving, including:

a) The “New Gold” Argument: A popular standpoint for why Bitcoin is likely to appreciate in value with the third halving is the shift in narrative regarding its purpose and use cases. Initially, crypto enthusiasts supported the idea that BTC would replace fiat as a currency for daily purchases. However, in recent years Bitcoin is being used more and more like gold — a safe-haven, long-term investment. Economists currently foresee a significant upward jump in gold prices in the coming year, with institutions like Bank of America lifting their target for the asset to $2000-$3000. This, combined with the fact that the Fed cannot print and, therefore, devaluate gold, bodes well for assets like BTC that are being perceived more and more like gold. Moreover, after the halving, Bitcoin’s S2F scarcity will be on a par with that of gold. If this new narrative persists, scarcity will become a natural driver of price growth and, from this perspective, Bitcoin’s prospects post-halving seem positive.

This new reality for BTC is explored more thoroughly in Bloomberg’s April 2020 Crypto Outlook, which predicts a likely upcoming surge in gold’s price and, with it, Bitcoin.

b) Efficient Market Hypothesis: In the context of the 2020 Bitcoin halving, an efficient market hypothesis-based scenario would see BTC prices increase ahead of the halving as investors anticipate the bullish effect of the fresh supply being cut in half. This occurrence is becoming more likely now as the market is different from that 4 or 8 years ago, when crypto derivatives markets were non-existent, institutional involvement was slim, and valuation frameworks were limited. Traders, institutions and investors alike are now anticipating the event, while the media hype around it could also draw in new investors. These circumstances indicate a potential increase in demand for Bitcoin around the halving, and thus a likely bull-run.

c) Mining & Favourable Difficulty Adjustment: As sole beneficiaries of the newly-minted BTCs, miners are the among largest net BTC sellers in the ecosystem, meaning their reactions to the Bitcoin halving may influence the asset’s prices.

With rewards halved and operational expenses on the up, miners’ revenues will decline. Тhose with low efficiency will be forced to reevaluate their operations or go out of business, potentially resulting in downward pressure on Bitcoin, while others — as Nexo’s large miner client base indicates — will choose to hold their BTC and borrow against it.

In either case, price support for the consistent sell pressure stemming from mining would, paradoxically, be established by miner capitulation and a net reduction in hash power on the network (i.e. favorable difficulty adjustments), helping maintain BTC prices.

4. The Case for Borrowing Around the Halving

Should a BTC price spike occur around and after the May 2020 Bitcoin halving, as argued above, this event would present an opportune moment for investors to borrow fiat against BTC and get more bang for their buck, while HODLing their crypto-assets as they grow in value, rather than selling.

With Nexo’s offering аs a lender centering on this so-called “billionaire’s approach” of HODLing mid to long term, and over 70% of our business being in BTC, we have seen an increasing number of our customers deploy this strategy to expand and diversify their investment portfolios around bull-runs. Miners, who form a considerable portion of our client base, have also opted for our crypto-backed credit lines to help maintain and grow their operations, as well as to cash in on their newly-minted BTCs.

This shift in perspective from quick-buck, knee-jerk selling to a more long-term game plan with regard to Bitcoin indicates both the emergence of a seasoned investor class within the crypto space and supports the fact that BTC is increasingly becoming a safe-haven investment option. We expect that investor behavior around this third Bitcoin halving will confirm this trend.

Having said this, it must be noted that absolute certainty about the outcome of the 2020 Bitcoin halving is impossible. As such, the above arguments do not constitute financial advice, but rather urge investors to maintain a critical perspective to ensure they play their assets to optimal ends in May 2020.

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