The community remains at odds over whether the upcoming block reward halving for Bitcoin will have a meaningful impact, or if it’s already priced in.
Defining Bitcoin’s Market Efficiency
Bitcoin’s block reward halving has been at the center of fervent debates for the past 5 years but more emphasis has been placed on this topic as the next halving event edges closer. This fervor of this discussion can be attributed to a lack of clarity as to how bitcoin is priced and treated by the broader market.
At the heart of this issue lies the “Efficient Market Hypothesis,” an investment theory that was popularized by Eugene Fama, a well-known academic in economics and portfolio management. In 1969, Fama’s research paper, Efficient Capital Markets: A Review of Theory and Empirical Work, considered his magnum opus, described market structures and offered a pricing theory where different degrees of information were priced in depending on the dynamics of the market.
In an attempt to argue that Bitcoin’s halving events are inherently priced in, proponents of this theory used the premise of “semi-strong efficiency” to describe how it applies to BTC. As per the semi-strong feature of Fama’s hypothesis, all publicly available information is reflected in prevailing market prices. By this logic, since the halving is a publicly known phenomenon, investors should be pricing in its effect on the current market price of Bitcoin.
But does knowing that the halving is going to happen equate to knowing the effect it will have on order books and demand-supply mechanics?
Effect on Market Price
When it comes to equity instruments, it is easier to price in news and forecasts because the instrument is backed by earnings, cash flows, and balance sheet assets. If consensus estimates by institutions for a particular company is that earnings will increase by 9%, this effect can be easily priced in because the end result is quantifiable.
Bitcoin’s value is much more difficult to quantify, however.
Its core proposition is coordinating trustless economic activity over an uncensorable network — both of which are qualitative and cannot be accurately quantified. The price of Bitcoin is even more difficult to predict as it is a monetary asset with no backing, and hence, no real intrinsic value either. Price, in this case, is simply a measure of demand and supply.
The block reward halving in May will reduce miner block subsidies from 12.5 to 6.25 BTC. While this isn’t a supply shock, as the absolute effect of the supply decrease is known, it certainly has a complicated effect on price. After halving events, miners earn less Bitcoin by way of block subsidies, which results in less supply coming into the open market. With demand constant and a unilateral reduction in supply, the obvious effect is an increase in market price.
This effect is known, but it cannot be estimated; a unique blend of factors play a key role in determining how price shapes up. These factors include the amount of Bitcoin miners decide to sell on a daily basis, fee revenue earned by miners, flow of market demand for Bitcoin, the extent of demand surplus (if any), and changes in overall liquidity, amongst many other intricacies.
Even in a market where semi-strong efficiency holds, new information always has the ability to influence prices. Bitcoin is an example of one of these markets, where publicly available information is priced in, but new information such as the real effect of a supply contraction cannot be priced in until it is adequately estimated.
Nic Carter, a partner at Castle Island Ventures, explains the convergence of the efficient market hypothesis proposed by Fama and its inability to price in the halving: :
“Fama defines an efficient market as a market in which prices always ‘fully reflect’ available information. If you were to stop reading here, you’d already have a better understanding of what is meant by efficient markets than the caricatures presented on Twitter.”
Halving Events Aren’t Priced in or Inherently Bullish
Despite probability on the side of the bulls, there is no concrete evidence that dictates halvings are intrinsically bullish events. In the case of the price not surging soon after the halving and fee revenue continuing at a similar level, miners will also endure a revenue halving since block subsidies contribute over 90% of their overall revenue.
This could, in turn, lead miners to sell a larger part of incoming Bitcoin supply to meet their expenses to reduce the effect of a supply contraction caused by the halving.
Hypothetically, if miners only had to spend 6 BTC to meet their expenses, this means 6 BTC were sold in the market and the remaining 6.5 BTC from the block reward was accumulated by them. If the price doesn’t immediately recover post-halving, this will lead to an accumulation of only half a Bitcoin per block.
To offset this, Bitcoin must be able to generate more fees to continue providing economic incentives for miners.
Another plausible explanation is that market participants, anticipating an increase in price, may sell their coins around the time of the halving — actually resulting in a price decrease.
6/ The BTC options market tells us an interesting story: there is no kink in the implied volatility term structure for the relevant expiry (Jun20). This means the options market does NOT anticipate any increased volatility around that time! pic.twitter.com/nYr12pi3Ga
— skew (@skewdotcom) January 6, 2020
So, while the halving is not estimable nor is it baked into the current market price, the halving doesn’t imply a default bullish scenario for the market. Everything depends on demand and supply — just as it should in a free market.