What is a Block Reward Halving?

In cryptocurrencies you might sometimes hear about an event called the “block reward halving.” It is a common concept in all cryptocurrencies with a Proof of Work (PoW) algorithm such a Bitcoin, Litecoin and Dogecoin. For the latter coin, another halving is about to happen in just several hours from now. To understand this event, it is first required to understand block rewards.

Block Rewards

In PoW mining transactions are validated by so-called miners who have to solve computational puzzles to this purpose. The security of the network is determined by the total computational power in it. For their effort, the miners receive new coins and transaction fees. The set of the most recent transactions that have not yet been recorded previously are referred to as a “block.” Once a block is validated, it is added to the “block chain”, a public ledger of all transactions. All the miners working on a block are in fact racing to solve the same puzzle. Once a solution has been found, the first to do so will be rewarded with new coins and transaction fees, before the miners continue to work on the next block.

Supply and Halving

To combat monetary (hyper)inflation, all cryptocurrencies start out with a predefined monetary policy. There is no central bank that can add unlimited money to the system, which is considered one of the main gains of cryptocurrencies. In the case of Bitcoin, the total supply has been capped at 21 million coins which will be reached in the year 2140. As rewards are halved every four years most coins will be mined by 2040, after that the amount of new coins per block will be negligible. Dogecoin on the other hand will add five billion coins per year perpetually, although this phase is already reached at the start of next year.

Effects

The most obvious effect of a halving is that profitability for miners will drop instantly if prices do not double suddenly. Because of this, hashrate tends to drop on a halving as some miners can no longer mine at a profit. These will switch off their miners. The more efficient a miner is, the more likely that a miner can still mine at a profit after a halving. Large numbers of small scale (relatively inefficient) miners get squeezed out of the market this, leaving only a smaller number of large scale (relatively efficient) miners. A bigger investment can buy more efficient miners. This is known as economies of scale, and has a centralizing effect on network hashrate increasing its vulnerability. In short, a halving generally has a negative impact on a coin’s security.

On the other hand, there is suddenly less new supply to accommodate new users. Depending on user growth and growth rate stability, this could produce some upward price pressure for the respective cryptocurrency. Especially if a coin is growing quickly, this should easily be observed. The impact should however be limited, as it is not the total coin supply that halves.

For Dogecoin, prices are expected to remain stable throughout the halving, given no emotional excitement surrounding the event. As a new generation of Scrypt ASICs is joining the Dogecoin (and Litecoin) network(s), hashrate is more likely to go up than down negating the negative impact. Also user growth for Dogecoin seems like it has stagnated, so also the upward price pressure is nullified.

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