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13 May 2021

An Ode And Forthcoming Obituary To Bitcoin’s Four-Year Cycle

An Ode And Forthcoming Obituary To Bitcoin’s Four-Year Cycle

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In this article, we’ll first take an in-depth look at why the bitcoin price moves in a four-year cycle related to its halving schedule.

We then dive into how this market cycle influences more fundamental properties of the Bitcoin network itself that are related to the behavior of miners and users.

After the halving, the supply of newly mined bitcoin that enters the market is cut in half.

If the demand for bitcoin remains unchanged, this means that a supply shortage is gradually formed.

As a result, the only way for the market to unlock supply to satisfy the demand for bitcoin is to entice current holders to sell their bitcoin—which means that the market price has to move up.

Due to bitcoin’s status as a Veblen good, this rising price tends to attract even more demand, exacerbating the already existing supply shortage and driving up the price much faster than it organically would.

Those price developments resulted in a temporary bubble each time that ended with a market crash and subsequent multi-month to multi-year bear market that was necessary for supply and demand to find a new equilibrium—each time at a (much) higher level than during the previous cycle.

As can be seen, the hash rate barely drops after each halving (white striped vertical lines), and as the bitcoin price and thus the BPT measure that we introduced in the previous paragraph increases, hash rate growth accelerates.

During the second half of the cycle, when price is cooling down, hash rate growth stagnates a bit—until the next halving occurs and a new market cycle incentivizes more rapid growth of this network characteristic that is so important for its overall security, actually making the network itself more valuable.

This means that during these periods of the cycle where the hash rate keeps going up, more new bitcoins are created than would be expected based on the original supply issuance schedule that assumes 10-minute block times.

When the bitcoin price growth stops and the market cycle finishes with a blow-off top that is followed by a cooldown period, mining profitability decreases, causing the daily coin issuance to go down again.

An implication of this mechanism is that, during busy times on the network, anyone that is looking to make an on-chain transaction on the network needs to bid up their transaction fee to get their tiny share of block space on the Bitcoin blockchain that is needed to get their transaction confirmed.

Since the value of the transaction fees that are included in Bitcoin blocks essentially represents the magnitude of this developing block space market, it is a better proxy for network activity than simply looking at transaction counts.

While it is difficult to predict exactly when the point will be reached where transaction fees will (consistently) account for the majority of the block reward (based on eyeballing the charts above; perhaps after one to three more cycles?), as long as there is at least some activity on the Bitcoin network, it is a given that this point will be reached at some point in the future because the block subsidy trends toward zero by design.

This brings us to the final part of this article, where we’ll hypothesize how that perspective would impact the four-year cycle, and what that future for Bitcoin would look like.

The subtitle of this article already gave away the direction of my take on this: when Bitcoin gets to the “full maturity” mentioned above and a healthy block space market exists that is able to sufficiently incentivize miners to structurally keep the lights on, I expect the four-year cycles as we know them today to fade into oblivion.

In the absence of a block subsidy, 100% of the new demand for bitcoin will have to be satisfied by purchasing bitcoin from existing holders (and to some extent miners that sell some of their fee revenue to pay for expenses, which will likely be just a fraction of the total supply that is available for sale on the market), creating a perfectly inelastic situation where price changes become a perfect reflection of changes in demand for bitcoin.

Second, as the percentage of bitcoin’s finite supply that has already been issued increases, the bitcoin price becomes an increasingly pure reflection of the market demand for bitcoin.

This means that in a long-term post-halving-cycle future, cyclicality in bitcoin will likely be more closely related to the actual economic activity of its market participants and thus their economic cycle (sometimes also called “business cycle”).

Third, if the bitcoin price increasingly becomes a pure reflection of the market demand for bitcoin, the likelihood of a dramatic exponential price rise past what we have seen so far increases.

After all, due to the ever-decreasing supply issuance rate, demand for bitcoin has an increasingly direct influence on the bitcoin price.

Fourth, another consequence of the absence of a four-year cycle as we know it could mean that the bitcoin price eventually becomes less volatile.

Finally, if a healthy block space market will indeed kill bitcoin’s four-year cycle, it means that transacting on the Bitcoin blockchain will likely have become quite expensive.

This means that in the future, most of us won’t be transacting via the Bitcoin base layer on a regular basis.

More likely, the block space fee pressure will incentivize more effective batching of transactions (or, as Nic Carter put it during Baltic Honeybadger 2018, “container ships, not parcels,”) and broader adoption of layers (e.g., the Lightning Network) that have been built on top of Bitcoin’s base layer, which most of us will probably primarily use to interact with bitcoin, aside from occasional channel opens or closes or large transactions.

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