Satoshi Nakamoto is God and perfected the design of Bitcoin. Or is it? There is one part of the protocol that continues to bother me: the Halvening (halving, whatever). I’m sure I’ve thought about this. His first Bitcoin should have an incremental decrease in supply per block. But the final design, the one we know of, cuts the block reward in half only after every 210,000 blocks (every four years). Obviously, this decision will have a big impact on price action, volatility, and adoption. Unfortunately, this is not the best supply method. Let’s check.
Bitcoin, as we know, has a supply schedule that follows the following hard-coded rule:
For non-mathies, this is the sum (Σ) of all new coins issued per block from launch until 32 halvings in the future. During the first 210,000 blocks (i=0) the block reward is 50 (50/(20) = 50/1 = 50). The first halving follows (i=1) and the block reward for the next 210,000 blocks is cut in half (50/21 = 50/2 = 25). This continues until the 32nd cycle ends in the year 2140 and the total supply reaches almost 21 million coins.
This choice of supply schedule has consequences. Because the supply suddenly decreased by 50% overnight, it shocked the market. While the demand remains unchanged, the price will adjust upwards, because Bitcoin is now twice as scarce. Rapid price increases lead to a cycle of hype, attracting media attention, attracting new adopters.
The halving is Bitcoin’s in-built media campaign. But it comes at a cost. Because the price is so volatile, the price rises to a blow-off peak, and the rollercoaster dives back into the abyss. This makes Bitcoin bad for many where drawdowns of 75-85% are normal.
The main feature of Bitcoin is the store of value (SoV) function, which makes it different from other innovations. If you FOMO at the top, the store of value function will only be fulfilled after four years. The only way a new hodler will hold onto their Bitcoin is if they fully understand the protocol, trust the code, and know that the price will recover and disappear after the next breakout. This is a level of abstraction and conviction that most prospective adopters lack. Negative short-term price movements further undermine the SoV proposition. It took months to properly understand Bitcoin (and fiat).
However, with other technologies, the benefits are obvious after the first use. TV, telephone, email, microwave are good examples of innovations where the value is seen within the first minutes.
To emphasize the effect of perception, look for example the adoption of color TV against the computer. Television, even earlier, was faster. Because its value is experienced immediately. The computer is a more obscure tool. Therefore, there are exceptions in the chart that buck the trend. It is important to ask why. Bitcoin may also be an outlier! Value perception plays a large role in the steepness of each individual curve. This is one of the main drivers of technology diffusion according to Everett Rogers who first studied these curves. This makes adoption narratives like “It’s like the Internet in 1994,” or “innovation adoption curves get steeper over time,” less convincing.
So, the question is: Is the current 4-year supply schedule good?
Further Decrease in Supply
The alternative is simple: ISR. There are no halvings, but each block has a small reduction in block reward. So block 0 has 50 BTC. Block 1 has 49.9999, and so on. A linear function is not ideal, but there are other options.
The ISR schedule cannot prevent volatility, but it can certainly reduce it, because there are no more hidden shocks in the market. Such a change would make Bitcoin a more stable asset, gradually increasing its price over time.
Will the media hype and attention be reduced, then? Likely. But how many people are still staying for the ride? Where is the best point between these two schedules? It is conceivable that ISR may improve adoption. The halving cycle can further confuse the perceived value of Bitcoin.
In the future, if we can test Bitcoin on other planets, or spin up another simulation, we will conduct this experiment. I hope the middle is not the best design. Satoshi was wrong…in retrospect.
This is a guest post on Bitcoin Graffiti. The opinions expressed are their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.