Halving Fallacy

Bitcoin consensus-rules produce a predictable rate of monetary inflation. This rate is reduced periodically at a point called the halving. There are several step functions in Bitcoin. The halving occurs every 210,000 strong blocks, the difficulty adjustment every 2,016 strong blocks and chain organization approximately every 10 minutes. The numeric values that control these intervals are arbitrary yet the discontinuity is necessary due to the discrete intervals required for proof of work. There is a theory that the halving creates a financial cliff for miners that may lead to a perpetual stall. The theory is based on the confluence of two step functions (halving and difficulty), causing the period of another (organization) to expand dramatically due to coincident reduction in miner profits.

The theory assumes that the difficulty adjustment resets average miner economic profit to zero, allowing only the top half of miners (by profitability) to survive, eventually reducing mining to just a few miners. In other words the difficulty adjustment is considered a positive pooling pressure. However there is no reason to believe that the adjustment reduces any miner's profit to zero. The consequence of the assumption is not that there will be few miners, but that there will be none, due to the difficulty adjustment alone. The adjustment actually does nothing to regulate miner profits, it controls only the organization period. With no adjustment, profit would be unaffected while the organization period and therefore variance would respond to total hash rate. Time preference, which dictates market return on capital, regulates miner profits just as it does in every market.

Consider the case of no price change. In this case there is no reason to expect a change in total hash rate, no adjustments to difficulty, and we can conclude that the average mine generates the market return on capital. In other words any number of independent miners can compete indefinitely (absent actual pooling pressures).

Consider also that price changes, difficulty adjustments, and reward fluctuations all effect miner profitability in the same manner. A difficulty adjustment and/or halving is therefore no more important to a miner than a comparable price fluctuation, and exhibits greater predictability. Miner profits are expected to always average the market rate of return on capital. Therefore the theory builds on an invalid assumption.

The theory also contemplates that reward may be insufficient to compensate miners for difficulty immediately following a halving. As such they may opt to reduce hash rate, extending confirmation times until fees rise, price rises and/or difficulty adjusts downward. Yet fees and price are determined in a market and can certainly rise to any level that people are willing to pay. There is no way to know what levels the market will support. Yet the two largest halvings have passed with no disruption. Fees and price have both risen, encouraging significant increases in total hash rate. Given that subsequent halvings will produce the equivalent of an exponentially lesser price reduction, there is no reason to believe the future events will be any more interesting than the past.

Finally, by controlling variance, which would otherwise rise indefinitely with price, adjustment is a negative pooling pressure. This is the opposite of the effect assumed by the theory.