Building the DPC Model, Part II
Modeling #bitcoin's block subsidy (miner reward) halving cycle
A continuation of
🧵 of 14
Modeling #bitcoin's block subsidy (miner reward) halving cycle
A continuation of
https://twitter.com/DeFi_initiate/status/1490074936634871808
🧵 of 14
1. What is the halving cycle, and why is it important for the price of #bitcoin? Let's review this article again before we go any further: investopedia.com/bitcoin-halvin…
2. Each block includes a reward for the miner who successfully solves the block; this is called the block subsidy. Every 4 years or so (210,000 blocks of ~10 minutes = ~3.99 years), this block subsidy (miner reward) is cut in half programmatically.
3. The block subsidy is gradually reduced over many years to keep #bitcoin's inflation in check. Since the value of a low-inflation asset is higher than that of a high-inflation one, the reward halving mechanism increases the value of bitcoin through controlling inflation.
4. Over the long run, the price of #bitcoin should be rising not only because of ever-increasing adoption (network effect) but also due to decreasing inflation. How can we estimate this price appreciation over time?
5. Various attempts have been made in the past, the most well-known of which is the stock-to-flow (S2F) model (based on the concept of scarcity). Since we know now that this is not the answer, let's take a fresh look at what is actually happening. Here is the monthly chart again. 
6. In addition to the blue price candles, I included the 3 halvings (labelled yellow), evenly-spaced vertical time markers (white), a sine wave (white) aligned to the white markers, and red/green arrows to highlight major price movements. Can you see the regular 4-year pattern?
7. The pattern is not perfect, but there is a clear rhythm from cycle to cyle. We want to capture this rhythm by taking prices from one halving cycle, and overlay them onto the next one. We have an initial problem in that the halving cycles are not exactly the same length.
8. This is especially true for the first cycle, which is much less than 4 years. We solve this by scaling the cycle periods by applying 200 evenly-spaced steps between two halvings (one step will be roughly 7.3 days in a 4-year cycle, but will vary in each case).
9. We come up against another problem, which is the 1.5-year period between genesis (8 Jan 2009) and 17 Jul 2010: there was no market for #bitcoin and consequently no prices. We solve this challenge by recognizing that price action will be compressed for the 1st halving cycle.
10. The second component is built on the following bases as a result:
- Halving cycles are not the same length but can be scaled to make them comparable
- Price multiples (i.e. actual price divided by the power law value) within cycles will exhibit similar behavior
- Halving cycles are not the same length but can be scaled to make them comparable
- Price multiples (i.e. actual price divided by the power law value) within cycles will exhibit similar behavior
11. To make the calculation robust, we need one more insight, and that is the role of trading volume. Not all prices are made equal: a closing price at low volume doesn't carry as much weight as one with high volume. We weight prices by the logarithm of daily dollar volume.
12. Using price multiples weighted by volume, we take an average across 2% of the halving cycle (4 steps) and thus develop a pattern within the 1st cycle. Next, this pattern is averaged with respective price multiples within the 2nd cycle.
13. This new pattern will reflect the combined behavior of the first two cycles. We repeat this procedure for the 3rd cycle, after which the cyclic rhythm of the price multiple will be a combination of patterns from 3 cycles.
14. Price multiples thus calculated are applied to respective power law values to get projected prices. Since all projections use only data from the past, projected values are fixed for past dates. Future projections are dynamically adjusted with each day's closing price.
15. This concludes the exposition of calculating the second, cyclic component of the DPC model.
The series will be continued with a look at how #bitcoin's daily closing prices are used to adjust the projection line (Part III of Building the DPC Model).
The series will be continued with a look at how #bitcoin's daily closing prices are used to adjust the projection line (Part III of Building the DPC Model).
The price multiple referred to above is correctly called the power law deviation (PLD). This is the term used in Part III.
Part III is here:
https://twitter.com/DeFi_initiate/status/1490373792136249344
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