It’s been a couple of weeks now that Bitcoin is trading below crucial $7000 price range and this is worrying for a number of factors. The main one being its mining costs.
Since 2018 when Bitcoin began its 2-year bear cycle, we’ve seen a lot of pressure on mining and especially the individual miners who were almost entirely wiped out by the pooled farms. The reason is that mining activities grew in the previous year and as the price of Bitcoin reached new ATH in 2017 many farms and mining operations popped up in countries where electricity costs are high but seemed durable, due to the high reward ratio at the time.
Since then we’ve had declining prices of these rewards – both in terms of fees (that went down significantly since the start of the bear cycle) and price value of bitcoin (which dropped from nearly $20k all the way to $5-6k where it currently sits).
What are the dangers?
Each block successfully mined brings a 12.5 BTC reward plus mining fees.
With the growth in number of new mining operations came an increase in the difficulty of the mining rate.
With more miners and the rise of pooled mining (grouping of individual miners sharing electrical and storage costs for reduced expenses), we end up with greater decentralisation of the Bitcoin network. This is a good thing.
However, things are not going only in one direction. The difficulty rate is adjustable, so as we see more miners joining the network, the difficulty rate increases and their chances of successfully mining a block decreases.
What follows is a drop in the profitability rate for miners, this means some of them drop out of the competition and subsequently causing a drop in the difficulty rate and the network hash rate with it.
The hash rate of a cryptocurrency is a parameter that gives the measure of the number of calculations that a given network can perform each second.
A higher hash rate means greater competition among miners to validate new blocks; it also increases the number of resources needed for performing a 51% attack, making the network more secure. So far, Bitcoin’s network has been the most secure and resistant to such 51% attack while many of the alts have experienced such attacks (ETC, ZEN and BTG are just a few examples in most recent times).
As I reported in my previous post, we are currently experiencing huge drops in both hash rate and mining difficulty rates in bitcoin, some of the biggest drops we’ve ever seen.
On March 26 it was reported that there was a –16% drop in the difficulty rate in a single day – the second biggest such drop in its history to date. At the same time the network hash rate has taken a steep plummet and is now down almost 45% from its 2020 peak.
Both events are due to a simple factor – Bitcoin’s current value is below its production cost. For the most part of the world at least…
There are still places in the world where mining costs are lower and in some regions it costs about $4-5k to mine a single bitcoin, in other places it can go to as low as $3500 but in the majority of the world, mining a single Bitcoin comes to more than $6000 and here lies the big issue with Bitcoin dropping below the $7000 price range.
Although there are still places with lower electricity rates, what we don’t want to see is miner centralisation. We’ve had that back in 2015-16 when majority of the mining was done in China. It still is, but since then we’ve diversified a lot and it’s important to keep Bitcoin’s network spread more evenly across the globe, less concentrated in one or two regions and more resilient against companies, governments or other centralised entities pressure to suppress or control it.
Another factor we should take into account right now is that we are soon facing the Bitcoin Halving – an event occurring every 4 years which cuts the mining rewards by half.
This is bound to happen this May and we will see the mining reward become 6.25 BTC per block – something that is typically seen as a catalyst of the price of Bitcoin but in this current economic crisis it is unclear whether it will achieve this purpose as fast as its necessary.
Most of the miners (if not all these days) are running their operations as a business. Gone are the days when Bitcoin was mined from a home computer by ideology-driven cyberpunks who cared about the tech.
Pretty much everyone involved in crypto today is driven by profit and the tech is just an added bonus. When one coin is not very profitable to mine, miners switch their machines to another. Many of the latest machines are programmable in a way that it’s easy to switch between various coins to mine based on their profitability. With this in mind, it is easy to see how we can end up with less diversity in Bitcoin mining and more centralisation as only the biggest mining farms (and those situated in regions with lowest costs) will continue mining BTC while many could migrate to other cryptocurrencies.
And last but not lease, we ought to take into account that the price of Bitcoin is completely driven by the trading market, i.e. the speculators.
Hodlers and users of the crpytocurrency have no say in what its market value is at the moment. The trading volume is what drives the prices up or down and with less interest in Bitcoin from an investment point of view, we will see less buying power. This could result in a further drop in its value. This happened to Litecoin last year just as it had its own halving event. The price dropped by 50% and more soon after.
Will this happen to Bitcoin? In the short term it seems very likely. What we should have experienced is a huge pump in the run-up to the halving event (it is just 50 days from now) that would take the price to the $13k-15k resistance levels, then followed by the inevitable correction down to the $7-8k levels which would have been reasonable. Unfortunately, with the Covid-19 outbreak and almost complete economic shutdown of so many countries, both institutional and retail investors pulled out a big chunk of their capital from crypto (and all other assets as well) and caused a premature price crash which is still struggling to recover.
What to look out for?
Right now the most important thing will be to watch closely how this pandemic will evolve, how quickly can it be resolved and how the markets will respond to it. The current recovery seems steady but it could be just a short term bounce that was driven by hope and if a recession begins straight away, we could also see a further plunge in the prices of all markets, including Bitcoin and all other crypto with it.
What’s the ideal scenario?
Well, the best thing will be if Bitcoin manages to hold its head above waters, that is above the $7k price range, possibly going back to at least it’s most recent support of $8-8.5k so that more miners can be back in business and from there I can expect rising prices once people realise that the current mass-printing of fiat currencies that’s happening all over the world will only devaluate them. As more and more people wake up to the fact that their fiat money are losing value with every next batch of new notes, they will inevitably want to invest their spare cash into the one currency that no one can overproduce and that is Bitcoin of course.
Other posts to check while you’re here: