The hash rate for Bitcoin, the number of estimated attempts to solve problems by all miners, continues to increase hitting new highs. Without the miners working these complex problems, Bitcoin transactions would come to a screeching halt. But, as anyone who has read just about anything on Bitcoin mining knows, the task is expensive; the cost to run one of these mining computers puts the electricity usage at an aluminum smelting facility to shame. In fact, it is virtually unprofitable at the current price of Bitcoin ( BTC-USD ). And, yet, miners continue to mine Bitcoin (and every other cryptocurrency) and are pushing new levels for their accomplished mathematic equations.
Given the expense of the computers, the cost of energy to run these computers, the current halving-rate and the price of Bitcoin, why are miners still doing anything? Answering that question may tell the secret to future price movements in Bitcoin, and, by extension, other cryptocurrencies.
The correlation between hash rate and price There is no correlation between Bitcoin hash rate and the price of Bitcoin, and yet, there is. The ironic thing about Bitcoin is that it deals with getting an answer and figuring out the question afterwards; it is exactly like the game show: Jeopardy .
And, with the question of how the hash rate affects price of Bitcoin, the answer is yes, and now to figure out the correct question.
Playing Jeopardy The answer is: Where do you get insightful, yet, intriguing financial analysis?
The question: What is Seeking Alpha?
With Bitcoin and other alt-coins, you are given an answer, although not in word form; the answer is numerical. You must then figure out the mathematical equation of how you got there.
Take the number 10. If I gave you that as an answer and told you that now you must figure out mathematically how the answer was derived, you may say, (9+1)=10. Congratulations, that is a correct way of getting to the number ten, however, that is not the answer.
Keep guessing.
But, just so you know, that first guess used a process in your brain which we will call a “hash”.
Your hash rate is the amount of times you can come up with an equation that amounts to 10 in a given period of time. This process is long and arduous. It uses cryptography to determine the outcome, hence, the fact that cryptocurrencies have the prefix “crypto” in front of it.
The Bitcoin Hash Rate Here are two charts to give a visual of what I am saying, the Bitcoin hash rate over the past year , and BTC-USD, both, over the past year.
Bitcoin Hash Rate BTC-USD 1-Year
The first graph is the tera hash rate, or the estimated number of Bitcoin transactions per second, measured in trillions.
The miners “guess” at solving a mathematical problem within any Bitcoin transaction and these attempts at figuring out what that solution to the problem is are measured in hashes. This is the computer “thinking” portion of the mining and what pushes the microprocessors of computers.
Whereas the Bitcoin hash rate has continued to increase, meaning more and more transactions have been completed, the price of Bitcoin has fallen and then remained fairly rangebound. I have not run any extensive statistical analysis between the two data series to determine the minutia of every day fluctuations and their respective correlation.
However, by being unscientific and just eyeballing the two charts, my take on this is simple: The correlation between the daily price fluctuations and the Bitcoin hash rate is basically nonexistent.
At first, I thought that perhaps the rise in hash rate was keeping the price of Bitcoin lower. You could easily argue that over a short course of time. However, to put that into perspective, here are two more charts that negate that thinking:
Both of these charts are over a 2-year period of time. If there was a correlation then the suggestion would be that the hash rate, or the amount of work that is being done by the miners, is reflective in the price.
This is the most simplistic economics rule of supply and demand. As price increases more entrants into the marketplace will arrive and thereby driving down price (Robert McLean, my economics professor at Pasadena City College would be proud of me).
And, more entrants entering into the marketplace, is exactly what has been happening. By more entrants, that is a multi-fold statement. First, it entails the number of individuals that form a group.
Second, it encompasses the number of computers in that group.
And, third, what are the capabilities of those computers (processor speeds)?
When someone mines Bitcoin they are rewarded for their efforts with a transaction fee. Also, there is a bonus here and there with the completion of mining a block in the form of being rewarded Bitcoin. So, there is incentive for mining, otherwise, no one would undertake the task. That incentive is what drives people to get involved in mining. There are costs associated with mining in two forms: buying a specific computer dedicated to mining and the electricity to run these computers. Both of these are cost prohibitive and barriers to entry.
And, yet, it is being done at increasingly larger and larger levels.
What these computers do There are a number of types of computers available for mining. Generally, the processes is undertaken by two groups of people: hobbyists and larger companies. Without getting too involved with the science behind the blockchain, let me break down what these computers do: They solve the complex mathematical problems needed to facilitate a transaction with Bitcoin. By doing this they are facilitating transactions. The computers themselves have capabilities.
Originally, the idea behind mining was that anyone would be able to use their computer at home to mine. By allowing for this process, the system remained democratized, meaning, the ability of large numbers of people to enter the field ensured that no one individual was able to monopolize the system. And, since these computers are all easily attainable to the general public, and since all computers are generally the same speed, the system would remain competitive…. and all is well in the world.
Enter the video graphics card. While all personal computers are basically capable of performing at the same relative speed, what people found was that if you increased your video graphics card your ability to process hashes, bitcoin and other cryptocurrency transactions, then you basically just put nitro into your computer and blew away the competition. And, so, the competition upgraded. Now, and suddenly, there was huge demand for video graphics cards and the more powerful the better.
Increased demand led to increased price, to the chagrin of video gamers. More and more, individuals were pushing the limits of their computers capabilities and with that, the need for more powerful, dedicated computers became the norm.
My MacBook Pro, a straight-out-of-the-box, 2015, just like this guy’s who mined for three straight years on his, has the capabilities of completing 16 MHs/s. That is impressive. However, today’s DragonMint 16T is measured in terahashes. A gigahash is 1,000 times more capable than my MacBook Pro, which is measured in megas. The tera, is 1,000 times more capable than a giga.
That means, today’s mining computers are 1,000,000 times faster than my laptop. The cost: about $1,200.00 new (about $900.00 used) on Amazon – about half the price of my laptop.
And then there is the electrical costs. The average cost of electricity in the United States is $0.12 per kilowatt.
At 16 THs/s, you would make money on your mining. However, at a cost of $1k for the machine, it would take you 3.
5 years to recoup your investment, as this calculation shows :
Sounds great, right? Why don’t you check out your competition here on YouTube before you rush out, quit your job and become a full-time Bitcoin miner?
About 6 months ago, when Bitcoin was priced ~$8,000.00, Morgan Stanley estimated that the breakeven point for Bitcoin would gradually lower as the hash rate increased and computers became more efficient. This is theoretical and a theory I share.
This would, in essence, provide a floor for the price of Bitcoin. As the price dropped because of efficiencies in mining, and their associated costs of purchasing hardware to do so dropped, the price would gradually gravitate towards that level.
Because of the dynamics of supply and demand, if you cannot be profitable at mining Bitcoin at a price, you will not mine Bitcoin. This is very likely to be true for smaller hobbyists, but our friends in China who have massive operations are likely to have cash in reserves that will allow them to float their operations in the hope of future price increases. In general, however, if cost drops below profitability, then supply of miners would drop as miners turned off their computers.
However, Bitcoin is becoming more widely used as time goes by, and therefore, the demand for mining would continue to increase. Price would have to follow and increase over time.
Here is my rationale for that: Look back up at the hash rate chart. It should be noted that there are two aspects to this chart.
First, the number of transactions that need to be completed. And second, the ability to achieve those total transactions. The hash rate is as high as it is because there are that many transactions that need to occur as well as the fact that there are capabilities of accomplishing those transactions.
Given that, you can see that the fundamentals of Bitcoin continue to improve; the cryptocurrency is being used more and more and transactions are occurring more and more driving the need for more computations to occur.
If Bitcoin miners started dropping off at prices below their breakeven, then the remaining miners would have the latitude to increase the transaction fee they receive from Bitcoin transactions. This would push up price. That would bring back in more miners maintaining a balance of sorts.
At the same time, there is the word: Difficulty; a term in cryptocurrencies.
Difficulty means how difficult it is to find a hash below a certain target number; below being a fairly good quote as to what goes on :
The target, at the time of writing this article, is that the SHA-256 hash of a block’s header must be a 256-bit alphanumeric string, and must start with 18 zeros . The target changes as the difficulty changes every 2016 blocks.
In essence, miners do not just have computers that look around for transactions to complete. They also have goals to accomplish with those transactions. The goals get more and more difficult as more and more transactions are completed. This makes the task of mining, well, difficult.
That also means the cost of mining a block increases for electricity and computing power. This acts as a driver for the price of Bitcoin, ultimately pushing price higher and higher.
It is akin to sprinting the 100-meter sprint. Take a look at world records for the 100-meter sprint . It is getting more and more difficult to break the record; the human body has limitations. And, this is all the more reason why the news of a breaking of a world record holds our attention during the Olympics when it does occur, driving up the value of the athlete accomplishing the task.
Computers are limited in their capabilities, as well.
And if you continue to push the yardstick further and further away, then there needs to be a continued increase in the abilities of the computers to accomplish those tasks. This would necessitate a higher transaction fee and only the very fastest and best computers out there would be able to price in a higher fee to accomplish these tasks. The costs of electricity increased as the bigger computers work harder and harder, computing faster and faster. Price must increase in line with cost.
Taking the halving rate into the equation There is a halving rate for Bitcoin.
Basically, when a miner completes a block and chains that to other blocks (hence the term blockchain), then the miner is rewarded Bitcoins. Here is a layout of the block rewards at the various stages :
Date reached Block Reward Era BTC/block Year (estimate) Start BTC BTC Added End BTC BTC Increase End BTC % of Limit 2009-01-03 0 1 50.00 2009 0 2625000 2625000 infinite 12.500% 2010-04-22 52500 1 50.00 2010 2625000 2625000 5250000 100.
00% 25.000% 2011-01-28 105000 1 50.00 2011* 5250000 2625000 7875000 50.00% 37.500% 2011-12-14 157500 1 50.
00 2012 7875000 2625000 105 33.33% 50.000% 2012-11-28 210000 2 25.00 2013 105 1312500 11812500 12.
50% 56.
250% 2013-10-09 262500 2 25.
00 2014 11812500 1312500 13125000 11.11% 62.500% 2014-08-11 315000 2 25.00 2015 13125000 1312500 14437500 10.00% 68.750% 2015-07-29 367500 2 25.00 2016 14437500 1312500 15750000 9.
09% 75.000% 2016-07-09 420000 3 12.
50 2016 15750000 656250 16406250 4.17% 78.125% 2017-06-23 472500 3 12.
50 2018 16406250 656250 17062500 4.00% 81.
250% 2018-05-29 525000 3 12.50 2019 17062500 656250 17718750 3.85% 84.375% 577500 3 12.
50 2020 17718750 656250 18375000 3.
70% 87.500% 630000 4 6.25 2021 18375000 328125 18703125 1.79% 89.063% 682500 4 6.
25 2022 18703125 328125 19031250 1.75% 90.625% 735000 4 6.25 2023 19031250 328125 19359375 1.72% 92.
188% 787500 4 6.
25 2024 19359375 328125 19687500 1.69% 93.750% In the beginning, miners were receiving 50 coins for their efforts. But, those rewards are cut in half at various stages until in the end there are no more rewards and there are no more new Bitcoins being mined.
This does not mean the end of the mining process. Miners will still earn a transaction fee. Still, it is noteworthy that as time goes by, the ability for miners to earn more and more Bitcoins declines. At the same time, as time goes by, the usage of Bitcoin ensures that miners are able to find more and more transactions that need to be completed (the increased hash rate usage). And, the fact that each facilitation is getting more and more difficult, and by extension, costly, this ensures that price must go higher, otherwise the miners will stop mining.
A feedback loop As usage of Bitcoin increases at its pace, the cost of mining rises due to the difficulty factor. Therefore, fees can increase to miners which would push up the price of Bitcoin. As the price continually evolves, more individuals will buy into Bitcoin as a continually rising store of value, drawing in more and more buyers and miners.
This acts as a feedback loop, ad infinitum.
I am often asked about my price predictions. I have seen some lofty price levels, and have even predicted an eventual Bitcoin $1 million . I just see the mechanics of Bitcoin, along with the limited supply and the continued increase in value as being an eventuality for the price predictions we have seen. However, I give no time frames.
But, I have become cautious about Bitcoin in one form: Scalability; what makes Bitcoin such a wonderful instrument may also be its downfall. Bitcoin suffers from the fact that it gets more and more difficult to process transactions as time goes by. Also, there is a mechanism that allows for miners to pass up a process because of a low transaction fee.
I don’t want to go into too much on this debate that has forced Bitcoin into a fork where the currency was split. However, I wonder about Bitcoin’s scalability aspects. There has to be limitations simply because there are limitations to what computers can accomplish in a period of time. For now, however, Bitcoin is poised to continue to move higher.
But, there are other cryptocurrencies out there that may very well overtake the original (my rationale for looking into diversifying into other alt-coins. I am currently looking into Ripple).
As Bitcoin usage increases, so will price The fundamentals of Bitcoin remain strong when you consider the amount of energy and computing power necessary to accomplish the goals of Bitcoin mining. So, yes, the hash rate absolutely affects the price of Bitcoin, just not in the most direct and obvious fashion that one would imagine.
Keeping a watchful eye on the hash rate for Bitcoin shows that more and more users are transacting in the cryptocurrency because they want/need to, and because, simply, they can; miners are doing their jobs. But, as the job of mining continues to get harder and harder, and computers continue to get more and more powerful, increasing costs, then the price of Bitcoin must also increase or the system will falter.
I look for sustained moves upward in Bitcoin as more and more users move in to the currency. I am bullish on the cryptocurrency and have been since I adopted the coin as viable. For me, it is a store of value, one that I can continue to increase my size with via my trading, as well as a store of value in the sense that the price will continue higher.
Disclosure: I am/we are long BTC-USD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha).
I have no business relationship with any company whose stock is mentioned in this article..
