The stakes of the bitcoin mining offer

We are often used to “enhance” an asset according to the dividends it pays, interest, etc. But cryptocurrencies, and more specifically bitcoin (BTC), are a special case. The question of the supply of bitcoin comes up regularly (see our article On the question of the supply of Bitcoin (BTC) – But what can the hash rate, the number of transactions, the number of miners or mining difficulty, and the cost of production determine the price of bitcoin?

The key figures of bitcoin supply

In our previous publication, we recalled the major role of supply on the price of bitcoin.

  • The mining supply (“new bitcoins”) represents only 2.6% of the total supply in 2022.
  • The speed of circulation of bitcoins in circulation can explain market trends. In 2022, the velocity of bitcoin is close to 0.66. What is lower than the dollar or the euro. The long-term bitcoin velocity is stable or slightly bearish.
  • Second, we are seeing a more moderate increase in the number of active addresses since 2018.
  • Finally, the cost of production tends to increase in the long term, under the effect of the increase in the hash rate, and more partially, in the number of transactions.

Under these conditions, we will focus on the parameters that influence the production cost of bitcoin. Therefore, we will see if miners can influence the price of bitcoin, and if not, if market conditions influence miners.

The determining parameters of mining

It therefore appears that the number of Bitcoin users and the number of transactions on the network have a significant impact on the cost of production. First of all, the more users and transactions there are, the greater the demand for confirmed transactions from miners. This results in higher transaction fees, as users are willing to pay higher fees to have their transactions confirmed faster.

Also, the hash rate is a measure of the total computing power of the Bitcoin network. It is directly related to the number of miners participating in validating transactions. A higher hash rate means there are more miners competing to solve the mathematical problems needed to add a new block to the blockchain. This increases the difficulty of calculations for miners and leads to increased electricity and hardware costs to maintain a high hash rate. | Charts – Total Hash Rate (TH/s)

The cost of production for miners is therefore directly influenced by the number of users, the number of transactions and the hash rate. The more users and transactions there are, the greater the demand for processing services, which increases transaction fees. A higher hash rate increases competition between miners, which increases operating costs.

An explanatory element to the price of bitcoin?

We see good long-term symmetry between the hash rate and bitcoin price. However, the hash rate also increases (but less) during phases of bitcoin price decline. It follows that the mining difficulty shows greater stability than the evolution of the bitcoin price. Other parameters must therefore be considered. | Charts – Total Number of Transactions

In the long term, we see the decrease in transaction costs compared to the amount of the transaction. If the total number of recorded transactions maintains a dynamic close to that of the hash rate, we can focus on daily transactions. Indeed, the comparison between the price of bitcoin and the number of transactions shows a more interesting evolution in the medium term. The stagnation in the number of transactions would generally explain the bearish phases on bitcoin. But despite everything, we notice significant discrepancies between the two variables. | Charts – Confirmed Transactions Per Day

Why is the hash rate changing?

Several variables explain the evolution of the hash rate. Thus, one of the most important is the profitability of the mining activity. When the price of bitcoin increases, the profitability of mining also increases, which attracts more miners to the network to take advantage of the potential profits. Similarly, when the price of Bitcoin decreases, profitability decreases and some miners may leave the network causing the hash rate to drop. To date, the United States accounts for more than 37% of the global hash. In 2019, China weighed no less than 75% of the hash.

Besides, another important factor is the availability of efficient mining hardware. Indeed, miners are always looking to use the most efficient and energy-efficient hardware to maximize their profits. When new mining equipment comes to market, it can lead to an increase in hash rate as miners upgrade their hardware to stay competitive.

Additionally, government policies and cryptocurrency regulations can also influence the hash rate. Cryptocurrency-friendly regulations can encourage mining activity in a given country, while restrictive regulations can discourage it. This was the case of China.

Mining profitability as a major indicator

Finally, the number of miners in the market can influence the Bitcoin network in several ways. One of the main effects is on network security. The more miners there are, the more secure the network is because it is more difficult for a single malicious actor to control the majority of the hash rate and compromise the blockchain.

However, a high number of miners can also lead to an increase in mining difficulty, which makes solving math problems more difficult and increases mining costs. If the price of bitcoin drops or if the transaction fees are not enough to offset the costs, some miners may leave the network. This can ultimately cause the hash rate to drop (at constant transactions). Here we see that demand plays a major role in mining activity.

As a result, high hash rate and secure network can attract more users and investors, which can potentially influence the price of Bitcoin. In fact, a safer and more efficient network can build investor confidence, leading to an increase in demand for bitcoin and, consequently, higher prices.

At the end of 2022, the profitability of miners was in question. The hash rate was high, showing the resilience of the miners, while the network difficulty was also high. In question, the maintenance of a high number of transactions and the rise in the cost of energy. This situation correlated with the end of the bear market.

The cost of production as a consequence of the price of bitcoin?

Although the cost of production is not the only variable that influences the price of bitcoin, it can act as a long-term price floor. This is because the cost of production is the actual cost for miners to mine bitcoin, which includes electricity, hardware, and miscellaneous costs.

The fall in the price of bitcoin below the cost of production can lead to losses for miners. This can lead to a decrease in hash rate and, therefore, an increase in mining difficulty, making mining less attractive for some miners. In the long term, if the price of Bitcoin stays below the cost of production for an extended period of time, it could cause some miners to exit the market permanently. This then reduces competition and allows the remaining miners to become more profitable.

Bitcoin mining difficulty. Source : | Charts – Network Difficulty

In conclusion, although the cost of production does not directly determine the price of Bitcoin, it plays a vital role in determining the long-term price floor. The number of users, hash rate, and number of miners in the market are all interrelated factors that can influence the dynamics of the Bitcoin network and ultimately the price of BTC.

In conclusion

In conclusion, we saw that the cost of producing bitcoin was dependent on the difficulty of mining, the hash rate, and the number of transactions. An increase in the number of users leads to an increase in the hash rate with a time per block close to 10 minutes. The energy mobilized by the network is then greater, and the cost of production increases. Unlike the price of gold, the cost of production is not a determinant of the price of bitcoin.

Under these conditions, the cost of production appears to derive from market conditions, but it nevertheless remains an important long-term indicator. The passage of the bitcoin price below the cost of production reflects the fact that the mining difficulty is too great, or the number of transactions too high, compared to the market price. This incentivizes miners to exit the market, or else it incentivizes bitcoin price to rebound if users want to see their transaction cleared at a reasonable cost.

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