Bitcoin Miner Activity and Bull Cycles

Just now, Forbes reported that the recent Bitcoin mining income potential has fallen 68% from its 2021 peak and 58% from the 2021 average.

Throughout 2021, despite the external shock event in May, the difficulty of the entire Bitcoin network was only reduced 4 times and increased 18 times.

The increase in difficulty reduces the mining output per unit computing power, while the decline in Bitcoin prices reduces the fiat currency income of the same mining output. The combination of these two factors has led to a decline in the profitability of Bitcoin mining.

As a result, the stocks of many listed Bitcoin mining companies fell sharply, by more than 60%.

However, readers who are familiar with Satoshi Nakamoto will easily find the logical errors in the Forbes report. Let us review what Satoshi Nakamoto pointed out in his forum post on February 21, 2010:

“The fair market price of something that is expected to increase in value already reflects the present value of the expected future growth. In your mind, you make a probability estimate of the chances that it will continue to grow.”

“The price of any commodity tends toward the cost of production. If the price is below the cost, then production slows down. If the price is above the cost, then you can make a profit by producing and selling more. At the same time, increased capacity (computing power) will increase difficulty, pushing the cost of production toward the price.”

“In later years, when new coins generated are only a small fraction of the total existing supply, market price will determine the cost of production, rather than the other way around.”

“Currently, capacity (computing power) is increasing rapidly, which suggests that people estimate the present value to be higher than the current production cost.”

Let’s review the changes in computing power during the first two Bitcoin bull cycles in 2013-2014 and 2017-2018.

The bull market started in early 2013 (13 dollars) and peaked at 1,100 dollars in November 2013 (an increase of 84 times). Then it fell back and dropped to 400 dollars in December (a drop of -64%). It rebounded to nearly 1,000 dollars in early 2014, and then continued to fall for a year until it fell to 200 dollars at the end of the year (a drop of -82%).

During the same period, Bitcoin’s hashrate rose from 25 Thash in early 2013 to 15P in early 2014. After that, although the price dropped, the hashrate continued to increase, reaching 330P in early 2015. Subsequently, during the bear market bottom in the first half of 2015, the hashrate did not increase much.

However, starting from the second half of 2015, as the market bottomed out and rebounded, computing power began to grow rapidly again, from 400P in July 2015 to over 700P in early 2016, reaching 1.5E in mid-2016, and 2.4E in early 2017.

The bull market started in early 2017 (800-900 dollars), peaked at nearly 20,000 dollars in December 2017 (a 19-fold increase), and then fell back to 11,000 dollars within the month (a drop of -45%). After rebounding to 17,000 dollars in January 2018, it continued to fall for a year and fell to 3,200 dollars at the end of the year (a drop of -84%).

During the same period, Bitcoin computing power rose from 2.4E at the beginning of 2017 to 15E at the end of 2017, and then continued to rise during the decline in 2018 to reach a peak of 53E in October 2018.

With the arrival of the deep bear market at the end of 2018, this cycle saw a "mining disaster" that was not seen in the previous cycle. The sharp drop in Bitcoin prices caused some miners to suffer heavy losses and were unable to support themselves. They had to shut down and stop production. This led to a two-month correction in Bitcoin computing power. From the top of 50E in October 2018, it fell to a minimum of around 35E at the end of 2018. The correction was as high as -30%.

That is to say, up to 1/3 of the miners went bankrupt.

But then, as the market bottomed out and rebounded, computing power began to grow again. By the beginning of 2019, it had recovered to 45E, broke through the 100E mark in early 2020, and broke through 150E in early 2021.

Even the black swan of the epidemic in early 2020 did not have a significant impact on miners due to the rapid recovery from the "312" crash.

Unexpectedly, this round of bull market cycle in 2021 has happened in a different way than before.

As the bull market is booming, a debate about environmental protection in mining is surging. In April and May 2021, Tesla CEO Elon Musk took the lead in launching an attack on Twitter, accusing Bitcoin mining of high carbon emissions and being environmentally unfriendly, and announcing the withdrawal of Tesla's official website's support for buying cars with Bitcoin, which had just been added at the beginning of the year. The battle against the environmental protection issues of Bitcoin mining has begun. Subsequently, the country with the largest Bitcoin mining computing power at the time began to expel Bitcoin miners in an all-round way.

The bull market was interrupted by external forces. Bitcoin computing power suffered the largest retracement in history, and the Bitcoin network suffered the largest external shock since its birth in 2009. The total network computing power, which was close to 190E in early May 2021, fell to 80-90E within 2 months, a drop of -55%.

In other words, more than half of the miners were killed.

During the same period, the secondary market for Bitcoin also experienced the "519" crash, with prices plunging from a high of nearly $65,000 in April to a low of $28,000 in June, a drop of -57%.

However, the Bitcoin network has shown amazing resilience. After suffering heavy losses in May and June, the computing power recovered rapidly and reached a new high in early 2022, breaking through the 200E mark.

Although the price of Bitcoin has been falling since it reached the second local peak of $69,000 in November 2021, and has now fallen below $30,000, the computing power of the entire network has been advancing through difficulties during the same period, and by May 2022, it has reached 230-250E.

Bitcoin mining has a characteristic that is different from any other commodity production, that is, no matter whether the production capacity, that is, the computing power, is high or low, its total output per unit time remains unchanged.

Changes in computing power will only result in changes in the total cost of mining, but will not affect the total output.

Since the miners’ means of production, such as machines, factories, electricity, and workers’ wages, are denominated in legal currency, the miners’ total profit = total output x Bitcoin price – total cost.

In a bull market cycle, the irrational rise in market prices will far outpace the speed at which miners expand production, thereby significantly increasing the excess profits of miners. The substantial increase in excess profits will also attract miners to expand production more aggressively.

In the past two cycles, miners would not be forced to stop expanding production until prices fell by more than 80%, which shows how huge the profits of miners are in a bull market.

This round of bull market has verified something that has never been verified in history, that is, what would happen if miners were forced to shrink instead of being forced to shrink by the transmission of falling market prices, but by direct exogenous shocks.

If the secondary market is unaware of or unresponsive to the contraction of miners, then if half of the miners are eliminated, the remaining half will enjoy all the profits (because the total output remains unchanged), thereby doubling their profits.

But we will see that the market is smart.

We have witnessed with our own eyes the “reverse” of what Satoshi Nakamoto talked about happening in real time.

The secondary market noticed the miners' contraction and "running away", so the market chose to plummet by half, thus cutting the total profit of miners in half. Therefore, the profits of the remaining half of the miners remain unchanged - compared to before the computing power contraction; compared to before the bull market started, there is still a significant increase, because the bull market price has increased several times.

Essentially, it is investors in the secondary market who invest in the mining production of Bitcoin miners.

Before concluding this article, let us raise a question for reflection: If the forced interruption from external forces in this round of bull market prevents miners from excessively obtaining excess profits, thereby reducing miners' excessive overdraft of investment, then do we still need a bear market of the same intensity as the previous one to weaken the miners' profits, thereby compensating and hedging the excess returns in the bull market stage?