Bitcoin has undergone the largest difficulty adjustment in history, and the S2F indicator once exceeded the limit

The market price of Bitcoin rose slightly last week, but overall it still fluctuated within the price range of US$32,775-36,460.

At the same time, the Bitcoin protocol has experienced the largest difficulty adjustment in history, with a difficulty reduction of 27.94%, and the protocol has also shown extraordinary resistance. Over the past week, the Bitcoin network has continued to produce blocks and transactions have been settled normally.

This week, we’ll focus on some on-chain mining metrics that help us gauge the significance of the shift that’s taking place.

Measuring mining transformation

Last week, as the impact of China’s Bitcoin mining ban was in full swing, we saw a lot of volatility in mining metrics. When a large percentage of the hashrate is offline, blocks are created at a slower rate until the difficulty adjusts downward. This readjusts the complexity of the mining puzzle to the average hashrate observed within the 2016 difficulty window (approximately 14 days).

Last week, the 24-hour average block time spiked to a short-term high of 1,958 seconds (32.6 minutes), which is more than 226% longer than the target block time of 600 seconds. This event only occurred briefly on June 28, after which the average block time returned to 800-900 seconds.

Looking at the long timeline, we can see that this is Bitcoin’s slowest average block time since the cypherpunk era in 2009, with the previous longest average block time being 1,774.5 seconds (occurring at the bottom of the last pullback before the 2017 bull run top).

To estimate the magnitude of the hashrate shift that is taking place, we can consider the estimated hashrate change from the stable peak observed from April to early May 2021. Note that hashrate is extrapolated based on block times and difficulty, and we use a 24-hour moving average here to smooth out some of the natural variation.

The network’s hashrate peaked at around 180 EH/s before dropping to a local low of 65 EH/s (coinciding with the 1,958 second average block time on June 28).

Currently, the Bitcoin network hashrate has recovered and stabilized in the range of 88-110 EH/s, reflecting an overall decrease in network hashrate of 38% - 49%, which provides an indicator of the proportion of network hashrate that is currently offline and affected by the Chinese ban.

Now that the protocol difficulty has adjusted, we can see that Bitcoin mining difficulty has reversed to its deepest point since the bear market capitulation period of 2018. A difficulty band reversal is an extremely rare event where the faster difficulty moving averages (9D, 14D, etc.) fall below the longer-term moving averages (128D, 200D).

Difficulty band reversals typically represent miner capitulation events, a phenomenon that is usually observed at the end of a bear market or when miner revenues are squeezed (after a halving event), as miners shut down unprofitable machines, which has historically been associated with strong bull market reversals.

Increased revenue for operating miners

While difficulty band reversals are historically bullish events, in this case, the huge logistical costs incurred by Chinese miners who are required to consume accumulated BTC inventories may create selling pressure. However, it is important to note that there is a certain balance in the revenue growth for the remaining ~50% of operating miners.

In April, when Bitcoin was trading in the $50,000-$60,000 range, the Bitcoin network hashrate peaked, with the entire mining industry generating $50 million to $60 million in revenue per day. Although Bitcoin prices have since fallen by about 50%, miners who are still operating estimate that about 38% to 49% of competing hashrate has left the network in the short term.

Today, Bitcoin miners earn a combined $25 million to $30 million a day, but that revenue is shared among smaller mining pools.

This means that after the latest difficulty adjustment, operating miners will incur the same operating expenses, but profitability will increase by nearly 2x, approaching profitability levels seen in April.

The Miner Outflow Multiple metric tracks the ratio of miner spending relative to its yearly average. From this we can see that miners have recently slowed down their spending significantly, even during the Great Migration. Historically, we have seen the following cyclical patterns in miner spending behavior:

1. HODLing in a bear market (green), miners are in a steady selling pattern (flat outflow multiple).

2. During a bull market (red), shipments increase, and miners will take advantage of the bull market and sell the mined coins at an accelerated rate (the outflow multiple increases).

3. Miner shipments declined after the market peaked (blue), likely due to increased conviction or a desire to limit excessive selling pressure (declining outflow multiples).

Impressively, even during the Great Migration, we did not see a significant increase in miner spending behavior. The speed at which hashrate recovers will provide further insight, as:

1. The rapid recovery of hashrate suggests that Chinese miners have successfully relocated, liquidated hardware, or otherwise recovered costs, reducing the risk of a BTC inventory sell-off;

2. A slow hash rate recovery would suggest the opposite and increase the likelihood of debt accumulation, creating a higher probability for miners to sell BTC.

In fact, the macro spending behavior of miners has changed dramatically since the beginning of 2020. In almost all of Bitcoin's transaction history, miners have been spending more Bitcoin than they have accumulated, so the unspent Bitcoin supply is structurally declining.

This means that miners have historically spent more coins than they accumulated.

The chart below shows the relationship between unspent miner supply (i.e. coinbase transactions that have never moved) and its 365-day moving average. The structural downward trend in miner selling that began in mid-2020 appears to have not only flattened, but reversed. Unspent BTC in coinbase output is now above its yearly average.

This suggests that miners have begun to accumulate Bitcoin in a way that the market has not seen so far. Given the timing of this event, there may be many factors to consider behind this:

1. In 2020, voices supporting Bitcoin became evident around the world, increasing the conviction of miners.

2. Miners have access to highly superior financing options such as coin-collateralized debt, liquidity options, and futures markets to hedge risk.

3. As global chip manufacturing capacity is limited, ASIC mining machine production decreases. As the price of coins rises, existing mining power becomes increasingly profitable because there is little new competition in the market.

As prices rebound in the bull market, BTC mining is likely to be particularly profitable during this halving period.

S2F indicator: Bitcoin is more scarce than gold

Many analysts this week pointed out that the Puell Multiple, a measure of miner profitability, has also fallen into “underestimation territory.” The Puell Multiple is calculated by taking the ratio of daily total dollar miner revenue to its 365-day moving average.

1. A high Puell Multiple indicates strong profitability, so miners have a high incentive to sell, increasing the liquid token supply on the market.

2. A low Puell Multiple indicates poor profitability, miner capitulation, and an increase in the hashrate share of stronger miners, ultimately leading to tight supply.

Like the Difficulty Band Reversal, this is also a rare event, having only occurred 5 times in history (usually during market capitulation events).

Note: The Puell Multiple has a revised Glassnode Academy entry that explains the metric in detail, as well as the mining market mechanics it describes.

However, like many indicators, who doesn’t want more details?

The main reason for the rapid decline (and then rapid reversal) of the Puell Multiple is actually a technical one:

1. On June 28, Bitcoin block times slowed by 226%.

2. This means that only 58 of the 144 target blocks (40%) were mined that day.

3. As a result, only 40% of the expected BTC was issued that day, causing a 60% drop in total miner revenue.

4. The difficulty adjustment has corrected this.

In fact, the issuance rate of Bitcoin once fell to a historical low of 0.71%, causing the S2F ratio to reach 140. If only this day is counted, Bitcoin is 2.37 times scarcer than gold (the S2F value of gold is 59).