Why does the reduction in BTC mining difficulty not mean the bottom is coming soon?

Editor's note: This article comes from Zhongben Xiaocong (ID: xcongapp).

According to OKLink.com data, at 10:51:46 on March 26, the Bitcoin network experienced a significant difficulty adjustment, with the difficulty adjusted to 13.91T, a decrease of 15.95%. This is the fifth time in Bitcoin history that the mining difficulty has been reduced by more than 10%. In the past, it has brought the bottom, but there are exceptions. In the first week of December 2018, the difficulty of Bitcoin mining dropped by 15.13%, but the price of Bitcoin did not rebound until four months later.

A sharp drop in mining difficulty usually marks a bottom, but there are exceptions

A sharp drop in Bitcoin mining difficulty usually marks the bottom of a bear market cycle because it indicates that some investors and miners are beginning to capitulate and retreat. When the hash rate of the Bitcoin network drops sharply, the protocol will also adjust accordingly to reduce the computing power required to mine BTC. When there are fewer miners mining and transactions on the network, the hash rate will also drop.

Miners, especially small miners or mining centers, usually suspend their operations when the price of Bitcoin drops significantly below their mining break-even costs. Large mining centers have the ability to continue mining at a loss because large mining farms tend to reserve cash. At the same time, mining organizations of a certain size usually have long-term contracts with power companies, which makes it more difficult for large mining farms to shut down equipment and end operations in a short period of time.

Normally, when investors and small miners flee the market in a panic, the price of Bitcoin is about to rebound. However, this was not the case with the 2018 mining difficulty drop.

In late 2018, there were several mining difficulty adjustments before Bitcoin prices rebounded, and after the first major mining difficulty drop of 15.13%, it took Bitcoin four months to have a relatively effective rebound.

The following figure shows the comparison between previous mining difficulty reductions and Bitcoin prices

How will Bitcoin perform in the coming months?

Miners faced many challenges in the first half of 2020 due to the global spread of COVID-19 and increased uncertainty in the cryptocurrency market. The coronavirus outbreak and its negative impact on the global economy came at the same time as the highly anticipated Bitcoin block reward halving. In the past, Bitcoin's bearish cycles were entirely dependent on trends in the cryptocurrency market. However, judging by the recent drop in Bitcoin prices, the increasing correlation between Bitcoin prices and the U.S. stock market is clearly affected by the decline in investor confidence in riskier assets in the broader financial markets.

A more than 10% drop in mining difficulty suggests that Bitcoin prices are getting closer to the bottom (but not immediately). According to historical data, the bottoming-out phase may last up to five months in a low price range.

Therefore, even if small miners stop operations and leave the market, the worst-case scenario may still happen. As one Bitcoin whale once said, it is difficult for Bitcoin to rebound immediately from a crash without experiencing a few months of low volatility.