What is the relationship between changes in Bitcoin mining difficulty and its price?

Most quantitative analysts look back at past Bitcoin bubbles to predict the approximate time of the latest bubble burst and its consequences. A quantitative analyst named Plan B on Twitter is a bit different. Rather than studying MACD, RSI or other price-related statistics, he is more interested in the relationship between changes in BTC mining difficulty and BTC prices.

This idea is also reflected in his daily tweets. He believes that daily transactions actually have little impact on the price of BTC. Miners are the biggest sellers and the group that can really affect the price of Bitcoin. "When comparing the recent large-scale "surrender" of miners with the previous bear market bottom, the downward trend of this key indicator may be the signal everyone is looking for, indicating that the current bear market has bottomed out."

Regarding the relationship between "mining difficulty and Bitcoin price", the current focus of research in this field is represented by Bitcoin quantitative analyst Plan B and On-chain metrics analyst Willy Woo. Both are very good at modeling analysis, and Willy Woo has more vividly demonstrated this relationship in the more systematic visualization indicator "Mining Difficulty Band" recently released. Although it cannot be used as a predictive indicator, many indicators may only be a posteriori, but as another perspective of the visualization of historical data of Bitcoin prices, there are always some interesting things to find.

Willy Woo’s Bitcoin mining difficulty band

First, let’s popularize the concept of “mining difficulty”. Mining difficulty is a dynamic parameter set to ensure that the speed of generating new Bitcoin blocks is one every 10 minutes on average. When the network finds that the block generation rate is faster than 10 minutes, the difficulty will be increased, and when it is slower than 10 minutes, the difficulty will be reduced. In short, it will reduce the difficulty for you when you can’t solve a math problem.

The Bitcoin Difficulty Ribbon proposed by Willy Woo is composed of the simple moving average of the mining difficulty at different times. Take D9 in the figure below as an example, which is a curve formed by taking the average value of the mining difficulty of the previous nine days at each time point. The difficulty ribbon is a collection of D9, D14...D200 curves. **Through this curve, it is easy to see the rate of change of mining difficulty and the impact of mining on Bitcoin prices. Contraction means that the average values ​​at different times are approaching, that is, the average value of the previous 9 days and 200 is similar, indicating that the rate of change of mining difficulty is decreasing.

When the difficulty band shrinks or intersects and flips, it is the best time to buy Bitcoin.

This indicator illustrates the impact of mining on the price of Bitcoin. The basic logic is that as new Bitcoins are mined, miners will sell the mined coins to pay for mining costs. This creates downward pressure on prices.

In a bear market, small miners with weaker strength will sell most of their coins to maintain their operations. But when they sell all their BTC and still cannot cover their costs, they will surrender (turn off the mining machine and stop mining), and then the hash power and network mining difficulty will be reduced (difficulty band shrinks). Only the big miners who sold less will be left, thus creating conditions for the start of a bull market.

Typically we see this at the end of a bear market cycle, after most small miners “surrender” and shut down, the selling pressure from these miners decreases, allowing the Bitcoin price to stabilize and then climb.

Bitcoin halving performance

In addition to this situation during a bear market, miners will also withdraw in large numbers when the Bitcoin block reward is halved, that is, the same mining cost can only mine half of the previous Bitcoin, but the market price of Bitcoin cannot keep up with the increase in speed. We can see that the mining difficulty band begins to shrink every time the vertical line in the above figure is halved.

What’s more interesting is that if you look at the structure of the 2019 and 2012 bull markets, you’ll find that the changes in mining difficulty are very similar in these two years. A large number of mines were shut down (the mining difficulty lines at different times intersected), and the resulting vacuum of selling pressure shortened the accumulation range before the price breakout. Therefore, the 2019 bull market is more similar to 2012 in structure than 2016. And it can be seen that the price of Bitcoin reversed significantly at its lowest point of $3,200 in December 2018.

Mining difficulty changes between 2012 and 2019

Plan B also came to a similar conclusion in an earlier chart. When the mining difficulty was adjusted downward to the lowest point (Difficulty Bottom), after a large number of miners withdrew, this was the turning point when the Bitcoin price turned from a bear market to a bull market.

Let’s use this model to look at recent data. As Bitcoin’s mining difficulty has recently been raised to a new record of 9.99T, and more than 100,000 top ASIC miners have been activated in the past two weeks, we can see that the difficulty band is showing a clear divergent trend.

But as mentioned earlier, this mining difficulty band is more of a visualization of historical data. Whether it has predictive significance or can be used as a signal to enter the Bitcoin market requires more data verification, but from the perspective of mining difficulty for miners, it is worth observing more. How will the price of Bitcoin go in 2020? We will wait and see.

References:

https://twitter.com/woonomic/status/1156968561404866560http://charts.woobull.com/bitcoin-difficulty-ribbon/https://cointelegraph.com/news/3-reasons-analysts-are-bullish-on-bitcoin-despite-33-price-correction

Author: Willy Woo&Plan B (both Twitter names)

Compiled by: Jessie@OrangeBook