The real dynamics between Bitcoin mining costs and prices

1. Linear superposition of investment/speculation behavior

This is a relatively important concept. Mining/coin speculation/coin hoarding fall into two categories:

Mining has fixed costs (mining machines, equipment) and ongoing costs (factory rent, manpower, electricity), and requires that the return must be greater than the investment, which is an investment behavior ;

Speculating on or hoarding cryptocurrencies is a speculative behavior, and the short-term returns can be negative .

Therefore, although these two behaviors may exist in the same entity (for example, a mining tycoon is also speculating/hoarding coins), they should be treated separately. This will not only make the analysis logic clearer, but also will not have any negative impact.

The so-called linear superposition means that you can regard a subject who is mining/speculating/hoarding coins at the same time as two subjects, one is investing (mining) and the other is speculating (speculating/hoarding coins). The advantage of doing this is that the market is composed of countless participants. It is not important who is doing what. What is important is what a certain type of participant is doing ( that is, we need to know the behavior of investors/miners as a whole and the behavior of speculators as a whole, because individual behavior is meaningless ). When we classify market participants into investors (miners) and speculators (coin speculators/hoarders), it will greatly improve the efficiency of analyzing problems.

For example , a miner recently publicly announced that he had hedged part of his future production when the price of the currency was $8,500. Later, the price of the currency rose to a maximum of $14,000, and was ridiculed by many people. In fact, the behavior of this miner is an extremely rational investment behavior. We can divide his behavior linearly into two potential parts:

1.8500 dollars to hedge future production;

At $2.8500, speculatively buy the same amount of Bitcoin as in the first item.

Then there are two linear components of his behavior, one is investment and the other is speculation. There is no problem with the investment part, because all industries (such as crude oil extraction) will use futures to lock in future output profits when profits are high. Because prices fluctuate very quickly and future prices are unpredictable, when prices are already able to lock in profits with high-profit futures, it is necessary to lock in profits from an investment perspective.

Therefore, the overall behavior of the mine owner can be divided into two types: A, hedging at 8500 B, not hedging at 8500

A is equivalent to performing only the first step but not the second step in the above operation;

B is equivalent to taking the first step in the above operation and also performing the second step at the same time.

This concept of equivalence is extremely important, and I recommend that you all understand it well.

Therefore, compared with operation A, operation B is just a speculative operation of buying Bitcoin at 8,500. Is this speculative operation correct? This depends on the miner's expectations of the future price of the currency, the cycle of his speculative operation, and whether there is a profit-taking and stop-loss strategy. In short, this speculative operation is right or not, and there is no problem, because the future price trend is essentially unpredictable.

In fact, the rational behavior of all miners is to sell the mined coins immediately, because this is the only way to lock in profits. Otherwise, once the coin price drops, the profits will decrease. If a miner does not sell the coins he mines immediately, we can linearly combine his behavior into 1. Sell the mined coins immediately ; and 2. Use the money from selling the coins to speculate and buy the same amount of coins immediately. The miners mentioned in this article refer to the rational behavior part of each miner (that is, the part that only performs step 1). We do not consider the speculative behavior of miners, because for speculative behavior, we can analyze all speculators in the market as a whole.

(Regarding this mine owner, there is another behavior that is ridiculed by many groups: buying a second-hand sports car. As a high-end consumer product, the price difference between new and second-hand sports cars is huge. The price drops by 15%-30% as soon as it lands, while the car itself has hardly changed. Buying a car that can immediately save 15%-30% of expenses is not only rational, but also smart . Laughing at such behavior is itself a very bad personal attack. I will not say more about this aspect. In addition, I only comment on the two matters of 8,500 hedging and buying a second-hand sports car. I don’t care about any other opinions/behaviors of this mine owner, and I don’t understand them. Please don’t think that I am "taking sides" or classifying me with any group. This will only expose your narrow-mindedness and ignorance. )

2. The cost of Bitcoin mining

The cost of Bitcoin mining can be divided into two parts:

One part is fixed investment (sunk cost), including the purchase of mining machines, factory buildings, and even the purchase of future fixed electricity according to the contract (that is, if this part of electricity is not used, payment must still be made according to the contract);

The other part is ongoing expenses (pay by usage time/volume), including factory rent, computing power rent, labor costs, and electricity costs.

When actual miners mine, they often have a mixture of two types of costs. Some miners have all their costs as ongoing expenses because they rent computing power, while some miners have most of their costs as fixed investments because the electricity is purchased according to the contract. It doesn’t matter who invests the money and how. What’s important is that everyone should know that the cost of miners consists of two parts. The fixed investment part is a sunk cost and has little effect on the actual on/off behavior. What really affects on/off (the computing power of the entire network) is the ongoing expenses.

Because the continuous expenses of each individual miner are different, some miners have free electricity and the continuous expenses are very small, while some miners have all their costs rented and the continuous expenses are very large, so when the price of the currency fluctuates, miners with different costs are affected differently. But no matter what, all rational miners will choose to shut down when the price of the currency is lower than the continuous cost. Why? Because mining is an investment, and investment has returns. The return must be positive to make the investment behavior continue. Why continue to invest if the return is negative? As long as the price of the currency is lower than the continuous mining cost, every extra minute of mining is a steady loss, so it must be shut down.

3. The dynamic relationship between mining costs and coin prices

Because the power on and off behavior is directly affected by the price of the currency, and shutting down is a very simple thing, when the price of the currency drops sharply, causing the return on investment of some miners with high continuous costs to be negative, these miners will shut down immediately. The more the price of the currency drops, the more miners will be affected, and the more they will shut down. This can be clearly seen from the changes in computing power during the big drop at the end of 2018:

As shown in the above figure, the price of the coin began to collapse in mid-November 2018, and the computing power immediately decreased (shutdown), and with the increase in the decline of the coin price, the number of shutdowns continued to increase, the computing power continued to decrease, and the difficulty decreased (this is slightly delayed because of the algorithm); and after the bottom rebounded at $3,100, the computing power that had been shut down was immediately restarted, and as the price continued to rebound, the restarted computing power increased. This is a very clear causal process in which price determines computing power (therefore changes difficulty/determines cost).

However, please note that this rapid adjustment process will only occur when the price of the currency plummets. In other words, a sharp drop in the price of the currency can quickly lead to a reduction in the computing power of the entire network/a reduction in mining costs, but the reverse is not necessarily true! Why?

Because it is easy to reduce the computing power of the entire network, just shut down the machine; and the increase of the computing power of the entire network depends on whether it is caused by the restart of the machine that has been shut down (such as after the rebound of $3100 above). If so, the adjustment will be very fast. If not, it means that the new computing power must be achieved by buying mining machines/building factories/signing various contracts. This is a long process. Therefore, in the process of continuous rise in the price of the currency, the increase in computing power is seriously lagging behind!!!

This can also be seen from the figure:

As shown in the above figure, during the sharp rise in the price of the currency at the end of 2017, the computing power continued to increase, and it continued to increase when the price of the currency peaked and plummeted (because the continuous mining cost was much lower than the price of the currency). It was not until 9 months later that the computing power and difficulty peaked simultaneously! This is because the cycle of deploying computing power is too long. For the same reason, many miners lost all their money because they made wrong predictions about the price trend when making investment decisions.

Summarize:

1. The price of the currency determines the computing power/mining cost, and the computing power/mining cost can be changed in real time when the price of the currency drops sharply;

2. When the price of the currency continues to rise, there is a long lag in the change of computing power/cost.

4. Does mining cost have any impact on the price of the currency?

If you have read the above section carefully, I think you can have your own logical inference. The mining cost has no logical impact on the coin price. On the contrary, the mining cost is determined by the coin price.

Some people say that this is not right. Why did the price of the currency stop falling when it just fell below the mining cost at the end of 2018?

This question is actually wrong. As mentioned above, the cost of continuous mining for each miner is different. Some miners have a cost of $5,000, some have a cost of $3,000, and some have a cost of $2,000 (but due to various conditions, miners with a cost of $2,000 cannot expand their production capacity indefinitely, otherwise there would be no miners with a cost of $5,000). Therefore, it is not the case that the price of the currency will stop falling once it falls below the "cost", because there is no fixed single cost line.

Second, $3,100 is 15.5% of the peak price of $20,000; the bottom of the coin price in 2015 was $150, which was 13% of the peak price of $1,160 in 2013. These two declines are actually very similar, and it can be completely considered that the coin price stopped falling due to the bottom-fishing behavior of long-term speculators.

The so-called mining cost affects the price of coins, which is actually completely reflected in speculation. In other words, when you think that the mining cost affects the price of coins, you expect other speculators (mainly the miners' own speculative weight) to buy long near the "cost" price for speculation , but is this really the case? This is not certain. Moreover, the market is dynamic, and speculative behavior will be affected by rewards and penalties. In other words, if the speculator makes money by buying near the cost, he may continue this mode; but when he continues this mode, the next time is likely to be not profitable, but loss. Therefore, it is basically impossible to have a stable and continuous speculation method of the same mode (such as buying near the cost price).

5. Bitcoin’s unique economic model is different from gold

Regardless of how the price and cost of Bitcoin change, the output of Bitcoin remains fixed, which is the basis fixed in the Bitcoin code. In contrast, the output of gold is affected by the price/cost of gold. When the price of gold rises or the cost of gold mining decreases, producers will increase the amount of gold mining, increase production capacity, and increase supply. The increase in supply itself will suppress the rise in gold prices. On the contrary, when the price of gold decreases or the cost of gold mining increases, the profit of producers will decrease, which will lead to a contraction in production capacity and a decrease in supply, thereby supporting the price of gold and suppressing its decline. Therefore, the mining model/mechanism of gold will itself suppress the volatility of gold and stabilize the price of gold. However, Bitcoin cannot stabilize the price of the currency because of its fixed production capacity, which is one of the reasons why the price of Bitcoin fluctuates greatly.

Author: Amin_ff89