Mining difficulty drops sharply, is Bitcoin entering a "death spiral" phase?

Recently, the continued decline in the cryptocurrency market has finally begun to be reflected in the Bitcoin mining industry. The mining industry, which seems to be unaffected by the price drop, is experiencing an "escape".

Bitcoin hash rate sees rare drop

At a basic level, miners compete to solve complex mathematical problems to produce Bitcoin blocks. When the hash rate increases, blocks can be mined faster; when the hash rate decreases, the opposite happens. In order to maintain a block production time of about 10 minutes, Bitcoin automatically adjusts the difficulty of mining every two weeks to automatically adjust the entry or exit of miners.

For many years, mining difficulty has almost always increased, and the reason is simple - the overall upward trend of Bitcoin prices, coupled with the rapid development of mining technology, has led to a continuous increase in hash rate, even during periods of negative market trajectories. However, the nearly one-year bear market has caused Bitcoin prices to fall by more than $16,000 from their all-time highs, and the continued negative market has disrupted this balance.

As shown in the figure, the Bitcoin hash rate has been declining since mid-October. Because the decline in Bitcoin prices has accelerated the elimination of old mining machines, many mining farms have entered a shutdown state to avoid operating at a loss. According to surveys, the average cost of mining a Bitcoin in a small mining farm is around $4,500, and since November 20, the Bitcoin price has been below this expected cost.

Miners’ exodus begins to show up in Bitcoin mining difficulty

On December 3, 2018, the 275th Bitcoin mining cycle started from block 552384, with a new difficulty of 5,646,403,851,534 (-15.13%). According to a data chart compiled by XDEX chief analyst Uli Qi, this is the second largest mining difficulty reduction in Bitcoin's ten-year history. The largest Bitcoin mining difficulty reduction was -18%, which occurred as early as November 1, 2011.

The ranking of Bitcoin mining difficulty decrease is as follows:

November 1, 2011: -18.0%

December 3, 2018: -15.1%

October 16, 2011: -13.1%

December 27, 2012: -11.6%

March 26, 2011: -9.5%

May 25, 2012: -9.2%

January 26, 2013: -8.6%

December 1, 2011: -8.5%

One point to add is that on November 18 this year, the difficulty of Bitcoin mining was reduced by 7.3%, which in itself was a major adjustment. Half a month later, on December 3, it experienced another sharp decline, indicating that the Bitcoin mining industry is undergoing unprecedented changes.

Currently, the Bitcoin hash rate is 37.7 EH/s, down 39% from 61.9 EH/s at the end of August and about 31% below the weekly average peak set on October 1.

Is the "death spiral" phase starting?

On December 3, Santa Clara University finance professor Otua Sarin published a paper that was bearish on Bitcoin. He believed that the recent decline in mining difficulty indicated that the Bitcoin market had entered a "death spiral" phase. The price of Bitcoin is already lower than the cost of mining, which will drive miners out of the market. As the cost of mining decreases, the price of Bitcoin will also decrease. In addition, a large number of investors shorted Bitcoin in the futures market, which will exacerbate the decline of Bitcoin.

Note: The scary thing about financial crises is not how much value they destroy or how many companies go bankrupt, but that they are self-fulfilling and uncontrollable, just like nuclear fission. Once triggered, the result is catastrophic. When this uncontrollable self-fulfills over time, we call it a "death spiral."

Sarin pointed out that the cost of mining exceeds the cost of selling in the futures market, which in itself is destroying the value of Bitcoin. For any rational investor (even those who firmly believe that the price of Bitcoin will rebound strongly), if the cost of mining is higher than the futures price, there is no motivation to continue mining.

Unlike gold, which retains its value even if mining stops, Bitcoin loses value without mining to maintain its ledger. Without mining, Bitcoin would be reduced to a set of worthless encrypted numbers.

Regarding the topic of Bitcoin's strong comeback after falling more than 80% in price many times, Sarin believes that the nature of the Bitcoin market today is fundamentally different from previous "boom and bust" cycles: in the current market, the "losers" are profit-driven investors, not "true believers." Moreover, the current futures market enables miners to hedge their profits by shorting Bitcoin.

However, eToro senior market analyst Greenspan said that considering the parabolic trend of Bitcoin prices in the past 12 months, the decline in Bitcoin hash rate is a healthy market adjustment and development. To maintain a constant block speed, Bitcoin's hash rate will be dynamically adjusted. Therefore, although some mining machines have entered a shutdown state, the adjustment of the hash rate will eventually reach a dynamic balance with the Bitcoin price.

The Bitcoin hash rate has indeed dropped significantly in the past few weeks, but this is not a critical issue. After all, the Bitcoin hash rate has experienced a sharp rise in the past year and is now only returning to its previous normal level.