DAR Crypto Weekly —2/7/20

Halvings and Hash Rates

Market Overview

Digital asset prices soared on the week with the total industry market cap up 7.1% to $278.2. Large-cap winner on the week were Tezos (XTZ +29.3%), Ethereum (ETH +18.9%), and Binance Coin (BNB +2.4%). Relative laggards in the large-cap category were Ethereum Classic (ETC -1.5%), Dash (DASH -0.6%), and Bitcoin SV (BSV +2.1%). Other noteworthy positive movers across the industry were ICON (ICON +86.2%), NEM (NEM +46.5%), and Enjin Coin (ENJ +44.0%). Other notable laggards on the week included Synthetix (SNX -7.9%), FTX Token (FTT +2.5%), and LEO (LEO +2.0%).

DAR Research and Events

The Block picked up a version of our analysis on price discovery in bitcoin spot markets. As more institutional players join the bitcoin markets, transparencies surrounding market manipulation and consumer protection become the primary issues for regulators: link

Members of DAR will be traveling throughout Europe next week. We love making new friends and meeting people in the community. Drop us a line to set up a meeting here.

Bitcoin Momentum Regained

After the massive run that happened from late spring to early summer 2019, Bitcoin’s price has struggled to maintain strength and fell through $7,000 in December. However, 2020 has been a completely new year with Bitcoin up roughly 30% since January 1st.

The year started off ominously from a world news perspective with the drone strike in Iraq, the impeachment trial here in the US, and the outbreak of the coronavirus in China. We’ve noticed an increase in the correlation of the price movement of Bitcoin with risk off events, which was most pronounced around the news of the drone strike, but these are mostly intraday moves. We’ve been working on some research to determine whether Bitcoin is a “risk on” or “risk off” asset. We truly believe that Bitcoin moves to the beat of its own drum, although we’ve noticed more recent intraday moves correlated with “risk off” events.

Hash Rates & Halvings

The Bitcoin network’s hash rate is currently at an all-time high of ~120 EH/s. A high hash rate reflects the growing number of miners that are vying for the chance to participate in the block validation process. This is a significant “recovery” following the September 24, 2019 “news” that Bitcoin’s hash rate had suddenly dropped 40% to ~68 EH/s in the span of 24 hours. This led to a 16% drop in the price of Bitcoin, and the destruction of $35B in value. As we had written previously, we believe that number simply reflected the incorporation of some longer to produce blocks in hash rate calculation estimates, not an actual drop in the network hash rate. In 3Q19, Hut 8, a public mining company in Canada published quarterly financials that revealed its all-in lifting cost was $6,221 per Bitcoin (marginal lifting cost of $4,363). Average network hash rates during 3Q were about 75 EH/s. Now that network hash rates are 60% higher, rough math says that their lifting costs would also be about 60% higher or $9,950 (marginal lifting cost of $7,000), above the price of Bitcoin today. While the lowest marginal lifting costs might be lower than that, our guess is that’s not markedly lower. If that’s the case, then miners aren’t wildly profitable at current price levels. Once the reward halving hits in May, they’ll be extremely unprofitable if the current network hash rate holds up.

So, what’s going on?

Marginal Production Costs

Assuming that miners are rational and adhere to economic principles (big assumption here), miners should continue to mine with existing equipment down to the marginal cost of production (variable cost). This is largely the cost of electricity but may include other minor expenses like pool fees. The latest version of Antminers from Bitmain were 21% more efficient than the previous generation so maybe the all-in lifting cost drops from $9,950 to $7,860 and the marginal cost drops from $7,000 to $5,530. Using these two prices, we can get a sense of where it economical to add mining capacity at current network hash rates, $7,860, and where the marginal lifting cost (shutdown cost) is, $5,530. We’ve heaped on several levels of logic here which may prove to be inaccurate, but we don’t think we’re too far off.

The Miner Gamble

We’ve established that its profitable to add new hash power to the network at current prices, but prices were under that $7,860 number until just recently. Furthermore, that $7,860 breakeven number becomes $15,720 in a few months at the reward halving. There are two explanations for the continued capacity additions in that case: either miners expect a price jump associated with the halving that will make new capacity additions economical today or they’re squeezing the last drops out of their hardware that will soon be obsolete. We think it’s a little of both but also note the fact that miners historically have demonstrated the willingness to run at a loss for short periods of time. If we look at network hash rate around the previous two halvings, we did notice a dip following the halving events. We’ll probably see something like that again. Hopefully, it won’t cause the same panic that the September 24th news did, but it’s best to be prepared for those types of headlines.

Searches Rise for the Halving, But Not Necessarily Bitcoin

We think there’s some interesting value to glean from social data, like Google search trends. This shows us that there is rising interest in the term “Bitcoin halving” but not necessarily “Bitcoin.” This tells us two things: there is rising interest in the event, but not the digital asset generally. This may mean that interest is still narrowly focused within the crypto community, but not necessarily the broad public. This is probably good for early adopters and investors. Once the general public is inquiring about Bitcoin, that’s usually a sign things are on their way to being overhyped.

And that’s all the time we have this week. Please reach out with any questions, comments, or feedback on our work.