Projections on Hash Rate and Bitcoin Price Post-Halving

By Joseph Todaro, John Todaro and James Todaro

Every four years the bitcoin network undergoes a pre-set inflation adjustment that results in a fifty percent reduction in the block reward. This event is appropriately referred to as the halving. The 2020 halving is set to occur in approximately two weeks in mid-May at block height 630,000 and will mark the third such event since the launch of the bitcoin network over a decade ago. This reduction in new token supply has a direct impact on mining revenue and consequently network hash rate. We expect that if the market price of bitcoin does not rise above key levels, there will likely be a significant but temporary decline in hash rate following the halving. This decline may spur bearish narratives including the ‘mining death spiral.’ Further, we find the mining death spiral theory to be unfounded but if misappropriated may place downward sell pressure on bitcoin.

A Decline in Bitcoin Mining Profitability

Bitcoin mining profitability will likely decline following the bitcoin halving as revenues decrease resulting from a reduction in the block reward. Bitcoin miners are currently estimated to break-even (BE) between ~$6,000–7,500 per BTC, assuming the below assumptions. A full in depth description of the following mining assumptions can be found here: https://tradeblock.com/blog/analyzing-bitcoin-miner-costs-from-previous-halvings-as-a-comparison-for-the-2020-halving

• Blended mining device costs: $1,000 per device
• Avg. device hash rate: 40 TH/s
• Avg. device useful lifespan: 2 years
• Avg. power consumption: 2200 W
• Electricity costs: $0.06 kWh

Currently, miners are likely operating above BE, as the market price of bitcoin moves in range between $7,500-$9,000 per BTC. If we assume the bitcoin network hash rate remains the same, or even rises modestly, and the market price of bitcoin remains range bound at current levels, then following the halving, miners will be operating at negative margins as mining BE costs rise to $12,000–$15,000 per BTC. We may expand the lower end of this range to ~$10,000 to appropriately account for the possible existence of uniquely efficient mining operations and variable factors like the low cost of electricity during the Chinese wet season and the acquisition of mining hardware at cost.

However, if the price of bitcoin does in fact rise within range of these key price thresholds, the majority of the mining network will likely be operating in profit post halving and we may not observe any significant decrease in network hash rate.

Post Halving Hash Rate Decline

Assuming the price of bitcoin stays range bound, given the above BE estimates following the halving, higher cost miners will look to take rigs offline as they operate at considerably negative mining margins. As such, we would expect a decline in the overall network hash rate as hash power is reduced. This would also lead to a consolidation in hash power market share as less scalable mining operators exit. The network hash rate is closely related to miners’ profit margins as the number of resources, in aggregate, committed to securing the network through mining activities rises, the costs associated with mining rise as well.

This would not be the first time the bitcoin network saw a reduction in hash rate. In March 2020, following a sharp market price correction in bitcoin after a COVID-19 inspired sell-off, the network saw its second largest mining difficulty adjustment ever as operators took rigs offline. Note that the price of bitcoin fell to around $4,500-$5,500 per coin, below then BE estimates of around $6,000–$8,000 per coin. Additionally, the bitcoin network also saw a temporary hash rate reduction in 2018 as the market price of bitcoin declined from all time highs to a low of ~$3,500 per coin in late 2018 and early 2019.

In order to limit a disruption in business, mining operators may maintain accelerated hash power after the halving and operate at negative margins for a percentage of time. Due in part to more robust lending markets for bitcoin miners, operators may have enough cash to operate at a loss for a limited amount of time. Nonetheless, if market prices do not rise above BE in a timely manner, then mining operators — starting with the least efficient — will likely begin to shutter mining rigs, reducing network hash power. With the resulting decreases in hash rate and miner revenue, there may be a resurgence in narratives challenging the miner-based economics of bitcoin’s Proof-of-Work (PoW) security model, one of which is the mining death spiral.

Unwinding the Mining Death Spiral

The mining death spiral (MDS) is the theory that a sudden drop in miner participation will result in a cascading effect that will bring the bitcoin blockchain to a prolonged standstill. While the MDS theory paints a rather catastrophic image, we have not found sufficient merit in its arguments.

The MDS theory adheres to the following thought process: after a sudden fall in the price of bitcoin or a drop in block reward following the halving, bitcoin miners will become largely unprofitable. Miners will react to this unprofitability by immediately powering down their mining rigs resulting in a sudden and significant reduction in hash rate. This will result in the lengthening of the time required to find any given block and extend difficulty adjustments times. Difficulty adjustments are dictated by hash rate and happen approximately every 2 weeks or more precisely every 2016 blocks―essentially regulating the cost of mining. As miners continue to shutter due to unprofitability, the block confirmation time and difficulty adjustment intervals continue to increase. This then results in extended periods of miner unprofitability which results in more miners powering down further extending difficulty adjustment intervals and block confirmation times. In the MDS theory, this process continues to spiral down resulting in a complete standstill of the bitcoin blockchain.

In this report, we will not detail the specific nature of mining operations. We have found that these factors have been appropriately addressed elsewhere and offer substantial cost-driven evidence against the MDS theory. However, we do think the following high-level response may offer supplemental value to the more specific cost-based analyses of mining operations addressed elsewhere.

For the benefit of simplicity, we will divide miners into two categories: those who are inefficient and poorly capitalized we will call opportunistic miners and those who are highly efficient and well capitalized we will call committed miners.

The opportunistic miners often quickly shutter, powering down their rigs as mining BEs are approached and profits turn negative. This resulting decrease in hash rate can be observed throughout the history of bitcoin around sudden price moves that make profitable mining unrealistic for opportunistic miners. The opportunistic miners often wait for difficulty adjustments or price appreciation to bring profitability back before restarting rigs. This usually results in temporary alterations in hash rates and miner participation.

The committed mining operations have larger margins, greater efficiency and operate with sufficiently long time frames. These qualities allow them to more easily weather bouts of high volatility unlike the opportunistic miners. During high historical volatility in both 2018 and 2020 when bitcoin saw downward price movements of nearly 50%, roughly similar to the impact of the halving event, the network hash rate only declined by 37% and 24%, respectively. These modest corrections in hash rate offer a strong indication of the behavior of committed miners during decreased or negative profitability. Furthermore, the volatility that makes opportunistic miners unprofitable, at times, allows committed miners to grab a larger share of the resulting block reward often increasing long term marketshare. This utilization of longer time frames by committed miners signals their high conviction in the future profitability of bitcoin mining. For this reason, maintaining operations even during times of short term unprofitability — allowing for difficulty adjustments that return operations to profitability — is part of a longer term bet on future cash flows. This is likely why throughout bitcoin’s history we have never seen sustained hash rate drawdowns and why we do not anticipate any change to that dynamic now.

Conclusion

The 2020 halving is a highly anticipated event that will likely have an impact on both the hash rate and the price of bitcoin. We expect a temporary decline in hash rate following the halving provided the price of bitcoin does not reach key thresholds that allow for widespread miner profitability.

This drop in hash rate and miner participation following the halving may revive the mining death spiral theory. However, we have found little evidence suggesting merit in this theory and view any downward impact this has on the price of bitcoin as the market’s misunderstanding of miner economics.