Bitcoin Hashrate vs Price

Translations: German 🇩🇪

Does the Bitcoin hashrate follow price movements, or does the price follow the Bitcoin hashrate? People have argued for either, and are convinced of their own arguments. Do you know why? Because they can both be correct, and I’ll explain why. It is widely believed that increased hashrate is associated with increased price, but I show that the opposite is also possible – increased hashrate can actually cause the price to fall in some situations.

First, I want to do a quick overview of supply and demand in Bitcoin (full article on this here). You can skip this if you’ve heard a real Bitcoiner’s explanation on this. It’s virtually impossible for a nocoiner’s explanation to be right, so read on if that’s all you’ve heard so far.

Bitcoin Supply:

New coins produced by miners
Old coins (sold by Bitcoiners)
IOU fractional reserve bitcoin (this soaks up dollar demand and is not actually bitcoin)

Bitcoin Demand:

Bitcoiners selling dollars to acquire bitcoin
Miners not selling newly mined coins

What is and isn’t demand or supply

Traders buying and selling over the period of the trade do not contribute to supply or demand – they only create volatility for the period of time in the trade. A buyer first pushes the price up, then back down as he/she exits, having no net effect. (This ignores profit/loss in USD for simplicity, and overall is negligible).
Anyone who is holding bitcoin with the intention of selling it for profit is a trader; see the point above.
Any trader who is planning to hold some bitcoin long term is part trader, part holder, and previously contributed to demand somewhat.
Anyone going “long” or “short” on a futures contract is a trader for the purposes of this discussion.
Anyone planning to sell bitcoin but lost their private key reduced future supply (or went from contributing no demand in the past, to having contributed to demand when they purchased.)

Next, I’ll explain what happens to supply and demand in two extreme-and-opposite scenarios, to make the subsequent point.

Scenario #1 – All miners are not interested in holding bitcoin long-term, they are trying to make more fiat.

In this scenario, the entire world’s mined coins are going to be sold. The current 6.25 Bitcoin block reward is part of the Bitcoin supply, and the miners are not keeping any of it.

Scenario #2 – All miners are Bitcoiners and are mining to accumulate bitcoin, not dollars.

In this scenario, miners are spending dollars on mining equipment and electricity, and in return are increasing their bitcoin balances. By not selling the mined bitcoin, they are reducing SUPPLY, which mathematically is equal and opposite to increasing DEMAND.

New Miners Join

Now imagine we’re in Scenario #1 with non-Bitcoiner miners, and some new Bitcoiner miners join and double the world hashrate. We now have half of the daily mined coins going to Bitcoiners who are not selling the coins; previously they were all being sold. In this situation, increased hashrate has contributed to demand, and pushes up the price until a new equilibrium is reached.

Now imagine the opposite; we’re in Scenario #2 with all Bitcoiner miners. Non-Bitcoiner miners join and double the hashrate. We now have half of the daily mined bitcoin that was going to be held, being sold! In this scenario, new miners who are profiting in dollars are pushing the price DOWN! Despite the hashrate going up. Unexpected right? It’s undeniably true though.

Scenario #3 – Reality. There’s a mixture of Bitcoiner and non-Bitcoiner miners (ratio unknown)

In reality, when a new cohort of miners comes on-line whether they push the price up or down depends on if they change the ratio of Bitcoin miners to non-Bitcoiner miners of the total. If they make no change to the world ratio, there is no impact on price.

But does the price move the hashrate or does the hashrate move the price?

At equilibrium, miners have no incentive on average to join or leave the network. If the price goes up (from non-miner demand/supply dynamics) then more miners are incentivised to join and the hashrate goes up. And the opposite is true. Price going down incentivises the most non-profitable miners to leave. It’s important to understand that more miners joining does not affect price through more coins being mined – the difficulty adjustment keeps the rate of new coin issuance steady, whether miners join or leave, and for any total number of miners in the world – even 1 lone miner. This is very different to every other commodity, where the price is pulled back down by increased mining, as miners increase the supply rate fed to the market.

As the price moves in either direction, it is not predictable if the Bitcoiner:non-Bitcoiner ratio of miners will change and in what way. A change in the ratio can exacerbate or dampen the price change caused by non-mining dynamics.

It’s completely plausible that the Bitcoin price could go up due to direct demand (supply of dollars) and Bitcoiner miners join the network, and push the price up further!

Should I complicate it?

It’s in my nature, I will. You can skip this if your head already hurts.

There are 3 types of Bitcoin-miners, and their ratio matters to the price.

Type 1 – Miners mining at market prices.

These people are using dollars to acquire bitcoin, and the amount they get is no different to the alternative of just buying bitcoin. Any contribution these miners make to the Bitcoiner:non-Bitcoiner ratio is nullified through the demand opportunity cost. If they didn’t mine, then more non-Bitcoiners would mine bitcoin, but these Bitcoiners would have bought that exact difference.

Type 2 – Mining in profit

These miners are effectively taking more dollars out of the system (that fiat-hungry miners would have had), and their contribution to the Bitcoiner:non-Bitcoiner ratio is meaningful. If they had chosen not to mine, and used their dollars to buy bitcoin, they would have had fewer, and fiat-hungry miners would have had more bitcoin to sell.

Type 3 – Mining at a loss (in fiat terms)

This means that the miner could have had more bitcoin if they used their dollars to directly buy bitcoin at the market price. This is, counterintuitively, contributing to hash that reduces the price. It’s not direct, but it’s a difference between two alternate universes.

What about improved miner equipment efficiency?

We’ve seen some snazzy new miners being produced, with massive gains in hashrate relative to the energy consumed. If these miners, for arguments’ (and simplicity’s) sake were evenly distributed amongst the current miners who replaced old equipment, what we’d see is an increase in hashrate, but no change in the distribution of who gets what fraction of the available new bitcoin. The chart of hashrate would, and actually currently is, tearing up, but the price is going down – we must factor in the “free” miner efficiency. I say “free”, referring to the fact that we have increased hashrate without having to directly pay more fiat for it. Of course, new equipment costs money, but the efficiency gains are effectively “free”.

So the efficiency in equipment is one explanation for the disparity in the hashrate increase and price, but also, as I explained earlier, there could just be more new hashrate associated miners interested in fiat gains, rather than more Bitcoiner miners.

Summary:

I wonder if your head is hurting because mine is.

Price will follow hashrate if the miner ratio changes.
The contribution of new hashrate to price depends on the change in the miner ratio
Hashrate will follow Price if it is caused by non-mining demand/supply dynamics.
The miner ratio can further be finessed by considering if Bitcoin miners are in profit, loss, or neutral.

Extra:

If you’re interested in how mining works, you can read my explainer here.

It naturally flows on from this piece, which I recommend you read first.

And if you want to see how mining profitability is calculated, I explain here.