When Mark Twain was on tour in London in 1897, an American newspaper mistakenly published his obituary. Twain responded to a reporter’s question about it by saying, “The information about my death is greatly exaggerated.” Something similar could be said about the fear of a drop in Bitcoin prices and the halving of Bitcoin in May 2020, causing a Bitcoin mining death spiral.
What is the 50% reduction of bitcoin mining?
Bitcoin miners work to add the next block in sequence to the blockchain, using specialized computer systems capable of complex calculations. The block is complete when the miner produces a random sequence of 64 characters called a hash to complete the mining process and permanently lock the block into the Bitcoin blockchain, so it can never be changed.
When Bitcoin began in 2009, the reward a miner received for processing a block of transactions was 50 Bitcoins. A halving takes place for every 210,000 blocks mined. The process of mining 210,000 blocks takes about four years. The first halving took place in 2012, which reduced the reward for mining to 25 Bitcoins. In 2016, the second halving took place, reducing the reward to 12.5 Bitcoins. In May 2020, the third halving occurred, which reduced the reward for mining a block to 6.25 Bitcoins.
There was concern prior to May 2020 that the halving event would significantly reduce the price of Bitcoin and perhaps cause a long-term downward trend. What happened this year was Bitcoin’s peak since the beginning of 2020, on February 14, 2020, with Bitcoin selling for $10371. Then, the price hit its lowest level since March 16, 2020, with Bitcoin selling for $5,024. As of June 25, 2020, the current price of Bitcoin was $9227.
With the global pandemic raging, many economic pressures took place in March 2020, so the halving may not be solely responsible for the decline in the price of Bitcoin. Nonetheless, the Bitcoin price at the end of June 2020 has now returned to a level close to the highest since the beginning of the year, so any concerns of a continued decline in the value of Bitcoin have been dispelled with a sharp turnaround in the price of Bitcoin to the upside.
What is the death spiral of Bitcoin mining?
The fear of a Bitcoin mining death spiral comes from the risk that when the price of Bitcoin gets too low, it becomes too expensive to mine Bitcoins. Miner capitulation occurs when miners stop producing Bitcoins. This could result in a breakdown of the Bitcoin system if there is not enough computer processing power applied to create the blocks of new transactions and add them to the blockchain.
There have been a few things, which may have caused a Bitcoin mining death spiral. This includes when there was a fork to create Bitcoin Cash in August 2017, to let it run separately as an offshoot of Bitcoin. Another potential cause of a Bitcoin mining death spiral was the halving that occurred in May 2020. In reality, none of these past events caused the much-feared Bitcoin mining death spiral.
How was the death spiral of Bitcoin mining avoided?
A game-theoretic assessment provides insight into the market dynamics of Bitcoin mining. The majority of Bitcoin mining uses ASIC computers that can handle other crypto-currencies as long as the processes are compatible with the ASIC computers’ capabilities. When Bitcoin Cash emerged from Bitcoin, the main concern was that miners would move away from Bitcoin and focus on Bitcoin Cash to the point that the Bitcoin network would fail. However, when miners switched to Bitcoin Cash, the hash rate for Bitcoin dropped, which created opportunities for miners to return to Bitcoin processing with advantage. To maximize potential profits, miners play this game with themselves all the time. This self-regulation has balanced the efforts so that Bitcoin Cash receives a lot of support and the Bitcoin network continues without interruption.
As far as the halving event is concerned, this is a good example of miners having to consider both short-term and long-term strategies. Miners/institutional investors work better at accumulating Bitcoins over the longer term. They can withstand periods when mining Bitcoin costs more than the value of Bitcoin created. It is part of the business model to operate with a temporary accounting loss, not consumed until the Bitcoins are sold. They anticipated a temporary period during which the value of Bitcoin would decline while hoping that the price of Bitcoin would eventually rebound. The price of Bitcoin rebounded after the event by half over the next month.
Can a drop in the price of Bitcoin cause a mining death spiral?
A sustained decline in Bitcoin prices, such as the trend seen in 2018, would be necessary to trigger a Bitcoin mining death spiral. Without a persistent strong downtrend, the risk of a Bitcoin mining death spiral is minimal. It is unlikely that a temporary negative period, in which mining costs exceed Bitcoin value rewards, will result in a permanent collapse of the Bitcoin market. Smaller miners, who operate less efficiently, may capitulate and abandon mining; however, institutional miners will not.
Institutional miners invest heavily in ASIC mining computers. When the price of Bitcoin falls below the break-even point, they have the choice of either putting their computer on temporary hold or continuing to mine Bitcoin at a loss. If they continue to mine, the loss may not exist in the future, if the price of Bitcoin rebounds. By continuing to mine, they are betting on a market rebound. A higher Bitcoin price later makes these hard times profitable with Bitcoins intended for sale in the future.
Eliminate the competition
Bitcoin mining is very competitive. Many miners are willing to continue even at diminishing returns. Some even add mining power to the network during difficult times. These miners are willing to mine Bitcoins at a loss to be well positioned when the market recovers and some of its competitors are out of the market.
Summary
The avoidance of a Bitcoin mining death spiral despite these challenges is encouraging for serious institutional miners and others who operate their Bitcoin mining operations in an ultra-efficient manner. A systemic challenge to Bitcoin mining eliminates the weakest operators and provides opportunities for the strongest. The strongest miners ensure that their operations are well-designed, energy-efficient, profitable and sufficiently funded to weather short-term fluctuations in the price of Bitcoin.