Understanding the Correlation Between the Bitcoin Price and Bitcoin Mining
What is Mining:
For a new asset class such as Bitcoin, the market is especially driven by the behavioural tendencies of its’ investors. As such, there are only a few forms of fundamental and technical analysis that can be performed to gain an inside edge on Bitcoin price speculation. One of the few tangible metrics investors look to for insight is mining, the process by which transactions are verified and new Bitcoins are added onto the blockchain.
The objective of mining is to add blocks onto the blockchain, it works by allocating your devices computational power to solve a cryptographic problem. When the problem is solved a new block is added. Within each block contains the transaction data of thousands of transactions made by participants on the network. When a block is mined, it is added to the chain of already mined blocks, hence the term “Blockchain”. For their efforts, the “miner” who solves the block is rewarded with a Bitcoin reward.
In the early days of Bitcoin, it was fairly easy to earn extra income and mine with your personal computer. However, the mining industry has become saturated with deep-pocketed competition, and now mining operations involve hundreds of sophisticated computers, cooling equipment, and consume hundreds of megawatts of electricity.
This industry has transformed from a passive hobby into a capital intensive battleground where the only successful mining entities are well-funded organizations. These firms are continually reinvesting their capital to gain a competitive advantage against the rest of the miners in the ecosystem. Thus, the mining sector is becoming heavily consolidated with just a few meaningful participants.
This has raised concerns over the decentralized nature of the network, while also creating several barriers to entry for new users who want to try mining.
The metric that illustrates how well miners are performing is called the “hash rate”. The hash rate is the speed at which a computer is completing an operation in the Bitcoin code. A higher hash rate means your mining device is completing more “hashes per second” therefore increasing the chances of solving the next block and receiving the reward.
As such, when the hash rate for Bitcoin is down, this means it takes longer to verify transactions and mine new Bitcoins. Comparatively, when the network is performing with a high hashrate it takes less time to verify transactions and mine new Bitcoins.
(Bitcoin Price and its relationship to the Hash Rate:Bitcoin Price TrendHash Rate Trend on the Bitcoin Network)
If we look at the two charts above, we can begin to see a correlation between Bitcoin’s price, and the network’s hashrate. Looking at the data from May-June of 2018, we can start to see the relationship between the mining community and the investment community and how this effects the market.
Once Bitcoin began to recover, more hashing power came back on network. From this we can deduce that price has a direct correlation to the networks hash rate.
As the price began to climb, miners wanted to get back into action because, as the price of Bitcoin continued to increase it became more and more profitable for the miners to mine on the network. Alternatively, when the price started to dip again, there was a drop in the network’s hash rate. Which means, as the price continued to fall, it became less and less profitable for miners to mine on the network, so they turned off their equipment.
Although this activity was more of the miners reaction to the market and less of a long-term strategy, looking at mining activity can be a key figure when determining the price volatility of Bitcoin, and if the digital asset is on the cusp of a bull or bear run. To purchase cryptocurrency, investors must use exchanges. Similarly, when miners have accumulated a large sum of Bitcoin and need to sell, they will also do so on exchanges.
So when the Bitcoin price is steadily climbing, so is the profitability to mine. During this positive growth period, miners are accumulating more Bitcoins than during periods of price declines. So now that they have more Bitcoin than usual, they have to sell it on exchanges, which helps provide liquidity to the market.
As more Bitcoins pass hands in the market, miners will continue to mine on the network, steadily increasing the hash rate.
This snowball effect can continue to occur until there is an external variable such as negative news from the community, or price activity in another cryptocurrency market to cause the price to decline and lure miners away from the market.
When their is a slight uptick in Bitcoin price, followed by an increase in the networks hash rate, this can be seen as the miner’s calculated response to Bitcoin’s price volatility, and could be a indicator that the snowball effect described above is on the horizon.
Looking at mining activity can provide critical insight into forecasting the price & demand of Bitcoin, which helps investors identify good opportunities to enter the market.
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