The Bitcoin markets have had to deal with a slew of bad news from China in recent weeks.
It all started with allegations that Sichuan miners had gone offline as a result of the province’s decision to restrict energy-intensive industrial activity like Bitcoin mining.
Then three of China’s biggest financial self-regulatory agencies issued an united statement reminding the public of the country’s 2017 prohibition on crypto assets. Then it was revealed that the Chinese State Council, led by President Xi Jinping’s top economic advisor, was cracking down on mining for the first time.
To top it off, the Chinese state-run news agency Xinhua published a critical story about crypto assets last Sunday, criticizing their risks in comparison to traditional financial instruments.
While a variety of variables have contributed to the sell-off, one thing is undeniable: something is brewing in China. Whatever it is, this chain of events has caused market participants to be concerned about Bitcoin’s future, particularly in terms of mining.
LET’S FOLLOW THE MONEY TO GET TO THE BOTTOM OF THIS.
The beautiful thing about Bitcoin’s financial openness is that it allows us to see how miners are reacting in real time to all of this. But, before we get into the actual mining data, let’s take a look at how miners interact with Bitcoin and how we can measure it.
One of the most common misconceptions regarding Bitcoin mining is that it is “extremely centralized,” with “supermajority control by handful of big mining (aka hashing) corporations,” to quote Elon Musk. This is demonstrably false. In actuality, what we commonly refer to as mining is a multi-layered process.
Miners cooperatively contribute their resources to so-called mining pools in order to boost their chances of success. Pools are big groups of individual miners who collaborate to mine the same block. When a pool mines a block successfully, it receives 6.25 freshly issued BTC plus all fees paid by users to have their transactions included in that block.
Following the fate of newly minted bitcoin can provide valuable information on the collective behavior of mining pools as well as the individual miners who operate inside them. Coin Indicators has developed a set of aggregate metrics that serve as proxies to distinguish these two quite different actors.
We compiled data from all “coinbase” transactions, which are the first transactions in every Bitcoin block, as a proxy for mining pool activity (not to be confused with the exchange). We aggregate data one hop from that transaction, i.e. all transactions that got funds from the coinbase, as a proxy for individual miner behavior.
The assumption that Bitcoin mining is centralized is demolished at a microscopic level if you track what occurs after one hop. Even at the individual miner level, there are many transactions beyond one hop that have dozens of receivers, which could indicate layered systems.
Let’s look at the data now that we’ve explained how aggregate miner behavior may be measured on-chain.
What does the data from the blockchain tell us? Individual miners must create a transaction that delivers payments to an exchange, an over-the-counter desk, or, in rare cases, directly to the buyer before they may effectively sell their coins. We would notice an increase in the movement of cash from particular miners (one hop) to other addresses in any of these scenarios.
Although the amount they get on a daily basis is little in comparison to global BTC volume, the data shows that markets react negatively when miners are likely selling (an rise in “flows sent”).
Miners are also speculators, so keep that in mind. They do store BTC on their balance sheets, despite the fact that the amount they earn in miner rewards is minimal in USD terms compared to the volume of global BTC markets. During times of uncertainty, when they anticipate a cash shortage, their collective activities have an impact on the market.
Put yourself in the shoes of a Chinese miner who may be forced to relocate to another nation. Regardless of the size of your business, you’ll almost certainly require funds to make that shift. The good news is that this is only a passing fad. The market impact was short-term and coincidental, as it had been with earlier surges in flows sent.
Surprisingly, the CCP’s current anti-mining campaign coincides with a time of year when some Chinese miners relocate from Inner Mongolia to Sichuan. The start of the rainy season in Sichuan has prompted this 2,000-kilometer migration, which enhances the capacity of the province’s hydroelectric power facilities, lowering electricity bills.
The rainy season in China has been shown to contribute to an increase in hash rate, a parameter that indirectly tracks the amount of resources given to Bitcoin.
If the CCP’s aggressive views on mining are followed up with enforcement efforts, this seasonal migration could be hampered, and the hash rate could fall below present levels.
We might witness a decline in hash rate from present levels if the CCP’s harsh views on mining lead to enforcement steps that further push miners to depart from China.
While it is uncertain how the Chinese mining community will react tactically to this development, the market has responded unfavorably in response to the possibility of a fall in hash rate. But, if there were to be a drop, how would this affect Bitcoin?
WHAT HAPPENS IF THE HASH RATE CRASHES?
Another common misunderstanding regarding mining is that daily hash rate estimates can accurately predict when miners will stop working. This frequently causes fear, as individuals grapple with the idea that a huge number of miners have gone offline all of a sudden. When “a single coal mine in Xinjiang flooded, almost killing miners, a single coal mine in Xinjiang flooded, almost murdering miners, a single coal mine in Xinjiang flooded, almost murdering miners, a single coal mine in Xinjiang flooded, …
[…] Bitcoin’s hash rate has plummeted by 35%.”
Hash rate isn’t an exact metric in reality. Hash rate formulas are used to calculate how much processing power is allocated to a network on a given day. However, there is one word in the metric’s name that is frequently left out: inferred. Because it’s impossible to get a precise daily change figure just by looking at on-chain data, it’s called “implied hash rate.”
Daily implied hash rate is a fickle statistic that is not ideal for tracking long-term changes in the mining ecosystem, yet crypto media sites frequently exploit hash rate variations with sensationalist “BTC HASH RATE DROPS X% ” headlines.
Because all daily hash rate algorithms are highly sensitive to how long blocks take to mine over a given lookup window, this instability exists.
Because mining is an unpredictable process (a Poisson process to be precise), it’s possible that a Bitcoin block will take an hour to mine without miners going offline (albeit a low-probability event).
Even if no changes in the mining landscape have occurred, a likely event would push daily hash rate predictions down significantly in the case above. Take a look at the methodology we developed at Coin Metrics to obtain daily implied hash rate estimates in the trillions of hashes per second (TH/s) unit if you want to learn more.
Increasing the measurement window is the only method to reduce the influence of these likely events on hash rate estimations. That isn’t to argue that the 24-hour, 144-block hash rate estimations should be abandoned. When attempting to measure miner behavior, we simply need to cease using it to make bold statements about actual changes in hash rate.
The one-month implied hash rate is a much better metric to use if you want a more accurate picture of changes in Bitcoin’s hash rate. This version of hash rate, as the name implies, includes changes that occurred over a rolling 30-day period.
On a time series, this statistic appears much better since it filters out all of the noise caused by big (yet likely) variations in block formation time. As a result, it’s a far better indicator for tracking Bitcoin’s hash rate over the medium to long term.
Because it filters out all of the noise created by substantial (but likely) variations in block creation time, the one-month inferred hash rate is a better metric for tracking mid to long-term changes in Bitcoin’s hash rate.
The one-month inferred hash rate is free to use, much like the one-day hash rate measure. You don’t even need to sign up to take a look. Make a copy of this and send it to the next crypto journalist who cites one-day hash rate changes as clickbait.
WHERE DOES ALL OF THIS LEAVE BITCOIN?
This hash rate experiment is crucial because, if the CCP continues to crack down on Bitcoin miners, we may see a significant shift in the composition and geographic location of Bitcoin miners. We’ll also need precise statistics to track the effects of a possible mass migration.
During my research for this essay, I reunited with a fellow Bitcoiner in China who believes that the CCP will take tougher enforcement action in the future, not if. Other industry observers with a lot more experience analyzing the CCP’s behavior agree with this assessment.
The People’s Bank of China (PBOC) is planning to create its own coin later this year, which is no coincidence. And Bitcoin is diametrically opposed to the strictly regulated digital yuan. Thankfully, Chinese citizens will still be able to use VPNs to access Bitcoin. Regardless of where Chinese miners go, Bitcoin will still be available for them if they ever need it.
Most significantly, this is a huge chance for Bitcoin to address two of its most frequently misunderstood criticisms: its reliance on Chinese miners and the carbon impact that involves. As a direct response to worries about Bitcoin’s carbon footprint, a slew of environmental, social, and governance (ESG) projects have sprung up.
With this in mind, the CCP’s latest round of regulatory scrutiny could not have come at a better time. One of the most beneficial fundamental events for Bitcoin in 2021 is the impending miner migration that is already taking place. Even if we witness a temporary dip in monthly indicated hash rate estimates as miners leave, it will be for a good reason.
The health of various crypto networks is a major focus of our work at Coin Metrics these days. We actively follow network attacks, such as 51 percent attacks, across key PoW networks, in addition to measures like hash rate. If you’re worried about Bitcoin’s vulnerability to assaults because of the possibility of a short-term decrease, don’t worry. A drop in monthly inferred hash rate estimates is unlikely to have a significant impact on Bitcoin’s security.
When you consider the huge amount of electrical and hardware resources required to successfully attack Bitcoin, it currently overpays for security by a large margin. Even if the monthly implied hash rate dropped in half, returning to levels not seen before November 2019, the network would still be extremely resistant to attacks.
A drop in hash rate would only have one significant effect: increased block times. This occurs when the mining difficulty parameter is set excessively high in comparison to the amount of miners online, causing blocks to be mined more slowly. While the network may get more clogged as a result, Bitcoin’s difficulty is naturally adjusted every two weeks, so this would be a temporary occurrence.
If, on the other hand, the monthly predicted hash rate does not drop significantly but miners remain geographically dispersed, Bitcoin will have become significantly more decentralized at the expense of short-term price volatility. If you ask me, it’s a good deal.