With the Bitcoin Halving Event due next week and much discussion of how it will affect bitcoin’s price, it’s a great time to consider what factors actually determine the price.
There are many thoughts floating around:
- Is it simply supply and demand?
- Is it just market cycles playing out?
- Is it fear and greed?
- Is it media hype or indifference?
- Or is it just the “Bitcoin Whales” manipulating the market to their advantage?
Certainly it is a bit of all of the above.
But for an underlying or baseline factor, we need to consider the breakeven cost to actually create (or “mine”) bitcoin.
The breakeven price, of course, is the basis of ALL production, be it oil, gold mining, farming, business, … you name it.
If price is above cost, you profit; if below cost for any significant length of time, you shut down temporarily or go out of business.
Thus, it is essential to have an idea of what bitcoin price the miners need to stay in business and keep the entire Bitcoin ecosystem afloat.
And it’s not just the mining of new bitcoin, it’s also the continuing support and validation (the “hash power“) of the entire global network.
Bitcoin (BTC), the token, is the reward system for the entire enterprise, so its price is all-important.
There are basically two main costs for a miner: the mining rig setup and the electricity cost to run it.
Most people believe that the miners with the lowest costs (especially electricity) will be the survivors and the ones who flourish.
But according to an article by Blockchain Solutions, the reality is different.That’s because the consistent improvements in mining rig technology allow those with higher electricity costs to stay in the game and compete with the lower-electricity-cost, but older-tech, miners.
Another important point made in the article is that the breakeven price is NOT the floor.
In reality, it is the miner capitulation and loss of hash power of the network that creates the price floor. In other words, the price floor will be LOWER than the breakeven price.
This creates another important dynamic: the fact that the bitcoin miners are almost always the main selling pressure on the bitcoin markets, because they HAVE to sell to cover their costs and make a profit to ensure survival.
Bitcoin holders (“HODLers“) and investment funds can hold or sell anytime, based on sentiment or market cycles.
Bitcoin mining rigs have a 3+ year life cycle.
Larger mining facilities have 5+ year life cycles, while small individual miners take approximately 18 months to break even on their capital costs.
As you can see, quite a financial commitment.
So, what happens when bitcoin’s price drops too low?
The inefficient miners eventually capitulate; they either shut down temporarily or close up shop forever.
Their rewards go to the efficient miners.
Therefore, only the most efficient miners keep running.
(As a side note, there are new lending platforms available to miners today that allow them to collateralize their bitcoin holdings and get cash or stablecoins to stay in the game longer. This can reduce or delay selling pressure on the markets.)
Now, what happens if the price of bitcoin drops further and stays low for an extended period, as it occasionally does?
The hash rate (or hash power) of the entire network drops. That is not good, as it weakens the security and integrity of the entire ecosystem.
What then occurs is that the Bitcoin algorithm for block mining automatically adjusts and becomes easier. In this way, the existing miners save energy and get rewarded easier so that they can stay in profit.
THIS IS THE MOST IMPORTANT CONCEPT TO UNDERSTAND!
This self-adjusting protocol is what allows bitcoin miners and the hash power to survive any and all price movements and ensure Bitcoin’s survivability.
Then when the price eventually recovers and the reward starts becoming more profitable, both the blockchain difficulty algorithm and the entrance of new and previously-shut miners create the impetus for the next up cycle.
Now if only the world’s central banks worked on a self-adjusting basis!
Well, wishful thinking can’t hurt.
Thankfully, we have Bitcoin – available for anyone, anywhere, anytime to utilize.
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