Bitcoin Difficulty Suggests Rally

Hi, I’m Kevin Zhou, Economist at Buttercoin (sign up here) a Silicon Valley / Wall Street backed Bitcoin Marketplace.  Every week we take a look at what’s happening in Bitcoin and share it, here’s the latest. 

Every week we start by taking an overview of the market, followed by recent and notable news in the bitcoin space and finally a closer look at some part of the bitcoin ecosystem.  This week we focus on bitcoin difficulty slowing its ascent and its effect on the markets.

This week markets traded between $360/BTC and $395/BTC.  Trading volumes have been moderate and volatility has been relatively low.

News this week:
  • Western Union sees backlash after claiming copyright infringement on bitcoin spoof ad:
  • Kraken was selected to aid in the mtgox liquidation:
    • Liquidation will likely be quick and both gox creditors and Kraken stand to benefit.
    • Gox creditors get some portion of their money back while Kraken gets an influx of new customers.
  • Approximately 70% of bitcoins have not moved in 6 months:
  • Switzerland will treat bitcoin like a currency:
  • Dutch official says bitcoin likely not liable for VAT:
  • Australian Senate holds first hearing into cryptocurrencies:
Since early August of this year, bitcoin difficulty has doubled while the price has dropped around 20%.  Miner profit margins are thus being squeezed on one side by the increased rarity of finding a block as well as the decreased nominal value of the reward.

The previously steep climb in mining difficulty over the past 22 months has started to flatten out.  The next difficulty adjustment will happen in about 2 days and is expected to be +.86% (the lowest since January 2013).  Moreover, three of the last four difficulty adjustments have been below +3%.  Compare this to last October where we saw difficulty increases of over 25%-40% each time.  This slowdown shows that the amount (in hashing power terms) of mining hardware being added onto the network by yet profitable miners are nearing equilibrium with the amount of mining hardware being taken off the network by now unprofitable miners.  It suggests that ASICs are possibly hitting a saturation point in the network where for a lot of miners the marginal cost of producing a bitcoin is now equal to or above the price of a bitcoin.  It also implies the further centralization of mining power to larger miners with greater efficiencies of scale.

This also affects the bitcoin markets.  Since a flatter difficulty adjustment schedule implies blocks are being generated at close to 10 minutes per block the number of bitcoins entering the economy every day is slowing down.  Compare this to October of last year when blocks were generated at close to 7 minutes per block.  That means now the network generates about 62 fewer blocks per day than last October.  This is equivalent to 1550 BTC less influx in bitcoin supply per day which means significantly less selling pressure in the market.

In addition to directly less selling pressure, there are circular effects which are bullish on price.  For example, miners are more likely to sell when they think other miners are also selling so as to get in front of each other and not to get stuck with a worse price and possibly become unable to continue with operations due to constant operating expenses.  Miners are more likely to hoard when they believe other miners are hoarding.  In other words, all else equal (e.g. consumer adoption growth), a steeper difficulty climb implies more selling by miners and a flatter difficulty climb implies more hoarding by miners.

It takes about $1.33m of new fiat money coming into the bitcoin economy to buy up the total bitcoin supply increase of about 3600 BTC per day.  This is the lowest dollar amount it's been in a year and the lowest BTC amount it's been in almost 2 years.  In light of all this, I am strongly bullish.

Kevin & Team Buttercoin
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