Crypto death spiral: Is it a genuine threat?

5 December, 2018

A month ago, Bitcoin was trading at roughly USD $6,400. It starts the day at the time of this writing at roughly $3,700. To say that Bitcoin has lost a tremendous amount of value in the last 30 days is to state the obvious. This has led cryptocurrency skeptics to predict the world is but one or two price drops away from a Bitcoin Death Spiral.

We try to keep our posts as upbeat and positive as possible, but we also feel that the death spiral talk warrants an explanation on our part. Knowing that many of our readers are cryptocurrency novices, we feel it wise to explain what all this means and whether there is a genuine threat to the cryptocurrency space.

If you own Bitcoin or another cryptocurrency for any reason - even if your reason is just to be able to play at your favorite online casino - the first thing we advise is that you not panic. Cryptocurrency prices rise and fall all the time. It is the nature of the beast. Panicking over the most recent price drop will not help. In fact, everyone panicking and selling would not be a good thing.

With that of the way, let us get to the core subject of this post. Let's discuss what a crypto death spiral is and whether there is a genuine threat we all need to be concerned about.

The value of Bitcoin Mining

As always, most of what we talk about will refer to Bitcoin. The principles can be transferred to just about every other cryptocurrency as well. Let us begin by discussing Bitcoin mining and the value it adds to the market.

Bitcoin is a digital currency that exists only as numbers on a blockchain ledger. In order for transactions to be considered legitimate, high-powered computers have to take data from the Bitcoin network, verify it for proof of work, and then confirm and finalize the transactions in question. Each new transaction that is finalized and confirmed gets added to the current block of the chain.

This process of collecting, decrypting, analyzing, and confirming transactions is known as 'mining'. Miners are rewarded for their time and effort via Bitcoin payments. In other words, they earn Bitcoin by mining. As such, mining adds value by keeping the entire blockchain functioning.

Do not underestimate the intrinsic value of mining. If there were no miners at all, no more Bitcoin transactions could ever occur. Any Bitcoin a person held in his or her wallet would instantly become worthless. Likewise, even a significant reduction in mining efforts reduces the speed at which transactions can take place, thus causing disruption in the system. This is where the death spiral talk comes in.

The cost of mining

Bitcoin's blockchain is a distributed ledger that continually grows with every single transaction. By design, the ledger is never-ending. So the larger it grows, the more computing power is necessary to verify and finalize transactions. We say all this to explain that mining Bitcoin requires a tremendous amount of resources.

Miners set up computers running powerful software 24 hours a day, seven days a week. It used to be that mining could be effectively accomplished with single desktop PCs running in miners' homes. Small-scale mining is still possible, but no longer realistic. Now there are large companies that exist solely for the purpose of mining. They set up vast server farms to churn out new coins hour after hour.

So what's the catch? Cost. According to MarketWatch contributor and Professor of Finance Atuyla Sarin, the cost of mining a single coin is roughly $5,000. That's a lot. So what do you suppose the owner of a Bitcoin Mining operation thinks when he or she turns on the computer in the morning only to discover that Bitcoin is worth around $3,700 per coin?

The operator begins to think that mining might be a losing proposition. Now a decision has to be made. Does he stop mining until the price goes up, or continue in the hope that the price starts climbing again?

Anatomy of a death spiral

Training pilots know very well what a death spiral is and they train for it because their lives depend on this training. I know because I have personal experience from practicing a recovery from a death spiral - many times. It's not fun. It's the real deal every time!

In terms of Bitcoin let's wind this up with an illustration of the anatomy of its potential death spiral.

Let us say that a large number of Bitcoin miners began questioning their efforts after learning that the price of Bitcoin this morning is just $3,700. Some of those miners are likely to stay in the game, pursuing a long-term strategy based on projected growth. Those miners pose very little risk to the system.

On the other hand, let's assume that just 30% of the skeptical miners decide to cease mining operations for the time being. Losing a sizeable number of miners would slow down the mining process, potentially taking 20 minutes to complete a block instead of the previous 10.

The longer it takes to mine, the longer it takes to earn a single coin. Those miners still in operation are now mining fewer coins in a single day because it is taking them longer to do what they do. Not only are they losing money on every block the process, they are also not processing as many blocks in a single day. Their operations lose even more money.

This creates a downward spiral caused by larger numbers of miners dropping out with each passing day. Fewer minors means slower transactions. Slower transactions mean fewer miners due to falling value. Eventually there will not be enough miners to keep the blockchain going. Bitcoin completely collapses as a result.

A theoretical conversation

Potential death spirals in the cryptocurrency market make for interesting conversation. But guess what? It is all theoretical. There has never been a cryptocurrency with a market capitalization and coin value as high as Bitcoin's that has gone into a death spiral. That could be the determining factor here.

The good news is that for every cryptocurrency skeptic now predicting a death spiral for Bitcoin, there is another bullish investor countering with his or her own evidence to say it is not going to happen. Crypto evangelists make some particularly good points.

First and foremost is the reality that cryptocurrency markets undergo normal corrections just like stock markets. Bitcoin has lost a lot of value before, and yet still found a way to survive and continue to grow. There are plenty of Bitcoin evangelists who believe the same thing will happen again. They believe the recent crash is nothing but a correction.

Another thing to consider is that there are two kinds of miners: those looking for short-term gain and those in it for the long haul. The former group are the most likely to pull out of mining once the price of Bitcoin falls below the cost of mining. That is expected.

On the other hand, those miners in it for the long haul recognize the market will fluctuate. They also know that, at times, they will lose money. But their strategy is to accumulate as many coins as possible while there are fewer miners in the market. The more coins they mine, the more money they will ultimately make when the price starts to rise again.

The likelihood of a death spiral

At this point, the likelihood of a death spiral does not appear that great. There is no doubt that the chance always exists no matter how strong the market is. But at the end of the day, there has been too much invested in Bitcoin's blockchain and large-scale mining to let it all fade away.

Big time miners knew what they were getting into when they started operations. They knew the cost of mining, the risks involved, and the fact that cryptocurrency can be rather volatile. Yet still they took the plunge. Why? Because they know the long-term value of Bitcoin.

The price of any cryptocurrency is ultimately determined by supply and demand. This is what high-powered miners understand. They know that there are only a limited number of Bitcoins to be had in the crypto universe, so when the last coin is mined, that's it. Those who hold the most coins will ultimately control its value at that point.

Whether you are a serious Bitcoin investor, or you just prefer using crypto to play online casino games, relax and take a breath. Cryptocurrency prices seem to have stabilized over the last week or so. Definitely keep an eye on where prices go from here, but don't work yourself into a froth worrying about a death spiral.

To all our faithful readers out there, we have this advice: go ahead and continue gambling online with your favorite cryptocurrency. If you are uneasy about Bitcoin, that's fine. There are online casinos that accept Bitcoin Cash, Litecoin, Ethereum, and others.

Both cryptocurrency and blockchain technology are here to stay. The market may reshuffle and generate new winners and losers, but even skeptics are not predicting the complete death of cryptocurrency. We could be in for some rough patches for a while, but Bitcoin and its competitors will ultimately survive.