Why Bitcoin's hash rate crash is important to miners

15 October, 2019

People who follow Bitcoin religiously are aware that the world's leading cryptocurrency underwent a hash rate crash during the last full week of September (2019). After reaching 98 million TH/s on September 23, Bitcoin crashed to 57.7 million the following day. It recovered somewhat, standing at 88.3 million by late afternoon on the 24th.

None of this may matter to you if you either do not understand hash rates or don't look at Bitcoin as a long-term investment. A hash rate crash is an important event if you are a miner, though. It means something in regard to the Bitcoin network's ability to verify transactions and simultaneously prevent a 51% attack.

No one knows yet what caused the crash or how it will affect Bitcoin in the long-term. We do know that for most of the day on September 23, Bitcoin's price fell. If nothing else, the crash could undermine what was anticipated to be a bull market through the end of the year.

Hash rates explained

A hash rate has nothing to do with shaved potatoes or social media hash tags. Rather, hash rate in the cryptocurrency world is the rate at which a network completes a hash function. The simplest way to understand it is to say that hash rate is a measurement of how fast a cryptocurrency network completes a single operation within the platform code.

For all intents and purposes, hash rates equate to transaction speed. The higher the rate, the faster the Bitcoin network is able to process transactions. Crashing from 98 million TH/s to under 58 million TH/s equates to a drop of 40%. That kind of performance loss shows up pretty quickly when you are dealing with large-scale trading.

Hash rates matter to crypto miners because it affects the speed at which they work. That speed affects their reward as well. Remember that mining is all about earning coins by completing the mathematical computations necessary to build blocks in the chain.

Building blocks is a matter of making what could equal millions of calculations just to complete the computations first. Every calculation equals a single hash. So if Bitcoin's hash rate is 98 million TH/s, that means mining computers are making calculations that quickly in order to build blocks.

Hash rates and mining difficulty

For you and me, hash rates are mainly applicable to transaction speed. But they mean more to coin miners. They are in competition to build blocks more quickly for the simple fact that only one coin is awarded per block. The miner that completes the next block first gets the coin. Hash rates make a difference here.

Bitcoin's code has been written to make mining more difficult as time goes by. The idea here is to make it harder to mine coins and therefore increase coin value with every successful mining attempt. The mechanism is necessary to maintain the value of an asset that is limited by design.

What you need to know is that mining difficulty and hash rates are linked. When mining difficulty goes up, hash rates go up as well. The system is built this way to prevent a single miner or small group of miners from launching a 51% attack, thereby taking over the network and stealing coins.

This suggests that a 40% drop in less than a day's time creates a security problem. Such a steep drop opens the door to a 51% attack, even though the chances of such an attack are still slim. Again, hash rates and mining difficulty are linked. When hash rates decline, so does mining difficulty.

More work affects profitability

Bitcoin's progressively more difficult mining is a way off insuring coins retain value. But it is not all sunshine and roses. As mining becomes more difficult, it also consumes more resources. Mining equipment has to get bigger and more powerful. It also consumes more electricity for each new block built. This eats into profits. Mining operations are generally compensated by higher coin values, but there is a tipping point at which mining becomes too expensive.

The end result is that larger mining operations buy out smaller operations that can no longer compete, thus consolidating their positions. Some smaller operations simply cease operating without being absorbed. But even this increases consolidation among a smaller number of players.

What do hash rates have to do with any of this? Small fluctuations are not a big deal. But a major crash that is sustained over a significant amount of time would allow the largest mining operations a competitive advantage given that they have more powerful equipment yet have to do less work to build blocks. As long as the hash rate remains low, they stand to make more profit.

History repeats itself

Bitcoin historians note that the recent hash rate crash is not a first. A similar crash happened back in November 2017 when Bitcoin was trading at around $8,000. When that particular crash occurred, Bitcoin's hash rate lost almost 50% in a short amount of time. This caused a bit of panic that resulted in a sell-off.

Interestingly enough, investors looking to get out of Bitcoin put their money into Bitcoin Cash instead. The latter experienced a very impressive surge in November of that year. However, Bitcoin's problems were not permanent. The network recovered its hash rate in short order and confidence was restored. A month later, Bitcoin reached its peak of just under $20,000.

Bitcoin's history does not necessarily foretell the results of the more recent hash rate crash. There is concern on the one hand that the crash could trigger what some people call the 'death spiral'. Such a scenario would see a total collapse of prices while both hash rates and transactions times slowed considerably. It could also open the door to a successful 51% attack.

On the other hand, the crash could be nothing more than a technical glitch that self corrects within days. In such a case, Bitcoins price would likely continue falling until hash rates were restored. At that point, some of the largest investors looking to profit from the commensurate sell-off would start pumping money into the network at whatever point they felt prices had bottomed out. That could start a bull run.

At the time this post was written, prices and hash rates still had not fully rebounded. There is no way for this author to know which way it will go. However, the death spiral scenario is highly unlikely.

Important lessons to learn

In closing this post, are there lessons to be learned from the hash rate crash? Absolutely. The first lesson is a simple reminder that no investment vehicle is immune to risk. Of all the lessons, this one is probably the most important. Bitcoin has a certain mystique that causes far too many people to believe it is invincible. Guess what? It is not.

Even if the hash rate crash turns out to be nothing, people have already taken a loss on their investments by selling in fear. Someone who's coins were worth $10,000 a few weeks ago lost out when they sold at the sub $9,000 mark. Here's the point: that's the way it goes when you invest. You win some and lose others. Bitcoin is as much a risk as any other cryptocurrency or traditional security.

The second lesson to be learned is that experts do not know as much as they try to make you believe. There are all sorts of opinions regarding what the crash means, what caused it, and where Bitcoin will go from here. But no one really knows. All we can do is let the dust settle and then look at evidence down the road.

Maybe someday we will figure out what led to the crash. Maybe we will not. But trying to make predictions about the future based on a single event is a fool's errand. Investments are too volatile for any such predictions to have any traction.

Lesson number three is a reminder that Bitcoin is not a tangible asset. It exists only as digital data tracked in a blockchain ledger. Even with all of the built-in security, Bitcoin can be reduced to nothing under the right circumstances. That is one of the risks of investing in cryptocurrency.

Unlike gold, you do not really possess anything when you own Bitcoin. Gold will always have value because it is tangible. Bitcoin may end up with no value if the bottom falls out.

Keep an eye on things

A hash rate crash is significant enough to be acknowledged. It is important to cryptocurrency miners in that it affects their profits, the amount of work they have to do to earn those profits, and the potential of a 51% attack. Rest assured that Bitcoin's top miners are paying attention to this most recent event.

For everyone else, there is no need to panic. Just keep an eye on things. In the unlikely event that hash rates and prices continue falling at an alarming rate, that could be an indication of the death spiral. In such a case, investors would be wise to cut their losses and run. But again, that is not likely to happen. It is more likely that things will bottom out before re-stabilizing and initiating new growth.