Bitcoin: It will because it has to (BTC-USD)

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Last time I hedged Bitcoin (BTC-USD), I said the best crypto asset by market capitalization was approaching my buy zone. In the two months since the publication of this article, we have seen the price drop to the lower part of this zone. While I can freely admit that I was wrong on that call, I want to revisit the current setup for those who view Bitcoin as a multi-year hold rather than a monthly hold.

Understand the mining process

Like gold, Bitcoin is “mined”. Although through a completely different form of mining. Gold and other metals are mined from the ground. Bitcoin and other cryptocurrencies are mined from the code. The idea that Bitcoin is created simply out of thin air is not accurate in my opinion. It takes a tremendous amount of energy to reward “miners” with freshly minted Bitcoin. Bitcoin is rewarded for securing the network and verifying transactions. When there are more miners securing the network, the hash rate increases.

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Last year, when China banned Bitcoin, the hash rate plummeted as China-based mining operations began going offline. This hash rate has since recovered and the Bitcoin network is as secure as ever. With more miners coming online competing for the same supply of Bitcoin, the difficulty of the block reward has increased.

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You can see in the table above that I have added a dotted line which represents the difficulty associated with mining Bitcoin. As the hash rate increases, the difficulty moves at roughly the same rate. This means that it takes more energy expenditure to mine the same bitcoin.

Profitability of the miner

The problem miners now find themselves in is one of higher entry costs with lower Bitcoin price. Their margin takes a hit. And to be clear, that’s largely by design. Bitcoin will continue to get harder to mine as the available mining supply continues to dwindle.

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Given the current increase in mining difficulties coupled with the sharp decline in asset prices, miners are now finding themselves at low 6-month profitability levels. While there is certainly no guarantee that profitability will increase from here, I believe that miners will be able to help push Bitcoin prices higher by controlling the flow of coins in an effort to defend their margin.

Stock to sell

The stock-flow model was popularized by the likes of anonymous Bitcoin analyst Plan B and Saifedean Ammous, author of The Bitcoin Standard. While the metric should definitely not be taken as an absolute measure of Bitcoin’s value, we are currently seeing quite a large gap between where Bitcoin is and where the model says it should be.

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At just under $109,400 per coin, Bitcoin would need to nearly triple its dollar value to revise the stock estimate to sell off. Bitcoin hasn’t really sniffed the stock to flow projection in nearly 10 months. This would indicate that the pattern is either broken or that Bitcoin is due for a major price increase. Given the increase in hash rate, I think miners will push price increases as they control the flow of newly minted coins.

The long term vision

When looking at Bitcoin on a multi-year logarithmic scale, you can get an idea of ​​when Bitcoin is approaching long-term trend support and resistance levels.

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Bitcoin clearly struggled to break out and could even potentially retest the lower range of the multi-year uptrend. This would theoretically place the price of Bitcoin between $25-30,000 by April. That said, I don’t believe that’s the most likely scenario.

Risks

Nothing is without risk and the same goes for Bitcoin. Although I have a long-term middle position that I regularly add to, the technical indicators I’ve generally seen in this secular bull run don’t look great.

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I favored the 8 and 20 week moving averages to make medium-term decisions. Bitcoin closing above the 8 week moving average would give me much more confidence going forward. I believe this will happen, but I see potential resistance at the 20 week moving average. Failure to break above this line would likely confirm a head and shoulders downtrend. A close above would set us up for a test of previous highs.

It is also feared that there could be some sort of regulatory action that negatively impacts the legality of Bitcoin in the United States. While Congress and the market await a crypto/CBDC report from the Federal Reserve, there is always the possibility that lawmakers or the SEC could create problems for the cryptocurrency space without help from the Fed.

Conclusion

Cryptocurrency is not for everyone. Understanding the relationship between mining profitability, hash rate, and price is key to understanding Bitcoin’s current fundamental setup. While I think a decline in asset prices could potentially occur, I think it is more likely that miners will push for an increase in mining profitability in the near term. In the long term, profitability will continue to decline but there will be ebbs and flows.

While the stock-flow pattern should never be the only catalyst to consider when deciding when to enter a Bitcoin position, if you believe in the idea that the pattern is a vindication of actual value at any given time, go long here seems like a pretty asymmetrical bet that would favor the bulls. I have been increasing my spot position over the past few days and will continue to do so if there is further weakness.

Bitcoin will go up because it needs to maintain a secure network. The Chinese precedent was set and it arguably strengthened the bull case for Bitcoin network security. Not so long ago, China accounted for over 70% of the Bitcoin hash rate. Since then, the country has fully embarked on Bitcoin mining, but the network has stabilized and continues to progress. As mining operations expand, the hash rate numbers will continue to increase. Ultimately, this means the price of Bitcoin must follow suit.

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