Price and Hash Rates: Which Follows Which?

Some feel that as hashing power on the network increases, so too should price. But is this really how the relationship between price and the hash rate works?

After spending some time learning about Bitcoin and its network, you may come across an article with a headline very similar to this one from April:

Or this one from October:

The implication of articles like these is that as hashing power on the network increases, so too should price. But is this really how the relationship between price and the hash rate works? 

There are two schools of thought:

‍Hash Rate Follows Price / Price Follows Hash Rate 

Before we compare and contrast these two schools of thought, a bit of background: As you may already know, miners on the Bitcoin network are paid a reward of 6.25 Bitcoins per block plus any fees that were paid by transactors to get into that block. These fees are variable, but the block reward is constant (except for a halving event that happens once every four years). 

To increase the chances of winning these rewards, miners add hashing power to their operation. All of the mining power on the entire network is known as the “hash rate”. 
The higher the hash rate, the more secure the network is. So does hash rate follow price or does price follow hash rate? Why are these even related?

Let’s go through the arguments for each.‍

Bitcoin Price Follows Hash Rate‍

We’ll start with the belief that price follows hash rate. Typically, you will see this thesis not coming from technical people, but instead from financial writers and analysts. The idea is actually pretty simple and goes something like this: 

‍“Hash rate is an indicator of market interest in Bitcoin. If miners are stepping up their investment in their business, it means they are bullish on the price of Bitcoin. The network is also becoming more secure, so that makes the investment safer long term.”‍

Sounds reasonable, but is it valid? Partly. 

It is generally true that network security increases as hash rate increases (though there are corner cases where this isn’t necessarily the case). The main issue with this line of thinking is the belief that hash rate is a good indicator of miner sentiment AND that miners have any special knowledge. The truth is, miners are likely not any more aware of how Bitcoin will perform than anyone else is. They are just running computers. Besides that, they are like anyone else. But even if we assume they did have special knowledge, it’s not totally clear why any bullishness on their part would result in an increase in the hash rate. 

They could simply just go buy more Bitcoin.  

All of this is theory though. What does the empirical data tell us? Take a look at this chart over-laying historical price with historical hash rate. 

As you can see, the hash rate of the Bitcoin network really never goes down. There are tiny drops that occur from one week to another, but the basic trend is to flatline or increase. You’d really need to zoom in to find scenarios where any dips in hash rate occur (and even then, these dips may only last a few weeks). 

Price is an entirely different story. You see peaks and troughs quite clearly. Certainly, the general trend is for price to increase, but the periods of price dips are quite clear. Some are even months long. And during those dips in price, hash rate increases (see the squared sections for examples).  

So it would appear that price does not follow hash rate, and both the empirical and theoretical data bear this out. So how about the other way around?

Hash Rate Follows Bitcoin Price

This idea is a little more nuanced, but generally it sounds something like the following: 

“Hash rate is (partly) a function of the current Bitcoin price. Miners have many costs, including electricity, facilities upkeep, staff, mining pool fees, and massive up-front capital outlays to pay for mining ASICs. All of these costs must be justified by the block reward and the fees they earn from finding a block. The relative value of those all depend on the price of Bitcoin. If the price of Bitcoin drops, some amount of miners very likely will not be able to continue operating profitably, and their hashing power will go off the network.” 

This data from F2 Pool shows that revenue changes from day to day even if hashing power stays the same. Sounds good, but you may be wondering, “If this is true, why does hash rate seem to only go up even when the price dips for extended periods of time?” The hash rate rarely drops for a couple of reasons.

First, ASICs are a quickly depreciating asset. Newer, more efficient ASICs are constantly being built and sold, so less power is needed per hash. Mining farms will upgrade their equipment often to gain that efficiency, so hash rate increases while total power consumption may stay the same. 

Second, those miners who are priced out of the market due to a low Bitcoin price will liquidate their ASICs as quickly as possible. That means all that hardware gets sold on the cheap to a mining operation that is still profitable at that Bitcoin price. The hashing power is just trading hands, but it isn’t really leaving the network (at least, not for long).

Conclusion

The hash rate can be a perplexing metric since it does not tell us many of the things analysts often think it does. 

At the end of the day, hash rate is just a function of the costs and rewards to mining. Most miners will not and cannot mine at a loss (at least not for long), but that doesn’t mean their hashing power leaves the network forever. No matter what, though, the price of Bitcoin is hugely important for miner profitability, so it will tend to dictate the hash rate in the short term.