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Bitcoin’s mining difficulty recently dropped roughly 32 percent in the last month following an extended bear market throughout 2018.

As miners continue to shut down due to unprofitability, those who remain mining will be rewarded with increased BTC accumulation (less competition), but the low prices may still preclude profits from most mining operations.

However, Bitcoin — and the broader cryptocurrency markets — have been making a recent surge in prices over the last several days, with Bitcoin surpassing $4,000 last night. Whether or not the momentum can be sustained and lure more miners back to the ecosystem is yet to be seen.

Bitcoin’s Mining Difficulty Adjustment

Bitcoin’s protocol accounts for miners shutting down by readjusting the target difficulty for mining blocks. The goal is to incentivize miners to stay mining on the chain by making the process cheaper and easier to find blocks.

Reductions in mining difficulty correlate closely to adverse price movements, and it represents an effective method for automatically adjusting incentives across the network without decisions needed from outside parties. A reduced mining difficulty and Bitcoin price also corresponds to decreased costs in mining hardware, further providing an opportunity for miners who remain on the chain to aggregate an advantage if they wish to expand their position in a bear market.

Speculation persists about Bitcoin’s ‘breakeven cost,’ but considering the various prices of electricity, hardware, and real estate, the notion of Bitcoin having a fixed mining cost does not take into account the dynamic difficulty adjustment.

As in all free markets, the price is the mechanism through which the market communicates information to participating entities (i.e., miners), so Bitcoin’s price remains the best indicator of average mining cost since the difficulty target readjusts to target it.

The difficulty has dropped significantly since September and is now mirroring levels in the middle of the summer. However, both the hash rate and mining difficulty — despite both being down — are substantially larger than they were last December, with the difficulty and the hash rate both roughly 2.7 times higher this month than at the same time last December.

Bitcoin’s ability to dynamically adjust to the mining market is a vital component of its sustainability. Reduced difficulty allows miners to find blocks faster and at cheaper rates, providing adequate incentive and decent returns on their investment.

The drastic drop in difficulty over the last month may trigger a return by many miners to the market, especially as it corresponds to a recent surge in prices leading into the holidays.  

Bitcoin’s mining difficulty adjustment is not perfect, however, as its control theory design has been criticized for having a delayed response to hash rate changes that can amplify downwards or upwards trends in price movements disproportionately. Further, extended periods of upward price movement can lead to blocks arriving faster than they should, and the opposite effect is true when there are extended periods of downward price pressures.

It will be fascinating to watch how Bitcoin mining plays out over the next few weeks as the holidays are looming, the price is surging, and both the hash rate and difficulty are down.

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