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When I last covered Bitcoin (BTC-USD) I said the top crypto asset by market cap was approaching my buy zone. In the two months since that article was published, we’ve seen the price plummet through the lower end of that zone. While I can freely admit I got that call wrong, I do want to revisit the current setup for those who view Bitcoin as a multi-year hold rather than as a month-to-month hold.
Like gold, Bitcoin is “mined.” Albeit through a completely different form of mining. Gold and other metals are mined out of the ground. Bitcoin and other cryptocurrencies are mined out of code. The notion that Bitcoin is created simply out of thin air is not accurate in my view. It takes a tremendous amount of energy to reward “miners” with freshly created Bitcoin. The Bitcoin is rewarded for securing the network and verifying transactions. When there are more miners securing the network, the hash-rate increases.
Last year when China banned Bitcoin, the hash-rate took a dive as China-based mining operations started to come offline. That hash-rate has since recovered and the Bitcoin network is just as secure as ever. With more miners coming online competing for the same Bitcoin supply, the difficulty in the block reward has increased.
You can see in the chart above that I’ve added a dotted line that represents the difficulty associated with mining Bitcoin. As the hash-rate increases, difficulty moves just about in lockstep. This means that it requires more energy expense to mine the same Bitcoin.
The problem that miners now find themselves in is one of higher input costs with a lower Bitcoin price. Their margin is taking a beating. And to be clear, this is largely by design. Bitcoin is going to continue to get more difficult to mine as the available mine supply continues to dwindle.
Given the current increase in mining difficulty coupled with the sharp price declines in the asset, miners now find themselves at 6-month profitability lows. While there’s certainly no guarantee profitability has to increase from here, I think miners will be able to help push Bitcoin prices back up by controlling the flow of the coins in an attempt to defend their margin.
The stock to flow model has been popularized by people like anonymous Bitcoin analyst Plan B and The Bitcoin Standard author Saifedean Ammous. While the metric certainly shouldn’t be taken as an absolute measure of Bitcoin’s value, we do currently find a fairly large discrepancy between where Bitcoin is and where the model says it should be.
At a little under $109,400 per coin, Bitcoin would have to nearly triple in dollar valuation to re-visit the stock to flow estimate. Bitcoin hasn’t really sniffed the stock to flow projection in close to 10 months. This would indicate the model is either broken or Bitcoin is due for a sizable move up in price. Given the increase in hash-rate, I believe miners will push price increases since they control the flow of newly minted coins.
When you look at Bitcoin on a logarithmic scale over the course of several years, you can get a sense of when Bitcoin is nearing long-term trend support and resistance levels.
Bitcoin has clearly struggled to break out and could potentially even retest the lower range of the multi-year uptrend. That would theoretically put the price of Bitcoin somewhere between $25-30k between now and April. That said, I don’t believe that is the most likely scenario.
Nothing is without risk and the same is true for Bitcoin. Though I have a long-term core position that I regularly add to, the technical indicators that I’ve generally had my eye on in this secular bull run don’t look terrific.
I’ve favored the 8-week and 20-week moving averages when making medium-term decisions. Bitcoin closing above the 8-week moving average would give me a lot more confidence going forward. I do believe that will happen but I see potential resistance at the 20-week moving average. Failure to get above that line would likely confirm a bearish head and shoulders pattern. A close above would set us up for a test of previous highs.
There is also the concern that there could be some sort of regulatory action that has a negative impact on Bitcoin’s legality in the United States. As Congress and the market await a crypto/CBDC report from the Federal Reserve, there’s always the possibility that lawmakers or the SEC could create problems for the cryptocurrency space without the Fed’s help.
Cryptocurrency is not for everyone. Understanding the relationship between mining profitability, hash-rate, and price is critical to understanding the current fundamental setup in Bitcoin. While I believe lower prices in the asset could potentially happen, I think there is a higher likelihood for miners to push for an increase in mining profitability in the short run. Long term, profitability will continue to decline but there will be ebbs and flows.
While the stock to flow model should never be the sole catalyst one looks at when deciding when to enter a Bitcoin position, if you believe the idea that the model is a justification for real value at any given time, going long spot here seems to be a pretty asymmetric bet that would favor bulls. I’ve increased my spot position in recent days and will continue to do so on any further weakness.
Bitcoin will go up because it must to maintain a secure network. The China precedent has been set and it has arguably strengthened the bull case for Bitcoin network security. It wasn’t that long ago that China accounted for over 70% of the Bitcoin hash-rate. The country has since punted on Bitcoin mining entirely yet the network has stabilized and continues to chug along. As mining operations expand, hash-rate figures to continue to rise. Ultimately that means the price of Bitcoin must do the same.
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Disclosure: I/we have a beneficial long position in the shares of BTC-USD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I’m not an investment advisor. Do your own research and be aware of your personal risk tolerance when buying or selling speculative digital assets.