The Great Hash-Rate Exodus of 2021

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China has finally put the hammer down on its native mining operations, causing bitcoin’s hash-rate to crash and flee to friendlier regions around the world. We’ve heard many different flavors of pseudo bans come out of China over the years but mining seemed to flourish in China without interruption. But times have changed and we’re entering a new era of bitcoin mining.

China has been a paradoxical component of the crypto ecosystem for a long time because it’s held a tough stance on many crypto related activities yet was also home to over 50% of the bitcoin network’s hash-rate since 2015. This somewhat confusing reality fed into an inaccurate “China controls Bitcoin” narrative that was hard to dislodge. This long running narrative has come crashing down in what seems like a flash, and it has broad implications for the network and the world.

China’s Mixed Relationship with Bitcoin (a timeline):

  • 2011: The first Chinese Bitcoin exchange, BTCChina, launched.
  • May 2013: Huobi and Bitmain are founded.
  • December 2013: The Chinese central bank released a statement saying that Bitcoin could not be used for products and services and that financial institutions could not buy or sell them.
  • August 2015: Four Chinese Bitcoin mining pools accounted for half of the Bitcoin network’s hashrate due to low electricity costs and local manufacturing facilities that could create low-cost, high-efficiency mining hardware, helping to foster a Bitcoin mining environment in China.
  • 2016: Huobi’s total reported volume surpassed $250 billion and accounted for over 60% of all reported Bitcoin exchange activity.
  • 2017: Initial Coin Offerings (ICOs) started to emerge.
  • September 2017: Government bans ICOs and fiat to crypto swaps; in response, many exchanges moved operations out of the country.
  • November 2019: Chinese state media released a front-page report praising Bitcoin as a successful application of blockchain technology and the government’s plan to issue its own digital currency.
  • June 2021: China and the various provinces of China force miners to shut down.

China’s reported reasoning behind the shutdowns centers around social order as well as energy and environmental concerns. From our perspective, the current regime’s concern over their lack of control is understandable given the freedom, privacy, and property rights that bitcoin affords its users. Bitcoin’s permission-lessness provides a clever route for Chinese citizens to circumvent the capital controls imposed by the Chinese Communist Party (CCP). This cannot be denied.

However, the government’s energy and environmental concerns don’t contain as much merit, given the nature of the electricity bitcoin miners are using in China. Much of the energy being used is non-rivalrous and will be produced regardless of the presence of bitcoin mining. Mining operations do not reduce retail consumers access to electricity and they’re paying for energy that often has no customers. In addition, bitcoin mining in China consumed a small fraction of the electricity China produces. In 2020 alone China reportedly produced about 7,623 TW/h while the entire bitcoin network is consuming electricity at a rate of about 70 TW/h per year. If about 55% of these 70 TW/h were consumed in China this means Chinese bitcoin miners were consuming a minuscule 0.5% of Chinese electricity production. Hardly a concerning amount. And lastly a large portion of that hash-rate is generated by zero-emission hydroelectric sources, located primarily in the Sichuan region of China. When we take these factors into account, it’s hard to take China’s concerns over energy and the environment seriously. China’s mining ecosystem consumes a negligible amount of non-rivalrous energy, a large portion of which is produced through zero-emission sustainable energy. Based on what we know about the qualities of bitcoin as well as the nature of Chinese based bitcoin mining, social control seems to be the overriding reason for the crackdown not energy or environmental issues.

Where is this hashrate going?

Kevin Zhang of Foundry is reporting that the earliest beneficiary are miners in Kazakhstan who have excess mining infrastructure available and are geographically proximate to China. Although Kazakhstan’s global economic impact is somewhat small, its collective hash-rate has placed the country in the top four hashers behind only China, the United States, and Russia for the last two years. If we measured the hash-to-GDP ratio of each country, Kazakhstan would easily be one of the top hashers in the world on a relative basis, and might even be number one.  

Kazakhstan is poised to benefit most in the short run but anecdotal reports and favorability assessments conducted by mining research groups suggest North America (United States (Texas) and Canada (Quebec)) in particular will be the biggest beneficiary of the Chinese miner migration, medium to long term. Thanks to a potent mix of factors including strong property rights, regulatory certainty, abundant energy supply, many operators with knowledge/know-how, and deep capital markets.

Given the trends we have observed, Hashrate Index anticipates that a non-trivial share of China’s hashrate will move to the United States, somewhere between 30-40%. With this immigration, a new balance of power for mining pools will come with it. We anticipate over 40 EH will be managed by US-based mining pools by the end of 2021.

Colin Harper, Hashrate Index

Even before the mining ban in China, there had been an emerging discussion in crypto-media and crypto social media centered around the growth of North American mining. Estimates provided by Compass Mining suggest North American miners had already purchased at least $500 million in mining hardware over the last year prior to the Chinese mining ban. In addition, certain regions of North America have been crafting positive regulatory frameworks and incentive programs for miners, and many mining-related entities have accessed North American capital markets over the last couple of years. The main obstacle holding North American mining back is a lack of open “rack space” or infrastructure that is ready to go today. According to estimates floated by operators, it should take 6-18 months to incorporate a lot of the Chinese hash-rate into North American mining operations.

After North America, greater Eurasia, also known as the Commonwealth of Independent States, which includes Russia & Kazakhstan, would be the next biggest beneficiary of the hashrate migration out of China. These countries are geographically, economically, and culturally closer to China and many already have serious mining operations.

South America & Northern Europe are also poised to attract some hash power. Venezuela and Norway, are petro-abundant states that have become more active in mining recently while Paraguay, El Salvador, and Iceland already mine or have publicized plans to utilize their renewable resources, hydroelectric in the case of Paraguay, and geothermal energy in the case of El Salvador and Iceland, to mine bitcoin.

Even though the mining exodus out of China to these other countries is real, we should keep in mind that some mining experts expect Chinese mining to continue being a force in bitcoin mining despite the official shutdown. 

China will continue to hold a significant share of hashrate, even if the industry is banned nationwide. The buildout costs are simply too attractive for venturers to ignore. In the case that cryptocurrency mining is banned across China, we would expect to see the industry continuing as an underground activity with mining centers continuing to be framed as cloud computing centers and secret operations being established. The logistics of uncovering such operations would be extremely difficult for authorities, given the wide breadth of remote regions in China and the current phenomenon of some miners disguising data centers as cloud computing centers. 

Compass Mining

Other Effects of the Exodus

Difficulty Adjustment

As a result of the Chinese mining ban, bitcoin recorded the largest difficulty adjustment in network history of 28% on July 2nd, 2021. Bitcoin’s hashrate had climbed to as high as ~180 terahash per second (TH/s) during April of 2021 and crashed to ~85 TH/s during the first week of July 2021 bringing bitcoin’s hashrate back to levels last seen in late 2019. A little more than half of the network shut down somewhat suddenly yet the bitcoin network chugged along producing block after block after block, demonstrating the incredible resiliency of the bitcoin network. Observant power users may have noticed that over the last two-weeks of June, blocks were created at a slightly slower pace than they’re accustomed to. This slowdown was caused by a sudden drop in network hash-rate during a certain difficulty level that wouldn’t be adjusted for another couple thousand blocks.

The difficulty level is set algorithmically by the bitcoin protocol which is trying to keep the user experience and the inflation rate of bitcoin as predictable and constant as possible. Satoshi wanted the bitcoin network to create blocks every ten minutes regardless of the amount of computing power that is dedicated to the network at any given time. To do this Satoshi created a difficulty adjustment algorithm, a critical component of bitcoin’s architecture. Every 2,016 blocks the bitcoin protocol takes an assessment of the frequency of blocks created and adjusts the difficulty level according to the size of the deviation away from the goal of 10 minute block times. For example, if the bitcoin network is creating blocks at the rate of 8-minute intervals over the last 2,016 blocks, the difficulty level will be incremented up 20% to make it harder for the network to create blocks. If the network is creating blocks at a rate of 12-minute intervals the difficulty adjustment will decrease the difficulty level by 20% to make it easier for the network to create blocks in 10 minutes. These bi-monthly adjustments keep the bitcoin protocol’s user experience dependable and inflation rate on schedule.

Bitcoin’s difficulty adjustment is similar to the concept of dynamic difficulty adjustment in video games. Video game makers strive to create games that adjust to the skill level of their players, which changes over time for every individual player and differs immensely from player to player. Video game creators don’t want to make the game too hard or too easy for its users but rather hit a sweet spot in the middle. Similarly, Satoshi created a multi-player monetary video game that adjusts to the strength of the network that’s playing the bitcoin mining game. This produces a good user experience and keeps bitcoin’s inflation schedule stable and on track. 

A New Mining Landscape 

The economics of mining have slightly changed because the prices for ASIC miners in the secondary market have plummeted and almost half of the competition for block rewards is temporarily gone.  Miners that are outside of China and have stayed operational should expect to earn more revenue as they should win block rewards with greater frequency due to controlling a greater proportion of the network’s hash-rate. On the cost side of the equation, due to so many large and medium size operations shutting down in China, the secondary hardware market has been flooded with supply from these operating selling their mining machines, tanking prices for old and/or used ASICs. The current word amongst mining circles indicates that new machine development and sales are probably on hold until this new used supply is absorbed by the greater mining industry. Higher revenue and lower costs are recipes for outsized profits for the miners who have stayed operational. This won’t last too long but it could be long enough to make the stakeholders of certain firms happy and give minor players the opportunity to become major players. 

As a result, we expect to see some measurable shifts in organizational power. Chinese mining giants like Bitmain, F2pool, and others will undoubtedly still play a large role going forward but this latest crackdown allows other organizations and services outside of China to play a bigger role in securing the network. China’s mistake is a blessing for mining organizations and services world-wide as well as a catalyst for greater decentralization.

Coda

The summer of 2021 is the beginning of the end of a long era of bitcoin mining that was dominated by Chinese hashers who had access to an abundance of cheap electricity as well as front row access to advanced mining equipment. Now that their access has been terminated by the CCP, a massive mining diaspora is underway with North America and Eurasia positioned favorably to absorb much of the hash-rate exodus over the next year and a half. Throughout it all, bitcoin’s relative decentralization will continue to grow as will the world’s faith in its anti-fragility.

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