I provided quotes and data today for the Wall Street Journal, as they broke the story that China is closing Bitcoin mining operations and I wanted to give more detail on the potential consequences.
- In the short term, the Bitcoin price would likely become even more volatile as people interpret the news;
- In the medium term, the loss of computing power would make it slower, and more expensive, to make transactions – possibly for weeks; and
- In the long term, the loss of Chinese miners could change the balance of power on decisions regarding the Bitcoin protocol and possibly even threaten the security of the network.
Read on for the detail, and sign up to the Chainalysis newsletter for more analysis.
Bitcoin mining is the use of electricity and computing power to solve a mathematical puzzle to find the next block in the chain. The first miner to solve the puzzle gets a reward, currently of 12.5 Bitcoin, and confirms a set of transactions.
Nearly 80% of Bitcoin mining occurs in China. If this were to be shut down, there would be effects in the short, medium and long term.
In the short term, the Bitcoin price would likely become even more volatile as people interpret the news, as happened when China moved against exchanges in September 2017.
In the medium term, the loss of computing power would make it slower, and more expensive, to make transactions. This is because the difficulty of mining Bitcoin, which also confirms transactions, automatically adjusts to take into account the computing power available. However, it takes a target of 14 days for the difficulty to adjust. Removing a large percentage of the computing power before the difficulty level adjusts means there are fewer chances of the network solving a really hard puzzle. So it will take longer to find the next block, in which transactions are confirmed, and the price of a transaction being included in that block will be bid up.
A consequence of this is that it may take more than 14 days for the difficulty to adjust. This is because the difficulty adjusts every 2,016 blocks, and it adjusts so that it takes 10 minutes to mine a block. 10 minutes multiplied by 2,016 equals 14 days. However, if it takes longer to mine a block as less computing power is available relative to the difficulty level, it will take longer to reach the 2,016 block adjustment point. As a result, transactions would slow and increase in price not just for 14 days, but possibly for many weeks.
This could be exacerbated if some miners switch to mining Bitcoin Cash, as this is likely to become relatively more profitable with the increased challenge of mining Bitcoin, further reducing the computing power focused on Bitcoin.
In the long term, the loss of Chinese miners could change the balance of power on decisions regarding the Bitcoin protocol, such as Segwit2X, and threaten the security of the network, if a surviving miner were to have over 50% of the computing power on the network. However, China’s miners may relocate and government policy may change, so these long term effects are highly uncertain.