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With the war in Ukraine raging on, and Russia targeted by crippling sanctions, fear is taking hold of the markets, including crypto.
Crypto investors are struggling to assess the effects of war in Ukraine on cryptocurrencies. One of the risks is a hit to Bitcoin’s hash rate.
The hash rate, a measure of the computing power involved in validation, is a key measure of network security. In Bitcoin’s network, it depends on mining.
Now, Russia, the third-largest Bitcoin miner faces boycotts, crippling sanctions and full-scale cyber warfare. While mining in Russia is working as normal so far, there are significant risks ahead. This is especially true as sanctions will likely include crypto.
For instance, last week, the Ethereum mining operation Flexpool announced halting all services in Russia.
We apologize to our Russian miners; many of you do not support the war. However, it is you who sustain your nation. Without the people, Russia cannot operate.
Many in the crypto space stand with Ukraine. Russian-born Ethereum founder Vitalik Buterin called the invasion a “crime against the Ukrainian and Russian people.”
While risks continue to mount, miners in Russia are reassuring their investors that all is well. Whit Gibbs from Compass Mining said that their facilities in Siberia are far from any geopolitical unrest.
I want to reassure our customers hosting in Russia that we are in constant communication with the facilities, which are in Siberia and well isolated from any geopolitical unrest. Compass has confirmed with our partners that all miners are safe and will continue running as normal.
However, sanctions, boycotts, and hacks targeting Russia will likely escalate.
Bitcoin’s hash rate is increasingly becoming exposed to geopolitical and regulatory risks in a limited number of countries.
One of them is Kazakstan, a country that could be going the way of China in cracking down on mining. The second-largest country in the world by BTC has rate has seen a huge influx of miners, following the mining crackdown in China.
Many miners moved from neighboring China due to low energy prices in Kazakhstan. Since then, Kazakhstan accounted for 18% of Bitcoin’s hash rate.
However, the authoritarian country is currently cracking down on crypto mining. The country is increasing mining taxes while closing mines that operate in the legal gray area.
Authorities are likely concerned about the increased energy consumption from mining. This is significant as Chinese authorities used the exact same justification for shutting down all mining in the country.
Since the Chinese crackdown, Bitcoin’s hash rate relies on an ever-smaller number of countries. With Kazakhstan at risk of going the way of China, the situation in Russia could be a major risk.
That’s why it is a good time to revisit the potential effects of the BTC hash rate on the price, and vice versa.
What is the Hash Rate?
But what is the hash rate and why is it important? Any blockchain network needs a way to determine if the transactions people make are legitimate.
To do that it needs to use a consensus mechanism. In particular, Bitcoin uses the oldest consensus mechanism – proof of work (PoW). PoW has miners solve complex mathematical equations to validate transactions.
Specifically, these equations involve a cryptographic process called hashing. The process allows converting a sequence of letters and numbers of any length to an alphanumeric sequence of fixed length.
In Bitcoin’s blockchain network. this allows storing all transaction data securely and efficiently. Because hashes can only be discovered at random, the process requires a lot of computational power.
The hash rate is a measure of that computational power. Specifically, it measures the number of hash computations – or hashes per second.
For example, Bitcoin’s network hash rate is at 209 exahashes per second (EH/s). That is the equivalent of 206 quintillion hashes per second.
The system is designed in that way to prevent spam. Without the need to expend energy, bots could spam the system with fraudulent transactions, hoping that a few would stick.
A strong hash rate also prevents the dreaded 51% attack. That is when one network participant gets a hold of the majority of the computing power in a network, allowing it to write false transactions.
What Affects the BTC Hash Rate?
The computing power in any network is affected by several factors. The most important of these are block rewards, energy prices, and the price of the crypto asset.
These factors are important due to their effect on mining profitability. The more profitable mining is, the more miners will expand their operations. When mining is less profitable, however, smaller and less efficient miners tend to fall out of the mining pool. This, in turn, decreases the hash rate.
Block rewards are the most obvious factor, as they are the direct rewards miners get. For Bitcoin, block rewards started at 50 BTC per block, subsequently halving approximately every four years.
These halving cycles mean that Bitcoin will be growing at an ever slowing pace. Due to that fact, there will never be more than 21-million coins. As block rewards drop, miners are less incentivized to mine Bitcoins. This could potentially lead to a drop in the hash rate in the long run.
While it may seem logical at first glance, mining difficulty does not affect the hash rate. Instead, mining difficulty adjusts itself automatically depending on the hash rate.
The adjustments work to keep an average block time at about 10 minutes. That means that the higher the hash rate, the more hash computations are required to mine a single block.
Moreover, energy prices play a huge role as well. As mining is very energy-intensive, energy makes up a large part of mining costs. This is why miners tend to favor countries where energy is cheap. Kazakhstan, Russia, the U.S. are mining hubs for that exact reason, as was China, before the crackdown.
Hash Rate and Price
One large factor influencing the hash rate is the price. However, the relationship between the two metrics is subject to some controversy. Some investors suggest that the hash rate is a good predictor of price. Others see the price driving the hash rate, by increasing mining rewards in cash terms.
While there are arguments for the former theory, studies seem to suggest that price drives the hash rate. Specifically, a 2019 study found a strong relationship between the two metrics from 2018 onward. Specifically, the hash rate lagged behind the price.
Just like with commodities like oil, a spike in price prompts producers to increase capacity. This means that, as the Bitcoin market matured, it started acting similarly to commodities.
There’s an obvious reason for this. As Philip Salter, head of operations at Genesis Mining explains, miners often amplify the effects on the price.
It’s no different from traditional markets, you have to sell everything to keep the operations going, to pay off your debts. As a miner you have bills to pay, you have to pay for electricity, for operations; and your expenses are in dollars, so as the price of bitcoin is dropping, it means you have to sell more of your inventory just to keep going.
These findings suggest that, while the hash rate is important for security, probably won’t impact the price of major cryptos like Bitcoin. The price of Bitcoin will likely be more influenced by demand considerations.