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There have been claims that Bitcoin price and difficulty correspond. Is there empirical data to support or refute this?

  • 4
    This doesn't answer your question, but: The logic for why this happens is not obvious. When the price of Bitcoins is higher, people are more likely to mine, especially people whose costs are close to their expected proceeds. The greater number of miners drives up the difficulty. Price drives difficulty, not the other way around. (If this is correct, it should be empirically verifiable -- which rises first?) – David Schwartz Sep 2 '11 at 8:19
  • I will second David on this, we have seen this recently with the price drop being followed by a decrease in network hashrate. – Alex Waters Sep 2 '11 at 9:08
  • @Alex Waters: Well that's an answer then, isn't it? If a price drop is seen to be followed by a decrease in hash rate (which obviously will lead to a difficulty drop) then that's empirical data relating price to difficulty. – David Schwartz Sep 2 '11 at 9:36
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If you look at the network hash rate, you'll notice that it fell off after the Bitcoin exchange rate dropped.

This leads to the conclusion that price drives difficulty. A drop in price caused a drop in difficulty. I have noticed this same correlation on another occasion; about two months ago.

Also, the reverse is probably true. When the price soared to $30+; the network hash rate accelerated greatly. The higher prices clearly attracted miners.

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    please check out my website bitcoinx.com/charts where you have both difficulty and price in one diagram. Mining profitability is available, too. – kermit Sep 29 '11 at 10:11
  • @phelix - Just what I was looking for. How did you compile the data for these charts? – goodguys_activate Sep 18 '12 at 23:24
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This relationship can be seen visually, though it is a rough correlation. In the all time chart (scroll down) you can see the orange being the price at Mt. Gox, and the grey line that steps up and down being the difficulty.

Summary: AFTER the price moves, the difficulty follow the same direction, ... lagging two to five weeks roughly: - http://tvori.info/bitcoin/charts

The green line shows profitability, which is not part of your question but is the most important line in that chart so I wanted to point that out.

Incidentally, following the traders on the #bitcoin-otc marketplace gives the anecdotal evidence that

  • When profitability is high miners are hoarding (they are saving their bitcoins and if adding capacity will do so using their cash to purchase)

  • When profitability is low miners are generally selling off. They have electricity bills to pay, credit card bills for the hardware they purchased, etc, and with less profits they liquidate their holdings. This of course, increases price volatility -- especially without any decent Bitcoin derivative instruments (e.g., an options market).

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Here you go!

Click the tab at the bottom Difficulty Versus Price for a chart view.

As-of Jul 4, 2012 here's those charts:

enter image description here enter image description here

0

The purpose of the difficulty is to ensure a blockchain solution is produced roughly every ten minutes. If there is a lot of hashing power available then solutions will be found quickly which causes a correction to make it harder, or conversely to make it easier.

So the nub of the question is what causes variation in the hashing power? The short answer is the efficiency of solving the problem. This introduces other aspects:

  • Cost of efficient solution finding systems (CPUs, GPUs, FPGAs, ASICs, supercomputers, mining trojans etc)
  • Level of altruism in the system

Assuming that most miners are in it for the money rather than just being enthusiasts, then the primary concern is profit margin. So long as a miner can turn a profit that exceeds other available investments then he is rational to continue mining. He then faces the problem of maximising his profit margin above the break even point.

Once way is to find and exploit a super-efficient way of solving the hashing problem just a little ahead of other miners then his operating costs are reduced without unduly affecting the difficulty level.

Another is to reduce operating costs, perhaps by taking advantage of free electricity. He may even enjoy the side effect of heating his home during cold winter months, this reducing his operating costs further.

This would mean that hash rate would be invariant against mild fluctuations in the price of a bitcoin.

So, in short, it is individual profit margin to miners that drives the hash rate, not the naked price of a bitcoin.

  • 1
    Yes, difficulty should be a laggy indicator of price because of the time it takes to get new rigs online and the unwillingness to take them offline. It will probably also be "sticky up", as even if bitcoin plunges into unprofitable to mine category, there will be people who will still mine at a loss in the hopes that bitcoins will increase in value (even though in that case they are better off shutting the miners down and buying bitcoins with the money they are spending on electricity). A psychological thing. – lemonginger Sep 2 '11 at 19:52

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