The Breakdown - Network Undergoes Biggest Difficulty Adjustment Ever; BMC Says 67.6% of North American Bitcoin Mining Is Sustainable

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Friday, July 2nd, and today we are discussing mining. It's a brave new world out there, and things are happening fast. Here's a recap in case you spent the last month, I don't know, hiking the Camino de Santiago or something, without an internet connection. Towards the middle end of May, the vice premier of China started talking about a Bitcoin mining ban. The Twitterati initially rolled their eyes at yet another China ban's crypto story,

Starting point is 00:00:47 but, interestingly, China-based miners did not. They started spring into action almost immediately, including liquidating some amount of their crypto to be able to act more nimbly. Over the following month, we saw numerous state-level implementations of a Bitcoin ban, including in a province that mines primarily with hydroelectric power. At first, there had been questions about whether it would be solely coal-powered mining targeted by this ban, but it turns out that no, it was mining in general. There has been a ton of discussions about motivations. Some have argued it's about ESG concerns and green goals. Others have said it's about China turning their focus

Starting point is 00:01:22 from attacking fintech to attacking crypto in order to clear any competition for their digital currency. Still, others have speculated that it's about fears of social destabilization that come with crypto while still others say it's about cracking down on local corruption. Whatever combination these things and others is correct, it has happened. As you heard on Long Read Sunday last week, the broad sense is that the Great Western Hash Rate migration is real. That being said, there is still a ton up in the air. What portion of miners are going to move their business to the U.S. to newly friendly jurisdictions like Texas and Kentucky? How many are going to move to more convenient countries bordering China like Kazakhstan or Russia? But as that happens in the short term,

Starting point is 00:02:03 a huge amount of hash power has left the network, as much as about 50%. Luckily, there is the difficulty adjustment, one of Bitcoin's most elegant and least appreciated features. So what is difficulty adjustment? In short, Satoshi knew the network would need to be resilient to exogenous shocks in the composition of miners. The difficulty adjustment is a process by which the network can automatically make winning blocks easier or more difficult, based on how much competition there is among miners. When lots and lots of miners are using lots and lots of power to try to mine blocks, the difficulty gets harder. When miners leave the network, the difficulty adjust down.

Starting point is 00:02:40 The difficulty matters because it can determine based on both the cost of capital expenditures as well as the cost of local electricity, whether a certain mining rig is actually profitable to mine with or not. When the difficulty is high, older machines can be useless, but can become profitable again when the difficulty decreases. This process happens every two weeks, well, every 2016 blocks, which at 10 minutes per block is roughly two weeks. Today we're expecting to see a roughly 27% drop in the difficulty, which will make it the biggest

Starting point is 00:03:08 difficulty adjustment ever. By a lot as well, it's 50% more of an adjustment than the previous biggest adjustment, which was 18%, all the way back in 2011. It's also the third straight difficulty decline, which hasn't happened since December 2018. The important thing about all this is, it will go off without a hitch, incentivizing more hash power to come back online, motivated purely by it being more economical for them to do so. Difficulty adjustment is one of the most truly insanely visionary parts of the design of this entire economic system. It is such a simple, clean, perfect use of market incentives to keep everything running smoothly. It is resilience incarnate. That wasn't the only interesting thing that happened with mining over the last 24 hours or so,

Starting point is 00:03:52 however. Again, for those who were off on the Appalachian Trail or whatever, around the time that all this China stuff was going down, Michael Saylor convened a group of the largest North American mining interests. He invited Elon Musk to the first meeting and they discussed, well, a ton of things, but the one conclusion or shared commitment that they came away with was about standard disclosures for energy usage. The idea was that whatever those numbers actually showed, at least they would be canonical rather than random estimates from random studies that critics could cherry pick to make things look worse than they were. This group called themselves the Bitcoin Mining Council, and there was a fair bit of controversy around it. Was it too much like the closed-door group

Starting point is 00:04:28 of corporates from the New York agreement? Why were they soliciting Elon? Et cetera, et cetera. Still, net-net, most bitcoiners have given the Bitcoin mining council the benefit of the doubt. And one interesting little nugget of the story as well was that at some point over the last couple weeks, in response to a tweet saying that he had completely abandoned Bitcoin, Elon said no, he hadn't, and in fact set an unofficial target of renewables composition at 50%. Once 50% of Bitcoin was mined by renewables and that was trending to improve, Tesla would begin accepting Bitcoin again. One of the most important developments in this space is that community banks, regional banks,

Starting point is 00:05:06 and credit unions can now start offering Bitcoin to their customers. That's right. Checking, saving, and now Bitcoin. It's all happening seamlessly thanks to a platform by NIDIG that offers institutional-grade custody and compliance. They're also the sponsor of The Breakdown. And if you want to find out more, go to nidig.com slash NLW. That's nydig.com forward slash NLW. I've talked about this on shows before, and I don't want to dwell on it, but I do think there is a certain logic in setting a target that advocates, particularly those on the regulatory side, can rally around.

Starting point is 00:05:46 Either way, the Bitcoin Mining Council popped up yesterday with an interesting document. Michael Saler tweeted, based on the Bitcoin Mining Council's survey of the network, mining electricity mix increased to 56% sustainable in quarter two, 2021, making Bitcoin one of the cleanest industries in the world. Now, that's a pretty spicy headline, especially in the context of that 50% of that 50% of that 50% of the world. 50% target from Elon, but what's the fine print? What are the details? Well, first, the composition of the group. The BMC now lists 23 members who represent 32% of global hash power. Their presentation argues that among those members, 67.6% of mining is sustainable sources. The 56% number represents the whole world and is an estimate. They argue that sustainable mining grew significantly between Q1 and Q2, from 36.8% to 56%, a 52.2% jump overall.

Starting point is 00:06:36 Now, when they say sustainable electricity, what do they mean? Well, they define it as electricity that's generated by hydro, wind, solar, nuclear, geothermal, and carbon-based generation with net carbon credits. They say it's based on the principles brought forward by the EIA's Net Zero by 2050 report. Second, on how they got the global data, quote, the BMC surveyed Bitcoin miners around the world asking three questions. One, how much electricity does your total fleet consume today? Two, what is the total percent of sustainable electricity within your fleet's power generation mix today? Three, what is the total aggregate hash rate of your fleet today?

Starting point is 00:07:10 One nugget I want to pull purely from a marketing and advocacy perspective is a new line that they're pitching. The slide that sets up the rest of the deck says, Bitcoin mining uses a negligible amount of energy, is rapidly becoming more efficient, and is powered by a higher mix of sustainable energy than any major country or industry. That higher mix of sustainable energy is obviously a narrative upending, and it's something that we can plausibly argue precisely because of the transparency of the network. So everyone just accepted these numbers as canonical now, right? Right? Well, this is Bitcoin. Of course not.

Starting point is 00:07:41 Larry Sirmak, who was on the show a couple weeks ago, responded to Sailor's tweet saying, this is really laughable. No methodology discussed, very dubious result, and super small sample of like 5% of the total hash rate. No one knows what the energy mix will look like until the hash rate from China relocates and a new proper study is conducted. Why do people trust this? That was tweeted mid-conference call, so a bit more was revealed, but Larry was still uncomfortable with how up in the air things are right now. Quote, How can any conclusions be made from the survey if more than 50% of hash rate went offline and is relocating at the moment, which can easily take months?

Starting point is 00:08:13 Zach Vole, who used to be at Coindesk and who is now working with Compass mining, agreed that there's too much up in the air for this to feel at all representative. Although Amanda Fabiano, who heads up Galaxy Digital's mining efforts, and who is on the council, replied, at what point would it be okay to pull, Zach? The network is literally always growing and changing. This is a snapshot of time. Next quarter will be another snapshot in time.

Starting point is 00:08:33 For my part, I don't think those concerns are illegitimate. This is a moment of seismic upheaval for the entire network, perhaps the most significant in the history of Bitcoin mining, at least since ASICs became available. However, I think I tend to come down on the side of Nick Carter. And so I'm going to read a few tweets from his thread about all of this. He says, the point is, we had no bottom-up data. Now we have bottom-up data for one-third of the network.

Starting point is 00:08:57 That's great. This whole exercise is an attempt to put together a patchwork of disparate sources. Obviously, more data is better than none. Still a lot of guesswork. Is the headline figure of 56% sustainable accurate? It relies on a bunch of assumptions on the rest of the world. I would encourage BMC to publish in full their additional methodological assumptions for out-of-sampal miners, otherwise we can't evaluate the combined figure. Should we wait until that 50% of lost hash rate comes back online before trying to evaluate Bitcoin's CO2 outlay? No, that could be in waiting for over a year. What matters is hash rate today, and much of that hash rate will be going

Starting point is 00:09:30 west, so BMC sample likely to be decently predictive. Is this a slam dunk? Not yet. BMC is still growing and will have more hash rate in quarter three. Also coming soon, new CBECI data, pool-based with less risk of sample bias. Together, these two data sets will give us unparalleled view into the energy mix. Many will attack BMC, especially over extrapolation to 56% sustainable. But even if you disagree with out-of-sample assumptions, in-sample data still useful. Huge share of North American mining represented, and ultimately we're dealing with North American press and North American investors. North American mining is clean. Be critical. I am too. See the thread. But there's genuinely useful new data here that you can use as a model input, even if you disagree with out-of-sampal

Starting point is 00:10:15 assumptions. Hell, you can make a model that stipulates that all rest of world mining is coal-based, go crazy. At this point, it's clear that the BMC has managed to amass a big coalition of miners in a short period of time. One-third of all hash rate, quite significant. Q3 will be bigger. Write them off at your own risk. These disclosures will move the needle. So many of the issues with mining coverage stemmed from academics and pundits given free rein to publish garbage, with no one to push back. Now Bitcoin miners are furnishing their own data. This stuff matters. I listen, I just tend to agree that having some data is almost infinitely preferable to no data. And frankly, whatever one thinks, if you weren't sure of how serious the Bitcoin Mining Council was going to be in terms

Starting point is 00:10:55 of becoming an advocacy group and changing the narrative around Bitcoin Mining, I think that answer is now clear. Anyways, guys, I hope you are headed to a great holiday weekend. I appreciate you listening. And until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Network Undergoes Biggest Difficulty Adjustment Ever; BMC Says 67.6% of North American Bitcoin Mining Is Sustainable

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