Why bitcoin’s price could still tumble

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Bitcoin prices are at fresh record highs in many currencies. In dollars the cryptocurrency is up more than 40 per cent over the past month. The $69,000 intra day high set in 2021 is within reach. Excitement is being fuelled by the approval of spot exchange traded funds in the US. Expected changes to the way bitcoins are created or “mined” due at the end of April are adding to the frenzy. 

The “halving” event which happens about every four years was written into bitcoin code by its creator as a means to enhance scarcity. It means that the number of coins a miner gets as a reward for completing each calculation will fall from 6.25 to 3.125. This mechanically raises the production cost and reduces supply at the same time.

Regardless of whether you believe bitcoin has any real value, prices remain tied to these underlying fundamentals. Opinions on the former are shifting as mainstream adoption grows; some $70bn has flowed into spot bitcoin exchange traded funds since they first went live in January, according to data from The Block. Rising demand from buyers anticipating the next halving explains why crypto bulls now gleefully predict bitcoin prices will soon exceed $100,000.

Look closer and this bullish target seems suspect. The current cost of production — largely the electricity required by computers making the calculations for mining — is currently about $27,000, thinks JPMorgan. This offers a sense of the price floor for bitcoin. Immediately after the halving this will jump short term to around $50,000.

Costs are also a function of the hashrate. This reflects the amount of processing power devoted to mining coins. The higher the hashrate — currently at a record high — the longer it takes to mine each coin. That in turn means higher costs for all involved, offering some comfort to buyers.

Yet, the recent surge has taken bitcoin prices far above the cost of production. For bitcoin in the past that has not been sustainable. Moreover, these costs should start falling shortly after the halving as less efficient miners drop out, unable to keep up. As older machines are retired, the hashrate should fall and with it production costs.

At some point the price rally will lose steam. Assume mining processing power falls by one-fifth then the cost of production will fall correspondingly to around $43,000. That offers a useful guide to where prices might find a floor once the current bout of mania subsides.

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