Bitcoin Miners are Escaping China
By: Lucas Nuzzi
Tags: Bitcoin, Bitcoin Mining, Mining, Cryptocurrency

Tracking what happens to newly issued bitcoins can yield meaningful insights into the collective behavior of both mining pools and the individual miners operating within them. In order to discern these two very different actors, Coin Metrics has produced a set of aggregate metrics that serve as proxies.

As a proxy for mining pool behavior, we aggregate data from all “coinbase” transactions; the first transaction of every Bitcoin block (not to be confused with the exchange). As a proxy for individual miner behavior, we aggregate data one hop from that transaction, meaning, all transactions that received funds from the coinbase.

As a proxy for mining pool behavior, we aggregate data from all “coinbase” transactions; the first transaction of every Bitcoin block (not to be confused with the exchange). As a proxy for individual miner behavior, we aggregate data one hop from that transaction, meaning, all transactions that received funds from the coinbase.

At a microscopic level, if you track what happens after one hop, the notion that Bitcoin mining is centralized is shattered. In fact, there are many transactions beyond one hop that have dozens of recipients, which may be indicative of layered structures even at the individual miner level. One theory is that several mining operations are joint ventures where partners may have complex payout structures. As such, measuring anything over one hop becomes more challenging and subjective.

Now that we covered how aggregate miner behavior can be measured on-chain, let’s take a look at the data.

What is the on-chain data telling us?

Before individual miners can effectively sell their coins, they must create a transaction that sends funds to a crypto exchange, an OTC desk, or even directly to the buyer (albeit in rare circumstances). In any of these scenarios, we would see an increase in the flow of funds being sent from individual miners (one hop) to other addresses.

The chart below shows exactly that. Aggregate flows sent by miners are at the highest levels since March 2020, when markets crashed at the onset of the COVID-19 pandemic. This supports the hypothesis that the latest sell-off was by Chinese miners that have sold part of their holdings in order to escape the latest wave of enforcement actions by the CCP

Although what they receive on a daily basis is small compared to global BTC volume, the data showcased above suggests that when miners are likely selling (an increase of Flows Sent), markets respond negatively.

Aggregate flows sent by miners are at the highest levels since March 2020, which supports the hypothesis that the latest sell-off was driven by Chinese miners that have sold part of their holdings in order to escape the latest wave of enforcement actions by the CCP.

Remember that miners are also speculators. Even though what they receive in miner rewards is small, in USD terms, relative to the volume of global BTC markets, they do hold BTC in their balance sheets. In times of uncertainty, when they expect to need cash, their collective actions affect the market.

Now put yourself in the shoes of a Chinese miner that might have to move to a different country. Regardless of the scale of your operations, you will likely need cash to finance that move. The good news is that this is a temporary phenomenon. As with previous spikes in Flows Sent, the market impact was short-term and close to coincidental.

Another interesting on-chain behavior worth highlighting is miners’ potential concerns towards centralized exchanges in light of the CCP’s crackdown. The current sell-off coincides with thousands of bitcoins being withdrawn from major exchanges and deposited to miner addresses, as shown below.

Interestingly, the CCP’s current crackdown on mining also coincides with a time of the year where some Chinese miners move their operations from Inner Mongolia to Sichuan. This 2,000km migration is motivated by the beginning of rainy season in Sichuan, which increases the capacity of its hydroelectric power plants, thereby decreasing electricity costs.

It has been observed that the rainy season in China contributes to an increase in Hash Rate, a metric that indirectly tracks the resources being allocated to Bitcoin. However, if the CCP’s hawkish comments on mining in fact translate to enforcement actions, this seasonal migration might be impacted, and Hash Rate might see a drop from current levels.

If the CCP’s hawkish comments on mining in fact translate to enforcement actions that further motivates miners to emigrate from China, we might see a contraction in Hash Rate from current levels.

While it is still unclear how the Chinese mining community is tactically responding to this development, the market has reacted negatively in light of a potential decrease in Hash Rate. But if a decrease were to occur, how would it impact Bitcoin?

What if Hash Rate Crashes?

Another gigantic misconception about mining is that daily Hash Rate figures can provide an authoritative view of when miners are pulling the plug. This frequently generates panic, as people struggle with the notion that a large portion of miners have suddenly gone offline. Another Elon quote illustrates this misconception well when he claimed that when “A single coal mine in Xinjiang flooded, almost killing miners, […] Bitcoin hash rate dropped 35%.”

In reality, Hash Rate is not a precise metric. Hash Rate formulas were designed to estimate how many computational resources are being allocated to a network on a given day. But there is a keyword that is often omitted in the metric’s name: implied. It’s called Implied Hash Rate because it is impossible to get a precise daily change figure by solely looking at on-chain data.

If you look at average daily Bitcoin Implied Hash Rate on Coin Metrics’ dashboard (what people usually just call hash rate), you will see that large (35%+) fluctuations occur frequently.

Source: Coin Metrics

Crypto media outlets often take advantage of Hash Rate fluctuations with sensationalist “BTC HASH RATE DROPS X%” headlines, but daily Implied Hash Rate is, by its very design, a volatile metric that is not suitable to track lasting changes in the mining landscape.

Crypto media outlets often take advantage of Hash Rate fluctuations with sensationalist “BTC Hashrate drops X%” headlines, but daily Implied Hash Rate is, by its very design, a volatile metric that is not suitable to track lasting changes in the mining landscape.

The reason for this volatility is that all daily Hash Rate formulas are highly sensitive to how long blocks have been taking to be mined over a given lookup window. Since mining is an unpredictable process (a Poisson process to be precise), there is a probability that a Bitcoin block could take an hour to be mined without miners necessarily having gone offline (albeit a low-probability event).

In the example above, a probable event would push daily Hash Rate estimates down considerably, even in the event that no changes in the mining landscape have actually occurred. If you want to understand this more deeply, take a look at the formula we created at Coin Metrics to attempt to calculate daily Implied Hash Rate figures, in the trillion of hashes per second (TH/s) unit.