Bitcoin's 'mining difficulty' is about to fall. Here's what that means for the cryptocurrency

Published Fri, Jul 2 20216:46 AM EDTUpdated Sat, Jul 3 20214:20 AM EDT

Bitcoin's mining difficulty is set to drop about 27% Friday by some estimates , as it seeks to make up for the lost computing power that left the network when China banned mining in various provinces two weeks ago. The adjustment shouldn't affect the price of bitcoin itself – that's set by supply and demand, whereas miners' role is in adding transactions onto the blockchain. Bitcoin mining companies may be about to benefit in a big way, however. "The miners are rubbing their hands in anticipation of this Friday," B. Riley Securities analyst Lucas Pipes said. "If you have a bitcoin mining machine hooked up today, you're making money hand over fist. You're going to be making slightly more money this coming Friday." It's set to be the largest-ever difficulty drop in bitcoin's history, according to Jaime Leverton, CEO of Canadian crypto mining firm Hut 8. She said it would be surprising for such a large difficulty adjustment to take place amid a bitcoin bull run, which is how she views the state of the current market. But it has all to do with the crackdown on mining operations in China two weeks ago. "The public markets haven't realized the value yet of this event for these companies," said Ethan Vera, chief operating officer at Luxor Tech, a blockchain company that runs mining pools for bitcoin and other digital coins, referring the crypto crackdown in China. "But it's going to be reflected in their financials this quarter." What is the difficulty adjustment? Mining difficulty indicates how hard it is for miners to solve that complex cryptographic puzzle that gets them a bitcoin reward. Today there are 144 blocks, each with 6.25 bitcoins, meaning 900 new bitcoins are rewarded on the network each day, according to Vera. When there's more computing power, miners find blocks at a faster rate and the network starts issuing more than 900 bitcoins per day. The Bitcoin protocol regulates that by adjusting how difficult it is for miners to find a block, so that perhaps the rate can go back down to 144 blocks per day. Why is this happening now? The same thing happens in reverse, Vera explained. When there's less computing power competing in the Bitcoin network – as there is today as a result of the bitcoin mining exodus from China – and miners are finding fewer than 144 blocks per day, the difficulty will decrease, making it easier to find blocks. The bitcoin network lost some 50% of its hashrate, or the computing power needed to mine bitcoin, when the Chinese government cracked down on mining operations in the country. China had been home to between 65% and 75% of the world's bitcoin miners. "This is a really good environment for bitcoin miners in North America and anywhere in the world that are still plugged in because ultimately it means we will see a larger share of bitcoin mining rewards," Leverton said. "For miners like ourselves this has an immediate upside from a revenue and profitability perspective." Miners generate revenue from mining bitcoin and ultimately converting it into fiat. Leverton said Hut 8 historically just holds the bitcoin and hasn't sold any of it since January. Leverton said the company currently has more than 3,800 bitcoins on its balance sheet. Pipes, who covers Riot and Marathon for B. Riley, said crypto mining firms broadly have the potential to perform better for the second quarter since they're earning more bitcoin than many people thought they would just a few weeks ago. "There are miners that are producing today – they have miners hooked up outside of China – and there are also those miners that have the potential to take in more miners that are looking for a home, they're well positioned to grow a lot from here," he said. With the highly anticipated difficulty adjustment, the benefits should be reflected in the market "instantaneously," though whether the market today is a fully efficient one is unclear, Pipes said. "I'd say it still has a fair bit to learn about understanding these business models inside and out," he said. Fundstrat's David Grider said the difficulty adjustment will benefit companies' financials over time. "Crypto mining stocks are higher beta plays to bitcoin and their performance has led bitcoin at times," Grider said. "Most crypto mining stocks peaked relative to bitcoin back in late February and March before bitcoin peaked in mid April." "Since the bitcoin sell off, most crypto mining stocks bottomed in May and have been outperforming relative to bitcoin," he added. "That may be one sign that some money is getting ready to go back up to it but also may be a sign of public equity money starting to flow there and could be flowing into the crypto assets themselves."

A cryptocurrency mining computer equipped with four cooling fans is seen on display at a computer mall in Hong Kong, January 29, 2018.

Bobby Yip | Reuters