Does price follow hash rate? Or does hash rate follow price?

When making predictions about the future price of Bitcoin, you will sometimes hear people claim that “price follows hash”. What they mean is that when you see the amount of computing power that is being used to mine Bitcoin increasing, you can expect an increase in the market price of Bitcoin to follow.

The reasoning is pretty simple. When more computing power is being used to mine Bitcoin, the cost of mining is going up, but the number of new bitcoins created is staying the same. If the miners’ costs to create those new bitcoins is going up, then they will have to sell them for a higher price in order to make a profit on their mining activity. So the new bitcoins entering the market will be priced higher, putting upward pressure on the overall price trend.

The problem with this view is that it is oversimplified. Price can go up and down for a bunch of different reasons. Miners are not the only people selling bitcoins. Almost no one buys things with Bitcoin directly. So long-term hodlers who decide to take some chips of the table and buy a house (for example) will sell their bitcons for dollars to do that. If a bunch of hodlers do this at the same time, there will be downward pressure on the Bitcoin price. The market will naturally find equillibrium between the upward pressure from the miners wanting to sell high and the hodler-house-buyers who are willing to sell lower in order to get their house today rather than next year.

There is also the possibility of the reverse dynamic, where hash follows price. If more and more people want to buy Bitcoin to actually use it, this obviously puts upward pressure on the price. If miners are just selling at the going market rate, then this upward price pressure translates into greater mining profitability. That increased profitability attracts more miners and gives existing miners incentive to invest in more hardware and generate more hash power. This should happen until the marginal cost of mining new bitcoins roughly approaches the spot price.

Yet another way this dynamic might play out is that speculators might choose to buy mining hardware rather than buying bitcoins directly. If a speculator is forecasting an increased bitcoin price, they might buy mining hardware to generate bitcoins for themselves rather than just buying the bitcoins on the open market. This is effectively like buying bitcoins with leverage. If they are correct about the future price increase, they will make a greater profit by buying mining hardware. But if they are incorrect, the return on investment in that hardware will be less than expected.

As you can see, there are multiple cross-currents at play between the level of hash power in the system and the market price. It’s not a direct relationship by any means.