Charlie Lee, the creator of of the popular alternative crypto currency Litecoin, has posted on Reddit a short and interesting analysis on why a few weeks after the first block reward halving the difficulty and price of LTC has returned to the level it was prior to the event. Below you can find his post quoted:
After the halving one would expect that either the price will go up or the hashrate must drop. This is because mining is designed with a Nash equilibrium of miner profit reaching 0 over time. So if miners are running at near 0 profit, and suddenly their revenue gets cut in half, miners would need to turn off their machines unless they are willing to mine at a loss.
The halving happened, and the price stayed the same. The hashrate dropped a little but then climbed back up pretty quickly to the previous level. That’s really unexpected, but I think I have an explanation. I talked to some Chineses miners at Scaling Bitcoin and learned something interesting. Most miners have found electricity for free or close to 0 cost. Chinese hydro power plants are sometimes generating too much electricity. That electricity goes to waste if it’s unused. So these plants have either sold the electricity for near 0-cost or they have partnered with miners to give them free electricity for a revenue share.
So this makes total sense now. If the electricity is free or close to 0 cost, then there’s no reason for miners to shut down their machines. They make half as much, but still profitable. These miners have also been asking around at the conference to try to buy old outdated Bitcoin/Litecoin ASICs. With 0-cost electricity, they can keep those machines running and still make money.
We considered the possibility that the reason behind was the introduction of newer generation of Scrypt ASIC miners from SFARDS and Innosilicon and the companies making them stacking up on hardware in their own mining data centers. But the possibility of a lot of Asian miners with zero cost to very very very cheap electricity mining with whatever hardware they can get and still profiting also sounds like a good enough reason. If that ends up being the actual reason it presents a bit of a problem for the normal home miners and small mining operations based outside of Asia that still need to pay for electricity and thus have higher cost for mining and smaller to no profit at all…