Does Bitcoin Have a Floor Price?

Our last crypto blog—Five Key Crypto Questions Answered—sparked another important question from our readers.

Some investors are curious if bitcoin has a floor price based on production costs. In short, it does not. The primary costs associated with bitcoin mining are generally fixed across a range of output. While electricity is the most variable cost, it can still be spread out over different levels of production depending on market conditions.

But this doesn’t mean terms like “floor price” and “marginal cost of production” have no relevance when it comes to bitcoin. In fact, these phrases can be quite useful in understanding and evaluating arguments within the bitcoin space—especially when dismissing unfounded claims.

Even without delving into the complex mechanics of bitcoin mining, it’s clear why its misguided to apply traditional concepts like a floor price and a marginal cost of production to bitcoin is misguided. These concepts originate from the realm of commodity production, where output increases as prices rise and decreases as prices fall. However, bitcoin operates on a fundamentally different principle. Its production follows a predetermined schedule, unaffected by price fluctuations. As a result, the ways of establishing equilibrium for commodities simply don’t apply.

Bitcoin vs. Commodities: A Different Supply Game

If you’re interested in a deeper dive into the economics, keep in mind that bitcoin doesn’t follow a single supply schedule like commodities such as oil or gold. For those traditional assets, the cost of extracting the next barrel of oil or an ounce of gold out of the ground doesn’t depend on its price. Instead, it’s based on the cost of labor, fuel, and other resources that it takes to extract the commodity from the earth. For instance, operating oil rigs in Saudi Arabia is relatively inexpensive, whereas running an oil sands operation in Canada involves significantly higher costs.

If I’m a low-cost operator like those in Saudi Arabia and the price of oil drops, my production costs stay the same. But some of my higher-cost competitors may be forced offline. Meanwhile my output stays constant, but I have to sell at a lower price, leading to reduced revenues and profits. That’s not how it works for a bitcoin miner. A key part of the bitcoin network’s incentive mechanism is “difficulty.” But what exactly does that mean, and how is it determined?

Mining Dynamics: How Difficulty Adjustments Forge Bitcoin

Essentially, bitcoin mining involves running numerous random number generators simultaneously to see which one can hit the correct random number first. While there’s more complexity to it—such as encrypting all the transaction information you want to include in the next block and ensuring their validity—the core idea is to encrypt everything in such a way that the output starts with a specific number of zeros. The more zeros required at the beginning of the output, the harder it becomes to find the right random number. This difficulty is what secures the network from fraud and ensures its integrity.

As time has passed and the price of bitcoin has risen, more miners with faster computer processors have entered the market. For a traditional commodity, this would typically lead to an increase in production volume, too. But bitcoin production follows a set schedule, ultimately capped at 21 million bitcoins. To stay on schedule, the network’s difficulty must increase as more computing power is added to the network (and fall if miners exit the network). This adjustment occurs every 2,016 blocks, with the goal of making the average time of around 10 minutes between blocks (and ensuring that difficulty adjustments occur roughly every two weeks).

What does that mean if I’m a miner? Imagine I’m the Saudi Arabia of crypto mining, equipped with the most state-of-the-art mining rigs (essentially powerful computers) running in a location with extremely low electricity prices. If bitcoin’s price falls, like in our Saudi oil example above, some of my higher-cost competitors will be forced to shut down. As a result, the network’s difficulty level will decrease. But the volume of bitcoin produced won’t decline—it must stay relatively constant, thanks to the difficulty adjustment mechanism. Since I’m highly efficient and now account for a larger proportion of the remaining mining power (the “total hash rate”), my share of the bitcoin produced increases. Even though electricity costs are my primary variable expense, the higher unit volume I produce during this period reduces my production cost per bitcoin (unless electricity prices rise for other reasons).

What happens to my total revenues and profits? That depends on the balance between the losses from lower bitcoin prices and the gains from a higher share of production.

Whether the price of bitcoin is $2,000, $20,000, or $200,000, the network will still continue to operate. That’s the beauty of its design. It’s also why it has no effective price floor.

Beyond Mining: Bitcoin’s Value in a Post-Production Era

Another flaw with arguments around the “marginal cost of production” for bitcoin is that by the middle of the next century, the total supply will have been created. At that point, miners will maintain the network by being compensated solely through transaction fees. There will be no more new bitcoins produced, and hence no “marginal cost of production” for bitcoin. If the value of bitcoin is measured by its production cost, what would it be worth then?

From a production standpoint, the price of bitcoin is as flexible as a blob of silly putty. You can stretch it, compact it, and then put it all back inside a little plastic egg. This inherent flexibility is a significant reason why our team doesn’t evaluate bitcoin from that perspective and dismisses arguments based on those grounds.