What happened

Last weekend, China's government was hard at work trying to stop the mining of cryptocurrencies in its country, causing the price of Bitcoin (BTC 0.32%) to drop. Bitcoin briefly dipped below $30,000, erasing all of its gains thus far in 2021. And while it's bounced back to around $34,800 as of this writing, it's still down for the week.

Cryptocurrency stocks like MicroStrategy (MSTR 10.04%), Canaan (CAN -10.26%), and Ebang International Holdings (EBON 2.05%) were all down this week as a result. As of market close on Thursday, these are down 10%, 10%, and 14%, respectively. Here's how these companies are handling these intensifying regulatory pressures.

MSTR Chart

MSTR data by YCharts.

So what

Over the weekend, reports out of China suggested that over 90% of cryptocurrency mining had been shut down. The government had power companies cut these companies off, leaving them without electricity to run their mining machines.

With a blockchain network like Bitcoin, the collective computational power is measured with what's called a "hash rate," which goes up with more powerful equipment and more overall devices plugged in. There's little doubt that mining machines are getting unplugged in China as the government cracks down. Over just the past month, the overall hash rate of the Bitcoin blockchain network is down more than 40%.

Bitcoin Network Hash Rate Chart

Bitcoin Network Hash Rate data by YCharts.

For cryptocurrency companies in China like Canaan and Ebang, the goal now is to find ways to work around what's happening. Ebang's management put out a statement on May 28 saying these new government regulations don't immediately impact its mining-hardware business. However, government regulation is something it lists in the risk-factor section of its filings with the Securities and Exchange Commission (SEC). In this section, Ebang notes that 99.8% of 2020 revenue came from China, so it's hard to imagine these new developments are a complete non-event. 

Canaan is also based in China but doesn't mine Bitcoin directly. Rather, it sells equipment used in mining, and so far in 2021, sales have been quite strong.

However, with just one revenue stream, the company has been hurt in the past when the price of Bitcoin fell and demand for its mining equipment plummeted. Therefore, management is looking to vertically integrate its business and mine Bitcoin directly, in addition to selling the hardware.

This week, Canaan announced its Avalon miners were already in neighboring Kazakhstan and operational. Generally speaking, diversifying revenue is a good move for businesses. So it will interesting to watch how this helps Canaan going forward.

A person programs code into a computer with cryptocurrency mining equipment attached.

Image source: Getty Images.

Now what

To be clear, the price of Bitcoin doesn't depend on its hash rate. Put another way, Bitcoin's all-time high didn't come when the hash rate was at an all-time high -- there's no causative relationship between the two. As for the price of Bitcoin, think about it using the simple economic principle of supply and demand. If there's more demand for bitcoin than supply, then the price rises.

However, losing 40% of its hash rate in a month is enough to at least shake confidence in Bitcoin, which stifles demand and causes the price to drop. Furthermore, there could be quite a few people in China selling coins, fearing that the government might regulate their personal holdings. This is also a Bitcoin-demand killer. 

Long term, it's not something that MicroStrategy CEO Michael Saylor is worried about -- and that's an understatement. Just this week, the company acquired over 13,000 more bitcoins and now holds more than 105,000 total, all of which have been purchased in less than a year. The company's average price is $26,080, but most of these were acquired with borrowed money via convertible notes. That makes this a high-stakes game for MicroStrategy, especially with the price approaching MicroStrategy's cost basis this past week.

Could there be anything to drive demand for Bitcoin in the second half of 2021 and help MicroStrategy? Yes, I believe there could be. A couple of weeks ago, Bitcoin developers and miners agreed upon an upgrade called Taproot that will give Bitcoin new features. The update is expected to happen in November.

Many cryptocurrency investors today hold Bitcoin, expecting it to go up. Fewer use it to send funds back and forth. But the Taproot update will allow developers to "build" features on top of Bitcoin, giving it more use cases. This indeed could drive new demand for Bitcoin long term, causing the price to rise.

Does Taproot guarantee Bitcoin will go back up? Absolutely not. Nothing is guaranteed in investing, and cryptocurrencies are more unpredictable than stocks. For now, it will be important to watch how miners prepare for the Taproot update and see what exact use cases developers think up in the months to come.