*2.3. Underlying Theory of Blockchain Information Indicators: Cost-Based Pricing Theory*

According to Noble and Gruca [24], the cost price of any service or product can be computed based on a predefined profit margin percent calculated over the total cost. The primary focus of the cost-based pricing theory focuses on the variable cost and fixed cost components classified as part of the internal cost. This pricing theory is crucial to BTCs miners as it helps them compute from which cost price is the mining activity more profitable. Blockchain information is one of the critical considerations of BTC's cost price, as per Wang and Vergne [5]. The mining hardware efficiency can be improved significantly using the right technology resulting in a reduced cost of mining the BTC and a lower price. The lower cost and lower price will lead to increased demand, resulting in ultimately improved return on the overall investment in BTC. Extra hashing power can be achieved for the global mining network on blockchain information which contradicts the lower cost of mining as the difficulty level increases leading to higher mining costs and higher prices for BTCs, resulting in reduced demand and lesser returns.

By developing a cost-of-production model for valuing Bitcoin, Hayes [25] showed that the three factors of computational power, rate of coin production, and mining difficulty used might account for more than 84% of relative value formation. Increasing the difficulty will result in fewer units produced for a given amount of hash power, increasing the relative cost of production. Similar to this, reducing the block reward will result in fewer units. The marginal cost of production is reduced with improved mining hardware energy efficiency, drop-in electricity charges globally, or reduced mining difficulty. With improvement in technical processes, the efficiency of the mining process also improves, which leads to a reduction in the cost of production, which in turn puts downward pressure on prices. In another study, Hayes [26] back-tests a marginal cost of production model applied to value Bitcoin. The author applied vector autoregression (VAR) and traditional regression models on the historical data from 29 June 2013, through 27 April 2018, when the mining difficulty changes, i.e., every two weeks. Results demonstrate that the marginal cost of production is important in explaining Bitcoin pricing in the long run (considering every two weeks a long run prediction).

The block size limits the number of transactions verified with each block, resulting in more computation power for verifying larger blocks. This increased need for more computational power will increase the cryptocurrency price in line with what has been discussed. By definition, hash rate means the quantum of processing and computing power that the mining process contributes to the network. The value of hash rate is referred to provide the value of the network power. Thus computed, this value is used to correct the mining difficulty, i.e., to increase or decrease it and thereby correspondingly increase or decrease the BTC price.

The average block time of the network is evaluated after n number of blocks, and if it is higher than the expected block time, then the level of difficulty of the proof of work algorithm is declined. On the contrary, if the average block time is less than expected, the difficulty level will increase, which is in line with the concept of economics called the law of diminishing marginal utility. The speed with which the things are made available, then the value decreases over time. In terms of BTC terminology, the faster the rate of unit formation, the lower the price of the coin goes.

Difficulty is changed based on the time it took to discover 2016 previous blocks. If a block is found every 10 min (finding 2016 blocks will take exactly 2 weeks). The more (or less) time was spent on finding the previous 2016 blocks the more will difficulty be lowered (raised). Because mining is still lucrative despite the difficulties adjusting higher and the margins becoming somewhat slimmer, more miners are encouraged to join. more miners joining the effort means that the network is growing, which is good for Bitcoin's price in the long run. This cycle keeps going until a sizable part of the miners can no longer keep up. Some are compelled to sell a growing proportion of the newly created Bitcoins, which finally depletes their treasuries. This causes an increased supply of Bitcoins for sale on the market. They eventually give up and cease mining. The difficulty is then adjusted downward when the hash rate declines.
