Is it still profitable? Bitcoin Mining Economics Explained
- Public miners sold more than 100% of their output in May, with many citing debt servicing and increased spending
- Bitcoin miners are generally considered the most committed hodlers because their business model is based on bitcoin remaining an appreciating asset
Bitcoin’s bear market has put intense pressure on mining profitability. On June 21, when bitcoin was trading near $20,000, mining major Bitfarm sold $82 million worth of bitcoin to bolster its balance sheet. And it wasn’t the only one. Public miners have sold more than 100% of their production in May, and many cited debt servicing and increased spending as the reason.
Even though the price of bitcoin has fallen from its all-time high of $69,000 in November 2021, the difficulty of mining the cryptocurrency has steadily increased. That’s because miners haven’t stopped or slowed down production – when the network increases total computing power, the protocol makes mining more difficult and therefore expensive.
At this peak of unprofitability, some of the most bullish bitcoin hodlers sell bitcoin at a low price to fund their mining efforts.
The big question is why? Is bitcoin mining still a profitable business, and what is the end game?
We sat down with Blockworks Editor-in-Chief David Canellis to get a better understanding.
How to Measure the Profitability of Bitcoin Mining
Bitcoin (BTC) is only profitable when mining costs are lower than the value of BTC rewards and transaction fees. It sounds simple, but the costing mechanisms and the economics involved are less straightforward.
Since cost drivers vary, it is best to assess miner behavior to analyze overall profitability. The fact that many miners are selling BTC at a low price is a good indicator that the costs are too high.
Bitcoin miners are generally considered the most committed hodlers because their business model is based on BTC remaining an appreciating asset. So when miners sell, it is mainly to cover costs. In an ideal scenario, they sell out during bullish cycles and accumulate into a bear.
For example, miners made large profits when bitcoin was up during the winter and spring of 2021. The net position of miners briefly fell to an extremely low level of -24,000 BTC per month, which which indicates that more BTC moved out of miners’ balance sheets than into them. . When the bitcoin price is falling, the miner’s net position is usually positive. This indicates that miners do not need to take profits from BTC to cover their expenses.
If miners are selling during bear cycles like they did in June, it is a sign that rising costs have forced miners to change their business plans. But it’s not necessarily a sign of capitulation – when miners go bankrupt, leave the network, and sell their bitcoin. Instead of just shifting gears, surrender is total surrender.
A war of attrition
This type of recent selloff is a signal that miners are in a war of attrition. At this point in the cycle, they double their mining efforts, even at a loss. They do everything they can to keep the lights on in hopes that they will be among the last hodlers standing.
To understand how and when miners are forced to capitulate, we need to explain the mechanics of the hash rate and its role in determining bitcoin mining costs.
Using hash rate to calculate bitcoin mining costs
When you read “bitcoin hash rate”, just think “total computing power on the bitcoin network”. Technically, it is the number of calculations, or more precisely hash guesses, that the network performs every second.
To understand how and why each computer rushes to guess each block hash, see our explanation of Proof-of-Work and Proof-of-Stake protocols.
To understand mining economics, it is crucial to know that as more and more computers and mining capabilities enter the network, the protocol makes this guessing game more difficult. As a result, miners must use more electricity to earn the same amount of rewards.
When computing capacity leaves the network, the hash rate decreases with the level of difficulty. Lag often occurs because the network makes difficulty adjustments every two weeks. But the fact is that miners can expend less energy for a similar amount of bitcoins when fewer machines are running.
Since the hash rate correlates with the energy consumption of miners, it provides a rough indicator of the total cost. Other variables including location, scale, maintenance, and upgrades also play a role, but the second most important variable is funding. Many mining institutions have interest payments and debts that they must repay in addition to operating costs. So even if a calculator says miners can make a profit at a specific bitcoin price, hash rate, and kilowatt price, that doesn’t take into account servicing the loans.
Take advantage of the risks of dependence and contagion
Many miners have taken out substantial borrowings during the last bull cycle to fund the expansion of their mining operations. Instead of spending bitcoins, they used their mining equipment and bitcoin rewards as collateral to acquire high interest loans with an LTV (loan to value) ratio as low as 30%. Vera’s estimates that there is approximately $4 billion in this type of financing. Lenders such as Galaxy Digital, NYDIG, BlockFi, Celsius, Foundry Networks and recently submarine Babel Finance have all accepted platforms as collateral in addition to cash installments.
This type of funding adds pressure from two different directions. First, with much of their equipment locked in collateral, it is difficult for miners to cut production when profitability is low. Second, loan repayments increase costs in a way that amplifies unprofitability.
So if miners are struggling to repay their loans, they might be forced to liquidate their bitcoin and hand over their machines to the lender. This would theoretically trigger the miners’ capitulation.
And loan deals carry contagion risks on both sides. Payment issues from miners put pressure on lenders’ balance sheets, but miners also risk losing their deposited BTC collateral.
Miners who have borrowed from these crypto lenders face another risk. Many lenders had exposure to Terra/Luna when it collapsed, as well as Celsius and other companies that faced liquidity crises. If one of these lenders goes bankrupt, miners could lose their deposited collateral.
The fragile balance sheets of some lenders mean they also need miners to stay in business so they can continue to repay their loans. But by keeping unprofitable miners in business, some believe that this act effectively keeps the bitcoin hash rate artificially high, meaning the cost of bitcoin mining does not fall to an affordable level.
What do miners get for being the last hodler standing?
Despite the unusually large sale of bitcoins by miners in May and June, the hash rate hit an all-time high of 266 million terahashes per second on June 7, according to Blockchain.com, and is just above 208 million at the time of writing.
We have yet to see a major capitulation and hash rate drop like the one that occurred from November 2018 to January 2019. But mere survival isn’t the only incentive to keep miners in a no-holds-barred position. profitable. Players still in the fight hope to gain a greater share of the mining rewards once less efficient or overleveraged participants are out of the game.
Most miners share rewards with a mining pool that distributes revenue based on each participant’s hash rate contribution. This structure makes mining revenues predictable but also increases competition. Miners need to keep adding hash rate to maintain and increase their revenue share.
Since the total bitcoin reward is roughly the same every 10 minutes, miners who survive a crisis get a bigger discount. And if you think bitcoin is basically a worthwhile asset, that extra slice of the pie has a multiplayer effect. Miners who remain in the game not only regain a profitable track record, but they earn more bitcoins at a reduced price.
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