In-depth investigation of Bitcoin mining (Part 2): Chinese mining machine manufacturers dominate, mining in the first half of the year can be said to be extremely profitable

Author: Bai Ye

Editor: Tang Han

This article is a companion piece to "In-depth Investigation of Bitcoin Mining: Are Humans Wasting Energy or Creating Energy?" Both articles are from Coinshares' in-depth investigation report on the Bitcoin mining industry. It is worth noting that although this article was written in June 2019, which deviates from the current status of the mining industry, the idea of ​​calculating mining costs in this article is worth learning and reference.

By reading this article, we can know that even if we choose to mine Bitcoin when the price of Bitcoin rises to $10,000 (June 2019), we may be able to mine Bitcoin at a cost of less than $3,500. The time lag between the mining market and the Bitcoin secondary market gives miners a huge arbitrage space. In addition, through the calculation method provided by Coinshares, we can find a way to price mining machines.

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There is no doubt that miners are critical to the Bitcoin protocol and the health of the network.

However, due to its opacity, the Bitcoin mining industry always gives people a sense of mystery, which has caused many misunderstandings. For example, many Bitcoin supporters hope to decentralize mining, but so far, the entire mining industry still tends to be centralized, and computing power is also concentrated in the hands of some large mining farms.

So, how can we achieve the ultimate goal of decentralized mining? It’s simple. We first need to have a deep understanding of Bitcoin and the Bitcoin mining ecosystem. It is also essential to fully study the Bitcoin mining network, because without extensive research and collection of mining dynamics and economic data, it is difficult to make accurate judgments about this “mysterious industry”.

Without further ado, let’s get to the point.

In general, although the proportion of transaction fees in miners’ total income has increased, the vast majority of miners’ income still comes from mining rewards rather than transaction fees.

According to data from CoinMarketcap.io, in 2018, the mining rewards received by Bitcoin miners reached $5.5 billion, of which $5.2 billion (about 97%) was newly mined Bitcoin, and another $300 million (about 3%) was transaction fees. If calculated based on the Bitcoin price on May 31, 2019 and the average fee per block over 30 days, the annual return of Bitcoin miners is expected to be $6.2 billion/year, of which 94% comes from newly mined Bitcoin and 6% comes from transaction fees.

01Bitcoin Network Development

The Bitcoin network hashrate was about 40 EH/s in November 2018, and grew to 50 EH/s in June 2019, a 25% increase. However, the growth rate of Bitcoin hashrate during this period was lower than the ten-year average (as shown in the figure below), but comparable to the five-year average (calculated from 2014, because 2014 was basically the landmark year that opened the industrial mining era).

In the past six months, we can actually divide the Bitcoin market into two stages: the cessation of decline and the rebound from the bottom. The initial price rebound of Bitcoin seems to have been somewhat affected by the flood season in southwest my country. From the current situation, the computing power of the Bitcoin network has fully recovered and has broken through the historical highest level.

During the transition period from Bitcoin bear market to bull market, we can observe two substantial macro trends:

1) Many mining entities go bankrupt, liquidate, or transfer ownership, and the miners who can survive in the market are those with sufficient capital reserves;

2) The latest generation of mining equipment is deployed on a large scale for the first time.

It is worth noting that the Bitcoin hashrate dropped by about 40% at the end of 2018, which was the first time that the hashrate dropped due to a sustained large-scale correction in the Bitcoin price. However, this situation does not lead to a death spiral for Bitcoin mining (i.e., the price drop causes some miners to shut down, the hashrate plummets, the security drops, and the price drops further). On the contrary, the Bitcoin system is acting completely according to its design, and the mining difficulty also decreases with the decrease in hashrate, and the decline in Bitcoin prices also leads to a reduction in mining costs.

Let’s look at the second phase of the first six months, the hash rate recovery phase, which was driven by two factors:

1) As the price of Bitcoin rebounded, most of the previously shut down mining equipment was restarted, and the cheap electricity price during the flood season also allowed the mining machines to obtain positive cash flow;

2) With the arrival of the rainy season, the next generation of mining equipment has been deployed on a large scale, mainly in Sichuan. The unit computing power (TH/s) and the dollar cost are also increasing, which is roughly consistent with the five-year trend (as shown in the figure below). Not only that, the improvement in mining efficiency has also led to the current mining efficiency reaching an all-time high of 11.5GH/J, higher than 10.5 GH/J in November 2018, an increase of more than 10%.

On the other hand, China still dominates the field of mining hardware manufacturing and shows no immediate signs of reducing production. Even though there are a series of negative rumors about Bitmain, you will find that other mining machine manufacturers are actually from China. Although there is a certain degree of uncertainty in regulatory policies on Bitcoin mining, and the frequency of censorship is increasing, these have not had much practical impact on Chinese miners. It is worth noting that many domestic miners are actually operating in a legal gray area, but there are large differences between different local jurisdictions. Some local governments seem to be more inclined to view the mining industry positively because it can generate strong local revenue. But there are also rumors that some local governments "do not welcome" miners, such as Inner Mongolia and Xinjiang during the dry season last year.

02Average Total Creation Cost/ROI Break-Even Level

According to current estimates, the depreciation of mining machines at ¢5/KWh and 18 months of capital expenditure is about $5,600, while this figure was about $8,500 in November last year. The US/BTC market creation cost (Market-Wide Creation Cost) under the assumption of 15% C&O working capital and standard capital expenditure is shown in the figure below:

From the table we can observe that miners have access to very cheap electricity (~¢3/kWh) and brand new next generation mining equipment (which may be depreciated in 2-3 years) , which can mine Bitcoin for less than $3,500. If miners can get more affordable mining equipment, the cost of Bitcoin mining may be even lower. We analyzed the US/BTC Market-Wide Creation Cost under the assumption of 15% C&O working capital and less than 50% and 25% standard capital expenditures, as shown in the following two figures:

Considering the recent rebound in Bitcoin prices, we believe that the current profit margins in the Bitcoin mining industry will be very high . The first two generations of mining hardware equipment can only generate positive ROI under relatively cheap electricity costs (< ¢5/kWh), while the next generation of new mining machines can generate positive ROI even under relatively expensive electricity costs (> ¢5/kWh), as shown in the following figure:

Marginal creation cost sensitivity of power operating capital and capital expenditure levels:

Marginal creation cost sensitivity of electricity operating capital and capital expenditure level at 0.05$/Kwh:

We also note that mining equipment prices collapsed on the secondary market in late 2018 and early 2019, resulting in a large number of ownership transfers. Using ¢5/kWh and an 18-month depreciation schedule, the market average total cost of creation has fallen from 53% in November 2018 to 38% today.

03Average Cashflow Breakeven Levels

Another cost indicator to consider is the average cash flow break-even level, which is crucial for estimating price levels, because once it falls below the average cash flow break-even level, ordinary miners will have to shut down their mining equipment. Of course, the return on investment break-even level indicator is equally important, but if the price continues to be below the average cash flow break-even level, it means that miners will get less and less money, which will affect the ownership ratio of the entire industry over time, and then lead to a decline in the computing power of the entire network.

If estimated at ¢5/kWh and 15% C&O operating capital, the current market average cash flow break-even point is about $3,300, higher than $3,000 in November 2018. The main reason for the improvement in this indicator is that the total computing power of the entire network has increased by 25%, and the mining efficiency of mainstream mining machines has also increased by about 10%.

04Electricity consumption of Bitcoin mining

At the time of writing, the total electricity consumed by Bitcoin mining is estimated to be 4.7 GW, which is composed of two parts: one part is the electricity consumed by mining alone, and the other is the additional electricity consumed by the mining machines required for heat dissipation/cooling (in 2018, it was estimated that this energy consumption accounted for 20% of the total electricity consumption of Bitcoin mining, but this proportion was found to be greatly exaggerated, so the ratio estimated in 2019 is about 10%).

Therefore, if we simply estimate the power consumption of Bitcoin mining, it is about 4.3GW, higher than 3.9GW in November 2018. However, the increase in power consumption is also reasonable, because the computing power of the entire network has increased by about 25% and the mining efficiency has also increased by about 10%.

It is worth mentioning that, in general, the more electricity the Bitcoin mining network consumes, the more electricity the electricity market is willing to sell to miners, and part of the block rewards (including newly mined Bitcoins and fees) miners receive from mining will also be paid to power suppliers. However, the mining efficiency of the mining machine has no effect on the total power consumption of the network, it just increases the computing power per unit of power consumption.

From this perspective, the higher the price of Bitcoin, the more miners will be attracted to mine, and they will have more money to pay power suppliers. Therefore, in the long run, the value of block rewards can affect the total electricity destruction of the entire mining network.