Competition in the mining industry: the battle for cost and market

After ten years of development, the main participants in mining have changed from scattered miners to mining pools that gather decentralized computing power. The units that constitute the industry ecology have also expanded from miners to mining machine manufacturers, chip manufacturers, mining machine hosting institutions, etc. The evolution from individuals to organizations and the refinement of the industry ecology mean that the mining industry is becoming more mature.

A bull market has made mining companies, which are at the upstream of the industry, lucrative. When the market takes a sharp turn for the worse, mining companies are also the first to bear the brunt. From wild growth to opportunities amid crisis, what is the outlook for the mining industry?

PANews interviewed Zhuang Zhong, CEO of BTC.com, a large mining pool that accounts for about 19% of the total Bitcoin network computing power. He revealed that BTC.com also plans to enter the PoS mining pool business and is currently connecting with some custody cooperation. In the interview, he also deeply revealed the past, present and future of mining development from the perspective of industry participants.

In 2018, three mining machine manufacturers, Ebang International, Canaan Creative and Bitmain, successively submitted prospectuses to Hong Kong. Although they all failed, it can be seen from the disclosed prospectuses that mining machine manufacturers, as upstream companies in the mining industry, have earned considerable revenue in the past bull market. Bitmain alone had revenue of US$743 million in the first half of 2018.

Zhuang Zhong admitted frankly, "The cost of mining in the early days was relatively low, and you could basically make money as soon as you turned on the machine." He believes that this stable profit situation may be related to the scale of the industry. Compared with users who invest in cryptocurrencies, there are not many people who directly participate in mining or mining-related activities, and the current scale of the entire industry is still relatively small.

Except for the peak of the bull market, the bubble of mining machines is relatively small. This is equivalent to the fact that while the cake is gradually getting bigger, the number of people eating the cake has not increased on a large scale, so those who originally ate the cake will naturally get more cake.

Therefore, in the past, mining basically did not need to consider the cost issue, or did not need to consider the cost issue carefully. In the bull market, when you can make money just by turning on the machine, small mining pools with little computing power can survive. But when the market turns from bull to bear, wild growth can no longer be sustained, and the contradiction between cost and benefit begins to become acute.

Bitcoin mine photo provided by BTC.com

"At the end of last year, many mining machines were indeed close to the shutdown price, and some mining farms with relatively high electricity costs were even completely unable to make ends meet." Faced with the sharp drop in coin prices, many miners began to actively save themselves and extend the life of mining machines by using unofficial versions of downclocking firmware.

There is actually a kind of "cost advantage theory" here.

Zhuangzhong believes that there is a balance between computing power and coin price. "After some mining machines shut down, the difficulty of mining decreases and the income increases. So as long as your mining cost is ahead of other users, you can keep mining."

In other words, no matter whether it is a bull market or a bear market, as long as miners shut down their machines later than their competitors, they can continue to earn profits. From this perspective, cost determines the life span of the mining business.

According to the statistics in the article "4-minute short video to understand the law of mining, is the flood season a "heart-saving pill?" published by PANews data news column PAData, in the past decade, the Bitcoin mining industry has shown a cyclical law of three years, consisting of a main profit period of about one year and an adjustment period of about two years.

The main profit period refers to the period when mining can obtain excess profits because the growth rate of computing power is lower than the growth rate of currency price over a period of time. On the contrary, the mining profit decreases and it is an adjustment period. January 2010 to June 2011, May 2013 to December 2013 and January 2017 to December 2017 are the three main profit periods in the past ten years. Starting from January 2018, it entered the latest round of adjustment period.

As an industry insider, Zhuang Zhong believes that "on the surface, there is indeed such a cyclical pattern in the mining industry, but the formation mechanism behind it is very complex." This complexity is largely due to the fact that market regulation in a free competition market often has obvious lags, and the causes of this lag are diverse.

First, the uncertainty of chip research and development and the cyclical nature of chip and mining machine production will affect the lag in market regulation.

“The chip R&D cycle is very uncertain, especially in the ramp-up phase of some new technologies. It is easy for R&D to fail, or the cost of developing new products is lower than that of old products (leading to abandonment). Even if R&D goes smoothly, there may be insufficient chip production capacity or insufficient mining machine production capacity.”

Based on this, it is estimated that there may be a lag of up to half a year from the time manufacturers see the market price rise to the time they complete the feedback of increasing the production of mining machines. Similarly, there will also be a lag in production capacity and R&D adjustments caused by price drops.

This lag is also reflected in mining pools. According to Zhuangzhong's observation, "From the time everyone saw this opportunity (coin price increase) last year and started to build mining pools to the time when small mining pools actually appeared, there was a time difference of about two to three months. Of course, after the computing power decreased, the speed at which small mining pools disappeared also had a certain delay."

The lag in market regulation is a problem faced by any industry operating in a free market economy environment, but the current mining industry is not mature enough to effectively prevent lag risks.

For example, the recent rebound was not anticipated by mining machine manufacturers, so they did not expand production capacity in advance. Neither did the miners, so they did not deploy a large number of mining machines before the flood season.

The lag in market regulation may cause resource mismatch. Since the previous decline in coin prices hindered the generation of new computing power in the market, when the coin price rebounded, the new computing power had no time to enter the market. This is one of the reasons why the actual computing power custody demand during the flood season is less than the custodian's custody capacity.

As a large mining pool, facing the risk of lagging market regulation, Zhuangzhong also frankly admitted that what BTC.com can do is to contact as many customers as possible and understand their needs on the one hand, and to ensure the stability of technology and control business costs on the other hand.

Mining is a highly competitive industry, with frequent changes in market share. Although the dominance of the top mining pools is relatively stable, the top rankings are also changing. On the other hand, more players are entering the market to get a piece of the pie, but in fact only a few mining pools can get excess profits. It should be said that the scale effect of mining pools has become prominent.

The scale effect of the mining pool referred to here is actually a positive cycle of the Matthew effect. Large mining pools gather more computing power in the market, and have a natural advantage in block generation. Even if they encounter a competition situation where blocks are generated at the same time, large mining pools are more likely to win the competition for conflicting blocks because of their high computing power.

Therefore, in the long run, the orphan block rate of large mining pools will be relatively low, and the fees that can be paid to users will also be reduced. In this way, large mining pools can attract more users, gather more computing power, obtain more lucrative revenue, and then have better resources to invest in business, such as increasing the deployment of nodes to improve the efficiency of block broadcasting, etc.

Zhuangzhong believes that “large mining pools have formed a relatively large scale effect on some currencies. It is not very obvious on Bitcoin, but it is still quite obvious on some currencies with a shorter block interval.”

However, at present, the scale effect of large mining pools cannot form differentiated competition among mining pools. The reason is that the types of currencies that can be mined are limited.

“Now, people actually have little choice. There are many currencies that are difficult for mining pools to make a profit, because the market value of some currencies looks high, but the value of the new tokens generated every day is not high.”

Regarding these currencies, Zhuangzhong further explained, “Assuming you have a 20% market share and a 3% fee, your actual income is only a few thousandths of the value of the new tokens generated every day. For currencies ranked after the top ten in terms of market capitalization, the amount of new tokens generated every day may be only tens of thousands or hundreds of thousands of RMB.”

Therefore, the mining business of the top mainstream coins by market value is bound to be a "battlefield" for major mining pools, because not competing or losing the competition is equivalent to being eliminated.

Faced with fierce competition from mainstream PoW currencies, it seems natural for mining pools to enter PoS mining and expand their business scope. Zhuangzhong revealed to PANews that BTC.com also plans to enter the PoS mining pool business and is currently connecting with some custody cooperation.

Recently, the concept of "PoS mining" has been hotly discussed, but in fact, there are no miners in the PoS consensus mechanism. Instead, the nodes assume responsibilities equivalent to those of miners. "PoS mining" is a concept extended from "PoW mining".

Why can the two be compared? The reason is that, to some extent, the essence of the two is the same. Both gather some form of computing power to reach a consensus. PoW gathers tangible computing power, while PoS gathers intangible computing power, which is mainly manifested in the rights and interests of the tokens held by users.

Bitcoin mine photo provided by BTC.com

At present, the proportion of PoS-type currencies in the entire market cannot be ignored, and the governance mechanism of some currencies naturally combines PoW and PoS, such as Dash and DCR, which have both mining parts and can deposit coins to obtain income. The switch of PoW mining pools to PoS mining itself is also a user demand for mining pool products.

However, this does not mean that the advantages of PoW mining business can be copied to PoS mining. These are two completely different business segments. The PoW ecosystem is open. For operating a PoW mining pool, as long as the coin can be mined, it can be done.

However, PoS mining is usually closed, and the ecological status of the mining pool is different. The entrance to computing power becomes exchanges and wallets. The mining pool needs to pay special attention to maintaining the relationship with the project party and the community. Or to put it more bluntly, in PoS mining, the wishes of the project party itself occupy a relatively important position.

At present, the business model of PoW mining is mainly to cash out the cryptocurrency obtained from mining, so the entire industry is greatly affected by the secondary trading market. However, Zhuang is optimistic about the future expansion prospects of PoW mining in terms of business model.

In Zhuangzhong’s opinion, the mining pool business is relatively small at present, and each mining pool has a certain degree of business dependence, and it is not a 100% independent business. For example, mining pools such as BTC.com and Antool have a certain dependence on mining machine manufacturers, while mining pools such as Huobi Mining Pool, OKEx, and ViaBTC are businesses under the exchange.

For the latter, an easy business model to develop is to introduce the exchange's platform currency. As for other mining pools, in addition to competition on fees, they may actively cooperate with some financial products in the future.

“In essence, we hope to go beyond the mining pool business itself and help users connect to more upstream and downstream resources and solve more problems.” Zhuangzhong believes that this is also what every mining pool may want to do at present.