MinerMovements #10

How Will Hardware Manufacturers Fare Post-Halving?

After the largest downward difficulty adjustment since ASICs started mining Bitcoin, the network difficulty has recorded two consecutive upward adjustments. Our latest Miner Insights piece details several factors likely playing into the higher hash rate and faster block times which drove the upward difficulty adjustments.

BTC price has traded at significantly higher levels than the lows observed in March which is one key variable conducive to miners deploying more hash rate. But with yesterday’s difficulty adjustment recording an increase of 8.45%, the bottom line will be significantly higher for miners across the industry.

Furthermore, the halving is scheduled to take place in roughly 19 days meaning that the miners margins will also be seeing their top line drop. The following weeks will shine a light on how the mining industry is going to change in response to the upcoming block subsidy reduction.

For a more detailed discussion on this, check out our halving piece from our last newsletter here. In this week’s cover piece, we explore how hardware manufacturers may be overexposed to an unexpected drop in demand for mining rigs, reminiscent of 2018.

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Competition among mining manufacturers is heating up. Over recent weeks, manufacturers have slashed prices, MicroBT rolled out three new mining rigs, and Bitmain issued cash coupons to customers.

All this has been unfolding as lower BTC prices and the upcoming block subsidy halving hurts demand prospects for the latest generation of rigs. When prices are high and miner margins are wide, demand for more powerful and efficient rigs commonly exceeds what manufacturers could ever supply to the market. At its peak, demand-supply imbalances can lead to rig prices rising to the point where there aren’t sufficient block rewards to ROI, significant price premiums on the secondary market, and the creation of markets for trading commitments to purchase future deliveries of rigs.

High demand for more powerful and efficient rigs has dominantly been the case since the BTC price run-up to ~$14k in Q2 2019. Miner returns reached roughly $0.5 daily per THash deployed and miners globally scrambled to get their facilities in the best position to capitalize on the next price run-up. Bullish narratives surrounding the halving further fueled this buying spree.

“The whole world strives to increase hashing power” Pavel Moravec, Co-CEO of Braiins

In recent conditions, miners have gobbled up any rigs that manufacturers have released to the market. But conditions have been changing. The halving has almost arrived. The price increase which was highly anticipated to accompany it failed to receive the memo. Furthermore, Bitcoin difficulty has been increasing over recent weeks, pushing up the cost for miners while BTC price has struggled to maintain valuations in the $7,000’s.

These factors add uncertainty to future demand for rigs. When demand is high, manufacturers can’t release rigs quickly enough. They are limited by the huge capital required and the amount of chips they can secure from foundries. But as sentiment shifts, manufacturers may be caught overexposed with huge expenses, inventory which is not selling, and a serious cash flow issue which threatens insolvency.

Cryptocurrencies recorded phenomenal price increases in Q4 2017. Margins for miners exploded as manufacturers couldn’t supply rigs fast enough to fulfil the demand from miners. Price increases initially outpaced increases in difficulty and the daily return per THash deployed reached $3.83 in December 2017. Manufacturers put in place plans to supply rigs to an extremely bullish miner market. Rig prices increased with Bitmain selling the Antminer S9 for $1,712 in Q1 2018 compared to $1,257 in 2017. However, in Q1 2018, a downtrend in cryptocurrency prices started which we are arguably still in today. Daily returns per THash deployed began to rapidly drop. By the end of March, the daily return had dropped to $0.46. At this point, Bitmain had $1.2 billion of inventory on their balance sheet, equalling 52% of the revenue generated from rig sales in 2017. By the end of Q2, daily returns would be $0.3 per THash deployed. The return would drop to $0.22 at the end of Q3 and $0.16 at the end of 2018 as illustrated below. Although Bitmain managed to turn a profit of over $1 billion in Q1 2018, mining machine prices had to be dropped and the company incurred a net loss of $395 million in Q2 2018 and faced a significant cash flow crisis with large chip order prepayments due to their foundry TSMC.

Are we facing similar circumstances today with manufacturers overexposing themselves amid a bullish mining market? With Bitcoin currently trading at less than half of the highs observed in Q2 and the halving price run-up failing to materialize, will manufacturers be left with significant amounts of unsold inventory? Here’s a quote from the Bitmain IPO prospectus which may be extremely pertinent to the disconnect between halving anticipations and reality.

In early 2018, we anticipated strong market growth for cryptocurrency mining hardware in 2018 due to the upward trend of cryptocurrencies price since the fourth quarter of 2017, and we placed a large amount of orders with our production partners in response to the anticipated significant sales growth. However, there had been significant market volatility in the market price of cryptocurrencies in the first half of 2018. As a result of such volatility, the expected economic return from cryptocurrency mining had been adversely affected and the sales of our mining hardware slowed down, which in turn caused an increase in our inventories level and a decrease in advances received from our customers in the first half of 2018. 

Mining machines prices have already been slashed to reflect the more bearish market conditions. Prices of the Antminer S17 series rigs and Whatsminer M30S and M20S have all been reduced by roughly 20% from mid-March to mid-April. Furthermore, the issuance of cash coupons by Bitmain will add liabilities to the balance sheet. Any manufacturers who sold rigs on credit over past months will likely find a significant rise in the amount of customers failing to pay. The only publicly listed Bitcoin ASIC manufacturer Canaan has recently released their first earnings report. The company reported a net loss of $114.7 million for Q4 and $148.6 million for the full year. The balance sheet highlights that Canaan had $28 million worth of inventory at year-end. An improvement from the end of 2018 when the company had roughly $85 million worth of inventory. However, it remains unknown how the Canaan balance sheet is shaping up in Q1 2020. In their business outlook, the earnings report discussed the anticipated impact of the COVID-19 outbreak on business operations.

As a result of the impact of the COVID-19 outbreak… we have lowered our expectations for business in the year of 2020. For the first quarter of 2020, the company expects total revenues not less than RMB60 million

How other manufacturers have fared in Q1 2020 also remains unknown. Bitmain has a significant overseas presence and this segment of their business will have taken a hit given the transportation lockdown. The other manufacturers may have their market more localized in China but their business will not be cushioned from the potential for a drop in demand for new rigs. While the world may have been striving to increase hashing power in 2019, depressed prices and reduction in the block subsidy will likely take their toll on demand. Falling daily returns for miners and manufacturers slashing prices would certainly suggest so.

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