The Matthew Mining Effect.
It’s Monday morning and Bitcoin price wrapped up last week’s trading by declining roughly 12% over the weekend. At the time of writing, the difficulty adjustment is set to take place in roughly five hours.
BTC.com is currently estimating that the difficulty will increase by 7.39%. A significant difficulty increase would certainly be expected given that Bitcoin hash rate estimates have risen to record highs and Chinese ASIC manufacturers and maintenance factories have gradually begun reopening after shutting down as the Coronavirus outbreak exacerbated.
The ASIC manufacturers and maintenance factories slowly returning to full operations means Bitcoin miners can acquire new mining rigs and fix rigs which were facing technical difficulties. While such factors are potential explanations for the recent increase in hash rate, the difficulty adjustment roughly two weeks from now will be far more uncertain.
If ASIC manufacturers can continue towards resuming full operating capacity, this would likely facilitate miners being able to deploy more hash rate. But if Coronavirus conditions continue to exacerbate, the return to full operations may pause or even revert.
Furthermore, the weekend Bitcoin price decline will force inefficient miners operating on the highest part of the cost curve to shut down operations. Data from Capriole Investments estimates the current market-wide cost of production to be $5,700.
Since our last newsletter release, there has been several new ASIC hardware announcements. This week’s cover piece analyses the impact of new mining rig releases on the Bitcoin mining industry.
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The Matthew Mining Effect
Over the past months, several new series of Bitcoin mining rigs have been announced. Bitmain announced their Antminer S19 series with the Antminer S19 Pro touting a hash rate of 110 TH/s.
Furthermore, MicroBT opened sales for their Whatminer M30S series in February while Canaan shipped their February batch of mining rigs which included the AvalonMiner 1166. Canaan also announced the AvalonMiner 1066 Pro with a hash rate of 55 TH and an energy efficiency of 60 J/TH.
Every cyclical release of mining rigs highlights an element intrinsic to the Bitcoin mining industry and one which rings true for all laissez-faire industries generally. The Matthew effect exponentially increases the advantages of efficient miners while putting increasing amounts of pressure on those operating below maximal efficiency.
Those most efficient miners, operating on the lowest end of the cost curve, increase their advantage while all those miners who are higher on the cost curve observe their returns move closer to the cash-flow breakeven. Those who are highest on the cost curve, the most inefficient, will be pushed below their cash-flow breakeven figure and will likely turn their mining rigs offline.
It’s a pure power law. Generally, the lower a miner goes on the cost curve, the exponentially greater their market position is. The higher a miner is on the cost curve, the exponentially weaker their market position is.
There are some unique situations such as hobbyist miners who are experimenting or crafty college students capitalizing on non-existent electricity rates. But these are the exception and not the rule.
Let’s look at the factors that make the Matthew effect ring true for mining.
When a Bitcoin miner establishes their operations, they are inherently long the value of their hash rate, short difficulty, and long bitcoin price. The value of their hash rate will diminish as price declines, or as difficulty increases, or both.
New hardware releases results in more hash rate deployed on the network, subsequently increasing difficulty. Miners are either forced to upgrade their hardware to maintain their current competitiveness or see their slice of the pie diminish as other miners deploy new hardware with higher hash rate outputs.
There will be other factors at play such as the fiat cost of the new hardware and whether the price of the new mining rig justifies the extra hash rate it provides. Every new mining rig release puts mid-scale and small-scale miners in a tough position. Do they upgrade to the new-generation ASICs, attempt to acquire more previous generation hardware at lower prices, or do they standby and risk extinction?
Why does efficiency give miners an exponentially greater advantage?
Miners who are lowest on the cost curve will generally have the widest profit margins. Miners are in the business of generating bitcoin but their operating costs are in fiat.
Miners who are the highest on the cost curve are forced to sell close to 100% of the bitcoin they generate to meet their operating costs. The lower a miner goes on the cost curve, the less the percentage of their mined bitcoin they are forced to sell.
These efficient miners have the privilege of being able to hold bitcoin and get exposure to any upside price movements. They can also choose to accumulate cash on their balance sheet.
When new mining rigs are released, accumulating cash on the balance sheet gives these miners the choice of upgrading their rigs and other infrastructure. Many miners will not have this choice as they are operating just at the margin.
Another angle to consider here is any new-generation mining rigs acquired by these miners will be deployed before difficulty levels have adjusted to reflect the higher hash rate. This makes the initial deployment of new mining rigs an extremely profitable phase.
By the time inefficient miners have acquired new releases, difficulty levels will have adjusted significantly higher and returns will be far lower. The efficient miners have benefitted from their position on the lower end of the cost curve while the inefficient miners are pushed closer to the margins.
And the cycle repeats with every mining rig release. Being lower on the cost curve gives miners protection against price drops and the option to acquire new releases of hardware at a time when difficulty levels have not yet adjusted higher.
Some businesses have spawned with the main goal of helping miners move lower on the cost curve. Texas-based HODL Ranch helps Bitcoin miners set up facilities in West Texas to benefit from the low-cost electricity rates and abundant renewable energy sources. HODL Ranch CTO Jesse Peltan shared his views on the importance of cost of production in the mining industry
“Peltan argues that in the long run what matters most is not Bitcoin’s price but “the cost of your production relative to other producers.” With low enough operational costs, larger producers will be insulated against price drops by marginal producers, which will get forced to shut down, he says.”
Oh, and one more thing. The Bitcoin halving is scheduled to take place in two months. Wolfie Zhao summarizes what the combination of new mining rig releases and the upcoming halving will mean for many miners.
“With bitcoin's halving event approaching in May, a programmed-in change that will reduce the network's mining rewards from 12.5 BTC per block to 6.25, older models like the S9 will become unprofitable unless bitcoin's price increases significantly. As such, miners may have to either upgrade or get out of the industry.”
The Coronavirus outbreak continues to exacerbate. The virus has become significantly more prevalent outside of China. In response, conferences are being cancelled and some restrictions on travel and work are being put in place by various governments. Bitcoin 2020 was scheduled to take place at the end of this month but has been postponed until Q3. We have found this website useful for keeping up to date with reported cases.
Stay safe miners.
Bitcoin Hash Rate Hits Record Highs as ASIC Manufacturers Resume Operations - Hash rate moves to all-time highs, ASIC manufacturers slowly resume operations, and several new series of mining rigs are announced. MinerUpdate reviews it all!
Luxor Mining Interview
We interviewed the founding team of Luxor Mining. Luxor Mining is a North American multi-cryptocurrency mining pool service. The Luxor team has been producing excellent mining content and completing some exciting work in the industry. The team shared their opinion on various types of mining hardware, how the altcoin market may shape up moving forward, and what needs to happen for America to capture a larger share of the hash rate pie.
Luxor described why ASICs are the end-goal for a PoW chain. Other general computing hardware can be programmed to other uses, resulting in a misalignment of incentives. Such hardware can act against the health of a network for short-term profit and switch its function later. On the other hand, ASICs will be worthless if they can’t mine on the chain they are designed for, which serves to align miners incentives with those of the network. Furthermore, the Luxor team noted that they are “aware of a few GPU farms that would be able to 51% attack any non-ASIC PoW chain”.
“Decentralization simply does not exist in the GPU world. It’s not any better than ASICs, and arguably worse”
The team detailed the challenges with mining in North America. The absence of a domestic ASIC manufacturer means that North American miners are typically last in line to receive ASICs, mining at much higher difficulty levels than when the ASIC is originally released. The build-out costs are also noted to be “2x greater compared to other regions”. Luxor Mining sees a domestic ASIC manufacturer and instruments for miners to hedge financial risk as two key puzzle pieces North America needs to grow its Bitcoin mining industry.
Best of the Rest
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Canaan Fodder - Investigative research by a short-seller raises alarming evidence concerning Canaan. The research highlights several concerning customer profiles and business relationships which may have existed solely to boost Canaan’s sales figures ahead of former IPO attempts.
Tales from the Crypt: A Bitcoin Podcast #136 with Paul Sztorc - Sztorc frames the proof-of-work versus proof-of-stake argument in economics theory, arguing that proof-of-stake is no less energy-intensive than proof-of-work. The argument is grounded in the theory that marginal cost equals marginal revenue (MC=MR). MC=MR proposes that block producers will always bid up the cost of producing a block close to the revenue available for producing it. Paul has also detailed his argument in his 2015 blog post “Nothing is Cheaper than Proof of Work”.
MinerUpdate.com is the leading crypto-mining publication. Our aim is to bridge the gap between the East to the West in mining while delivering to our readers the latest insights and developments in the industry. Our publication is ad-free, bias-free, with no conflict of interest when it comes to delivering high-quality content. In October 2019, MinerUpdate hosted MinerSummit, the first English crypto mining event in China.