Institutionalization of Bitcoin mining is an inevitable trend in the next five years

2020 marks the first year of institutionalization of mining, which brings both benefits and challenges.

There are few investments that offer venture capital-style upside and infrastructure-style downside. Energy arbitrage combined with accumulating Bitcoin (BTC) on corporate balance sheets can achieve this. This is why we are seeing a surge of institutions entering the Bitcoin mining market and starting to build large facilities.

The hungry demand for a new generation of mining machines

At its peak in early 2018, Bitmain was able to produce more than 95,000 mining machines per week. However, since then, production levels have declined, partly as a result of its ongoing legal battles. In the other corner, Whatsminer will deliver hundreds of thousands of machines in a year.

With the western US receiving only limited allocations of these machines, and with 17 publicly traded mining companies and ASIC financiers and large corporations announcing almost simultaneous weekly purchases of top-tier Bitcoin miners, one can see how the supply of the latest equipment can quickly dry up. Building relationships with manufacturers is now essential to securing large allocations of new machines. How do you get into this queue? With plenty of money.

Lower initial capital expenditure

Economies of scale stand in stark contrast to decentralization. However, like most other industries, mining attracts investment with scale. Large mining companies receive discounts on the retail price of ASIC miners. The average payback period for new generation equipment is about 300 days, so discounts can reduce the payback period for large institutions by more than a month. Large miners can also take down payments and installments, which in some cases are about 20%, while the retail industry is more than 50%. This allows miners to buy more machines and build them faster.

In terms of infrastructure, in most cases, building a 30 MW farm can produce electricity at a much lower cost per MW than a 3 MW facility.

Maximize operating profit

If you want cheap electricity, then it will cost a lot of money, such as buying land, building large infrastructure, purchasing generators and other equipment, financing performance bonds, etc. Although some miners are taking advantage of small amounts of cheap energy, overall, electricity is the most profitable. They are able to invest the necessary funds to ensure the best lead. It is well known that the cost of electricity is one of the important determinants of success.

In addition to procuring cheap electricity, large miners can negotiate lower mining pool fees, firmware development fees, and ASIC management software fees. They can reduce the labor required per megawatt, improve management efficiency, and use electricity more efficiently.

Get advanced capital support

Bitcoin mining is a capital-intensive business. It requires continuous equipment upgrades and new equipment purchases. Building a 10-megawatt farm with new equipment can cost nearly $10 million, depending on the purchase price. Access to various forms of funding (e.g., debt, equity, mining equipment financing) is essential for mining farms to maintain scale and enjoy the benefits mentioned above.

From 2018 to 2019, most of these mining operations were financed through a mix of debt and equity at the traditional corporate level. In 2020, we have seen an explosion in ASIC financing. Today, large and reputable mining farms are able to raise funds from the financial industry using their own purchased ASIC mining machines as collateral. The number of these financiers is still limited, so they prioritize lending to high-quality operators with the highest returns and lowest risks.

Manufacturer services are more refined and professional

When presented with an opportunity to mine, one of the first questions the committee asks about the equipment is: “Where is the equipment from? Who is the manufacturer? Is there a warranty? What is the pricing? Why does the price change from day to day? When will the machine be shipped?”

Manufacturers like Bitmain were pioneers in the mining west. In 2016, an arms race began over who could bring the most machines to market. Details of company policies, shipping and pricing, warranties, viable repair centers, and transparency have been quietly supported behind the scenes.

When agencies entered the industry, the first thing that started to change was the production mentality of manufacturers, and then everything else began to shift. Now, manufacturers have to hold weekly conference calls with major customers to discuss their production visibility and provide more transparency into operations. Most manufacturers now offer machine warranties, they have opened overseas repair centers, and although it is a long way to go, they want more transparency in shipping and pricing.

MicroBT, Bitmain, and others who want to compete in the West are likely to continue this trend toward professionalization.

Mining pool competition

“How do we actually get paid?” is another typical question that institutions ask. The answer is in mining pools. Mining pools are buyers of hashrate. Therefore, questions arise about who this counterparty is and what are the risks associated with trading with them.

Mining pools have historically been a black box in the mining value chain. Institutions have helped increase transparency in pool pricing, reduced the number of pools that steal hashrate from miners, and incentivized pools to build new feature sets. The mining pool industry is evolving rapidly, and if companies don’t keep up, they will be left behind. All of these trends will benefit institutions that need better, more compliant counterparties.

Industry consolidation

There will be a wave of consolidation in the mining industry in the future. There are hundreds of great companies and teams fighting for this new market, and these institutions and teams have been seized by institutions.

The main consolidation will take place at the mine site level. Similar to the real estate sector, these mergers and acquisitions are likely to be based on projects rather than companies.

Other verticals such as mining pools, mining machine manufacturers, ASIC management software, mining media, firmware developers and ASIC mining machine resellers can also be combined into a broader product.

Financial services companies will also be natural acquirers as they seek to build ecosystems spanning the mining and financial value chains.

Financialization of Hash Power

In every traditional commodity industry, companies have the ability to use financial instruments to hedge cash flows through futures and options, sell part of their production in purchase agreements or forwards, increase their holdings of derivatives, etc.

To date, there are very few financial instruments based on hash rate. The entry of institutions will change this situation because they are creating demand for such products. The demand of miners must be met by other market participants, such as traders, to form a liquid market.

Mining prospects in the next five years

In 2015, if you told miners where we are today, they would not have believed it: millions of ASIC miners securing the network, using gigawatts of electricity, and institutions like Fidelity having their own Bitcoin mining operations.

It’s hard to predict how the industry will evolve over the next five years, but I do think institutions will continue to drive innovation in the space, creating a more secure network for Bitcoin. But this will bring new challenges, such as protocol-level scrutiny, more know-your-customer/anti-money laundering, less decentralization, etc. Traditional Bitcoin-native mining companies must work hand in hand with these new entrants to shape a better future for Bitcoin.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Ethan Vera is the co-founder of Luxor Mining, a North American hashrate clearing platform that serves the Bitcoin and altcoin mining community. In addition, Ethan is the co-founder of Hashrate Index, a database of every data site related to mining. Prior to joining the Bitcoin mining industry, Ethan was an investment banker at Goldman Sachs.