Interpreting the evolution of miners’ Bitcoin pricing power after halving from the perspective of mining economics

As the market value of Bitcoin continues to increase, more external factors will have an increasingly greater impact on its price, and miners' absolute pricing power over Bitcoin will evolve into relative pricing power.

Original title: "The Evolution of Bitcoin Miners from Absolute Pricing Power to Relative Pricing Power"
Written by: Jocy & Bohan

The Economics Behind Mining

The upstream of the Bitcoin industry chain is mainly composed of mining industry participants such as individual miners, mining farms, mining pools and Bitcoin mining machine manufacturers. The FPPS (Full Pay-per-Share) of miners' mining includes mining rewards and transaction fees, while PPS (Pay-per-Share) only includes mining rewards. Transaction fees will change at any time and rise when the network is congested. When the Bitcoin mining reward is halved, miners rely more on transaction fees. Overall, the miner market is a self-balancing market, so there will be no long-term mining difficulties. The impact of miners on the price of Bitcoin is mainly determined by the pressure of their Bitcoin sales rewards.

The core variables behind the economics of mining

Bitcoin Price/Rewards: If the price is too low or the rewards are reduced, the revenue generated by the mining machine may not be able to cover the electricity bill and the mining machine may need to be temporarily shut down or sold on the second-hand market.

Total network computing power: The computing power of the entire network mainly depends on the capital interest in the mining machine industry and the performance of future mining machines. If the coin price is stable and the total network computing power is improved (such as the launch of new mining machines on the market), it is still possible that the mining machines will be scrapped in advance, thus causing the capital expenditure of investing in mining machines to be unable to be recovered. From the current mining machine market, the income of ASIC mining machines has tended to be stable. ASIC mining machines refer to mining machines that use ASIC chips as the core of computing power. ASIC is an electronic circuit designed specifically for a specific purpose. Since ASIC chips are only built for specific calculations, their efficiency can be much higher than general computing chips such as CPUs. The main chip manufacturers are Samsung and Teclast. The new mining machines mainly use 7-nanometer chip technology, while 5-nanometer chips are still under testing and are unlikely to be mass-produced in the short term. Therefore, the income of mining machines using 7-nanometer chips will gradually tend to be stable in the next few years, and they will also be the most sought-after mining machine models.

The core variables behind the economics of mining are:

Without considering depreciation and other fixed expenses and operating costs such as labor

When the total network computing power reaches H*, the current mining machine operating income will not be able to cover the electricity cost. The computing power energy consumption ratio (C/w) of the mining machine shows the overall performance of the miner. The higher the computing power energy consumption ratio, the greater the corresponding H*.

The current computing power is showing a steady upward trend, so the higher the computing power and energy consumption ratio of the mining machine, the later it will be scrapped. Therefore, when the price of the currency is stable, the mining farms tend to buy the most advanced equipment to eliminate the mining machines with lower efficiency. It can be seen that as long as the upstream industry can continuously launch new equipment with higher efficiency, it will receive orders.

The critical index of current coin price and total network computing power

According to Blockware's research, the current mining industry is composed of approximately 38.65% s17 and 61.38% s9 mining machines in terms of Bitmain's mining machines. We compared the critical index of Bitmain's third-generation mining machines at present (end of May 2020) and the critical index on May 11, 2020 (before halving), and studied the impact of halving on Bitcoin miners. In addition, we also analyzed the revenue of miners in different electricity price ranges:

Break-even price and break-even computing power of mining machines after halving

Break-even price and break-even hashrate of mining machines before halving

With an electricity cost of $0.052 per kWh, we can see that the halving of Bitcoin does not have a big impact on the most advanced s19 mining machine, because as long as the price does not fall below $3,860, the s19 will continue to make a profit. However, the situation is different for the s9 mining machine. Before the halving, as long as the price does not fall below $6,672, miners will continue to make a profit, and after the halving, the price needs to reach $10,453 to break even. According to Blockware's research, the current mining industry is composed of approximately 38.63% s17 and 61.38% s9 mining machines. If we take a weighted average based on this ratio, we can see that the break-even price of income and expenditure before the halving is $3,863, and after the halving, it will take $7,272 to break even.

According to the current computing power after halving, the mining machine can only be profitable when the electricity fee is 0.04 US dollars per kWh and the coin price is 8,500 US dollars or above. For the most advanced s19 mining machine, at the current average electricity fee of 0.05-0.06 US dollars per kWh, it can be profitable as long as the coin price is 4,500 US dollars or above. For the current average mining pool configuration, under the average electricity fee, miners can still make a profit as long as the coin price is greater than 5,000 US dollars.

So we can see that after halving:

Old mining machines (s9) are basically unprofitable, so miners need

1. Update mining machine

2. Keep selling Bitcoin to maintain operations until the last minute (this miner believes that the price of Bitcoin will continue to rise - above $10,000)

After all the old mining machines are offline, the computing power of the entire network will decline, the profit margin of miners will increase, and new miners will enter and start a new cycle. Therefore, the entire mining industry is a self-balancing market, and systemic crises will not cause mining accidents. By drawing the break-even curve, we can see the currency price and electricity cost corresponding to different break-even points under the current computing power:

Through profit and loss analysis we found that:

1. After the halving, miners need a higher coin price to maintain a profit-loss balance when electricity costs and computing power remain unchanged. No matter what kind of mining machine, it will be more sensitive to changes in coin prices and electricity costs after the halving (the slope increases).

2. In general, the more advanced the mining machine, the lower its overall sensitivity to electricity costs and coin prices (smaller slope).

3. For large mining pools with advanced mining machines, the halving of Bitcoin will not cause losses or other impacts.

4. With the current electricity cost of $0.05+, the s9 mining machine is no longer profitable, but if used with the s17 mining machine, it can be profitable when the coin price is above $7,400.

5. Therefore, the timely update of mining machines after the halving will be one of the key factors to maintain profitability

6. The technological innovation of mining machines is the most important factor in determining the lifeblood of the mining industry.

Source: blockchain.com

By observing the total network computing power in the past month, we can find that after the halving, the computing power experienced a brief decline and then began to rebound.

As the flood season arrives, we believe that computing power will continue to rise, which will lead to an increase in mining difficulty, and therefore BTC unit computing power profitability will also decrease, which will lead to a decrease in Bitcoin supply per unit time, so Bitcoin may fluctuate upward in the short term.

Will the halving be the main driver of Bitcoin's price reaching new highs?

The current view that Bitcoin halving will cause price increases is mainly explained based on two dimensions: the stock to flow model and the selling pressure of miners.

Stock to flow model

The dominant indicator of stock to flow is the ratio of stock to capacity (stock/annual output), which explains the scarcity of assets. The larger the s2f, the scarcer the asset (the stock becomes larger and the output becomes smaller). Since the reward of Bitcoin becomes smaller after the halving, the s2f ratio of Bitcoin will become larger.

Source: Plan B

The above figure shows the relationship between the valuation of Bitcoin price through the S2F model and the actual price of Bitcoin. We can see that there is a certain degree of correlation between the actual price of Bitcoin and the model price, but we believe that this model cannot directly explain that the decline in supply has caused the rise in Bitcoin price:

1. Such models lack fundamental basis. The S2F model only considers the relationship between supply and price, and believes that this factor is the main reason for the dominant price. We do not think that supply is the dominant factor in Bitcoin prices, because the total issuance of Bitcoin is fixed. No matter how the demand for Bitcoin changes, miners cannot change the supply of Bitcoin. This is very different from metals such as gold. Gold miners can choose to speed up mining when the price of gold rises. Therefore, the supply of Bitcoin is inelastic. Basic economic theory tells us that in a market with inelastic supply, the main indicator affecting prices is demand, not supply.

2. In addition, even if such a relationship exists, this model does not explain why a sudden drop in supply would be an information shock that would cause price fluctuations. Since Bitcoin’s halving is transparent public information, based on the efficient market hypothesis, we know that the impact of halving has been taken into account in the current Bitcoin price.

3. We have seen that the last Bitcoin halving occurred in July 2016, and after the halving, the price of Bitcoin did not completely follow the price trend of the s2f model. Bitcoin did not reach the estimated value of the model until the end of 2017, which was a gap of 1 and a half years. Therefore, we do not think that the s2f model can be used to value the price of Bitcoin well.

Selling pressure from miners

The behavior of miners can be interpreted from the following perspectives:

1. Only when the price of Bitcoin remains at a high level for a long time can miners make stable profits. Short-term price increases/decreases cannot have a huge impact on the entire mining industry.

2. Some miners are Bitcoin hoarders and hold a large amount of Bitcoin, so there is no obvious liquidity crisis in the short term. In addition, Bitcoin mortgage lending has also solved some liquidity problems for miners.

3. Regardless of how Bitcoin miners choose to participate in mining (connecting computing power to mining pools/selling computing power to computing power hosting providers), the monopoly of the mining industry is still the upstream mining machine manufacturers. Therefore, in a bull market, mining machine manufacturers will have the power to decide the price of mining machines, and in a bear market, the demand for mining machines will also decline. Therefore, the real ruler of the mining industry is the mining machine manufacturer.

4. Since some mining farms use a mixture of old and new mining machines, in order to meet the power company's contract, they must also guarantee a fixed monthly electricity fee, so they will not shut down.

To sum up, mining machine manufacturers are the dominant players in the mining industry. The short-term rise and fall of Bitcoin will not cause miners to suddenly shut down and stop production. Whether miners continue to participate in mining in the future depends on their ability to resist liquidity crises.

The impact of this halving on miners should follow the following logic:

1. Miners reduce the impact of Bitcoin halving by increasing liquidity in various ways (staking, selling Bitcoin).

2. Some capable miners will implement arrangements for equipment upgrades, while small miners may need to continue to rely on selling Bitcoin to maintain operations.

3. Since efficient miners will update their equipment to make their mining capabilities more efficient, this will make it more difficult for inefficient miners who rely on selling Bitcoin to maintain their operations, and will eventually cause inefficient miners to exit the market.

4. The remaining high-performance miners redistribute the computing power of the entire network. The Bitcoin price is about 8,800 US dollars when the halving occurs. The block reward obtained by the miners is equivalent to the Bitcoin price of about 4,400 US dollars before the halving. This price is between $3,900 and $5,300 from March 12 to 16, when the Bitcoin network computing power dropped from 120EH/s to 95EH/s. We can see that the decline in computing power caused the difficulty of Bitcoin mining to drop from 16.55T to 13.913T in the subsequent cycle.
   Source: Glassnode Studio

6. When the difficulty coefficient adjustment is completed, the surplus of miners remaining in the market continues to increase, and new miners have the opportunity to enter, thus the mining market enters a new cycle.

Therefore, we see that the Bitcoin miner market is a long-term balanced market. Perhaps now inefficient miners still hold a positive attitude, thinking that they can wait until the computing power decreases and the difficulty is reduced to make profits again, but in fact, the computing power will only decrease when they exit the market themselves. Therefore, the market will keep inefficient miners under liquidity pressure until they have to exit the market. At that time, the market computing power will be rebalanced, the difficulty will be readjusted, and the mining market will enter a new cycle.

Since selling pressure is no longer a variable, a stable indicator naturally cannot be a determining factor in a fluctuating price.

The halving is more of a proof that the Bitcoin mechanism is working as designed

The fundamentals of secondary market prices are still based on the relationship between supply and demand. The net outflow or inflow of the market is the direct factor affecting the price. We see that the news of Bitcoin halving is an absolute hot topic in the industry.

Source: Cointelegraph

We can see that the search popularity of Bitcoin halving on the Internet has increased significantly. People's attention to the event will bring greater net inflows to the market. Therefore, we believe that the impact of halving on Bitcoin prices is mainly in the following aspects:

1. It proves that the Bitcoin mechanism works as designed and that Bitcoin is indeed a successful cryptocurrency, thus increasing market enthusiasm.

2. The increase in market enthusiasm has increased the net inflow into the market, leading to a short-term increase in prices.

Where do the bitcoins mined by miners go?

Miners usually sell Bitcoin through exchanges. If we analyze the data from January 2017 to January 2020, we can see that more than a quarter of all BTC received by exchanges came from mining pools. Therefore, miners must be extra careful when selling Bitcoin rewards, because their actions may lead to a large sell-off in the market.

Source: CoinDesk

Since Bitcoin miners need to sell their Bitcoins at a suitable price in exchange for legal currency to maintain costs, we can know that miners tend to build inventory during bear markets and reduce inventory during bull markets when operations allow. The following figure also proves this:

Source: CoinDesk

Recently, on June 3, 2020, within 5 minutes of the start of US trading hours, the price of Bitcoin fell 8%, from $10,137 to $9,298. But miners continue to sell their Bitcoins:

Source: ByteTree

We can see that on June 3, miners mined 844 bitcoins but the sales of uncolored bitcoins reached 920, which caused the MRI index to exceed 100%. This shows that miners believe that the market is still strong and supported, so the sales of uncolored bitcoins also show that miners are optimistic about the current market price.

If we look at the unsold uncolored bitcoins (January 2009 to January 2020), we find that the highest point in the inventory of Bitcoin miners occurred on March 11, 2011, when there were 2,593,051 unsold bitcoins. The increase in the inventory of Bitcoin in 2009-2010 was mainly due to the ease of mining Bitcoin at the time, after which the inventory of Bitcoin began to decline gradually.

Sources: Byte Tree

Therefore, MRI actually reflects to some extent that there are strong bids in the market that make miners willing to sell their Bitcoins.

When the bid is lowered, MRI will also decrease, and the inventory of undyed Bitcoin will increase. In fact, MRI reflects the demand for Bitcoin. High MRI reflects the strong market demand to a certain extent. We believe that miners are savvy participants. In a balanced market, they will consume the inventory when the market is strong.

In summary, as a core component of the Bitcoin industry, miners have a great influence on the early price of Bitcoin. In the future, they will still be one of the most important players in the Bitcoin ecosystem, but as the market value of Bitcoin continues to increase, more external factors will have an increasing impact on its price, such as the secondary market becoming more active, and the increasing interest of institutions in Bitcoin, which have laid the foundation for Bitcoin to become a mainstream asset.

References

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