How billionaire-backed Bitcoin mining firm Layer1 is making a killing from downtime

It’s everyone’s dream to make money without doing anything. Bitcoin mining company Layer1 is making that dream a reality – they’ve found a way to make money even when their Bitcoin mining machines are turned off.

Layer1 is a blockchain startup funded by billionaire Peter Thiel, a bitcoin mining company to be exact. In recent months, the company has been busy installing a large number of steel containers (which look like shipping containers) filled with high-end bitcoin ASIC miners, which are immersed in cooling tanks of mineral oil, on a grassy field in West Texas. Why West Texas? Thanks to abundant natural gas and a large number of wind turbines, the electricity there is one of the cheapest in the world, which is exactly where bitcoin production is most needed.

"Bitcoin mining is about turning electricity into money," said CEO and co-founder Alex Liegl. By this fall, Layer1 will have dozens of these large containers running around the clock to convert 100 megawatts into bitcoin. Liegl said their average production cost is about $1,000 per bitcoin - equivalent to a 90% profit margin at the current bitcoin price of $9,100.

However, Liegl is oddly excited about having to shut down their bitcoin mining rigs this summer.

West Texas has already seen a string of 40-degree days this year. But the real heat and humidity won’t arrive until August, when Texas’s electric grid needs to bear the weight of every home air conditioner as it blasts across the state. In one intense week in 2019, wholesale electricity prices in the area of ​​the grid managed by the Electric Reliability Council of Texas (ERCOT) soared from about $120 per megawatt-hour to a peak of $9,000 per megawatt-hour. Texas reached that level of electricity demand only for the third time in history. Although the peak pricing lasted only an hour or so, it was enough to generate a tidy profit. Hugh Wynne, an analyst at the research firm SSR, estimates that Texas generators generate about 15% of their annual revenue during the 1% of peak hours (compared to the top 3% of revenue for grid generators in temperate California).

It turns out that mining farms operating large numbers of bitcoin mining machines are the best place to arbitrage electricity prices during peak hours. Layer1 has signed a so-called "government demand response" contract, under which they will shut down all the machines during peak electricity consumption hours, leaving their 100-megawatt load flowing into the grid. "We are the insurance underwriter for the energy network. If there is insufficient supply, we can apply for a shutdown," said 27-year-old Liegl. The best thing about this operation is that they get paid regardless of whether there is a grid emergency. Just for their willingness to stop bitcoin production, Layer1 collects an annual premium equal to $19 per megawatt-hour of their expected electricity demand - about $17 million. Given that Layer1's long-term contract costs are around $25 per megawatt-hour, this brings their annual electricity price costs down by 75% to less than 1 cent per kilowatt-hour (just 10% of the price paid by residential users).

It may seem incredible that grid operators are paying so much for Layer 1, especially as the coronavirus reduces electricity demand, but it makes sense, said Ed Hirs, a lecturer in energy economics at the University of Houston and a researcher at the University of California, Houston, and consulting firm BDO: "It's much more cost-effective than building a whole new power plant or power system that sits on standby."

While this may be a new concept for bitcoin miners, it has historical precedent. Two decades ago, industrialist Charles Hurwitz bought energy-hungry aluminum smelters in the Pacific Northwest, earning more money reselling the power than making the metal. “It used to be called load management,” says Dan Delurey, a consultant at the Wedgemere Group. “In old commercial buildings, you can still find wires connected to air conditioning systems so that grid operators can send a signal to shut off the power. More recently, we’ve seen companies install radio-based devices to control water heaters and lighting systems.” Indeed, grid management is such a hot area that in 2017, Italian power giant Enel bought Boston-based Enernoc for $250 million, and Itron ITRI bought Comverge for $100 million, and entities like Delurey, known as “power producers,” have emerged, as have Layer1, which is both a producer and consumer of power.

As for Layer1, Liegel said his next step is to vertically integrate into financial products, including bitcoin derivatives. "We are building an internal energy trading department that will be a virtual power plant. It's incredible. It's like digging a hole in my backyard and trying to dig oil out of the ground."