Understanding Bitcoin Market Participants - Miners Drive Bitcoin Prices

Many analysts believe that the minimum price of Bitcoin is determined by the break-even price of Bitcoin miners’ production costs. This statement is inaccurate. In fact, as the price approaches the production cost of miners, the selling pressure on Bitcoin tends to accelerate. There is a constant selling pressure on the price of Bitcoin from miners. The actual determinant supporting the price is the net reduction of hash power on the network (favorable difficulty adjustment) by miners stopping mining. It is crucial to understand the game theory as it applies to miners. The cost of producing Bitcoin for a miner can be derived from their electricity bill, because 95% of the operating cost of a miner is electricity usage. Therefore, miners need Bitcoin to be at a certain price so that the Bitcoin income they earn is greater than their electricity bill. Miners with the lowest electricity bills have a clear comparative advantage. We will analyze the following points:

1. Bitcoin Network:

Who are the market participants and how do they influence the price of Bitcoin?

Analyze the mining network layer by layer

2. How will the next generation of mining machines balance the competitive environment – ​​allowing miners with high electricity rates to win the game.

3. Myth busting – “The breakeven price for miners is the price floor.”

4. The impact of the 2020 halving on the Bitcoin industry – hitting the trifecta.

5. Difficulty: Satoshi Nakamoto’s original network stabilization mechanism - understand its gravity.

6. How miners stopping mining will accelerate the bottom of Bitcoin.

1 Three main types of Bitcoin market participants

1. Investment funds - hedge funds, venture capital funds, family offices and other institutional investors. They almost exclusively adopt a "long only" strategy and rarely adopt a short strategy. They usually have a long-term bullish bias, but have the ability to exit their positions at any time and leave when the test is confirmed.

2. Holders - long-term accumulators who seek to maximize their Bitcoin holdings. Retail investors have a long-term bullish bias and are less sensitive to price fluctuations than investment funds. However, like investment funds, holders can liquidate their entire positions and exit at any time.

3. Miners - the backbone of the Bitcoin network.

Miners have a stronger belief in Bitcoin than investment funds and coin hodlers. They have a long horizon. They invest in assets with long lifecycles that cannot be repurposed or quickly liquidated at fair market value. ASIC mining equipment has a lifecycle of 3+ years and can only be used to mine the Sha-256 protocol (almost exclusively Bitcoin). Bitcoin mining facilities have a lifecycle of 5+ years and are usually retooled warehouses designed specifically for cooling mining equipment. On average, it takes miners 18 months to break even after investing money in mining equipment, facility expansion, and electricity expenses. Miners are the main driver of selling pressure on the Bitcoin network. As they receive all the newly produced Bitcoin, they must sell it immediately to fund the capital and operating expenses of their mining operations.

2. Selling pressure from miners

Currently, approximately 54,000 new Bitcoins are mined each month. If Bitcoin is trading at $10,000, this equates to approximately $540 million in new Bitcoins released to miners each month. Miners must sell a large portion of the 54,000 Bitcoins to pay for electricity. Miners with higher electricity costs must sell more of their Bitcoin revenue to pay for electricity. Most of the capital outflow on the Bitcoin network is driven by miners.

3. Analyzing the mining network layer by layer

This chart illustrates the distribution of electricity prices for miners, with the percentage of hashing power giving the percentage of Bitcoin mining rewards each tier receives.

The dynamic has changed over the past eight months due to the release of new generation miners. Bitmain’s S17 Pro 50T uses 50% more energy but has 300% more hashing power than the Bitmain S9 13.5T. Each S17 Pro 50T deployed has the equivalent hashing power of four S9 13.5T mining rigs. Tier 1 and Tier 2 miners once accounted for a higher percentage of the network hashrate, but they have much less incentive to upgrade to the next generation of mining rigs due to lower electricity costs. The older generation S9 13.5T uses 16nm chips, while the S17 Pro 50T uses 7nm chips. Innovation in chips makes electricity less relevant because fewer watts are consumed per terahash. Next generation mining rigs reduce the financial impact of high electricity prices. Conversely, low electricity costs reduce the impact of the relative disadvantages of inefficient older mining rigs. For Tier 1 and Tier 2, the opportunity cost of Bitcoin/balance sheet depletion in exchange for lowering production costs by upgrading their mining rigs is unfavorable based on the current percentage of old mining rigs still on the network. Tier 1 and Tier 2 will remain competitive with old mining rigs as long as other tiers use old mining rigs. Mining is about viability and being more competitive than peers. As future hashrate from next generation mining rigs in Tiers 3-8 approaches 100%, Tiers 1-2 will be forced to upgrade. The halving could trigger this event.

As electricity costs increase, the opportunity cost of depleting Bitcoin reserves/balance sheets to invest capital into purchasing next-generation mining equipment becomes increasingly favorable. In May 2019, forward-thinking miners began to anticipate the risk of S9 shutdowns due to the 2020 halving. As a result, over the past 8 months, Tiers 3-8 have actively led the hardware upgrade cycle to next-generation miners, while Tiers 1 and 2 continue to use older S9s. The next-generation mining equipment upgrade cycle has increased the network hash rate by 80% and increased the proportion of the network hash rate represented by Tiers 3-8 - diluting Tiers 1 and 2's share of the total network hash rate.

Therefore, this does not match the predictions of environmentalists who have been vocal about the Bitcoin network. Many have predicted excessive consumption of energy as the Bitcoin network exceeds a certain hash rate, but because mining equipment has fundamentally become more efficient, the energy consumption rate of the network hash has dropped significantly.

5. Understanding Bitcoin Miner Behavior

The analysis below shows the selling pressure from margin compression for miners operating at various electricity prices, and the subsequent relief of selling pressure once unprofitable miners shut down (the impact of difficulty). We present a simulation based on game theory that illustrates the behavior and decisions of miners under various scenarios. These are not Bitcoin price targets, but rather illustrations of the impact on the mining network when Bitcoin is at specific price levels before and after the halving. For this simulation, a single average kWh rate is used for all miners within the “miner layer.” This simplification incorporates the number of mining rigs that “shut down” at each Bitcoin breakeven price threshold. This creates a waterfall when miners shut down, amplifying the magnitude of the subsequent adjustments in network difficulty and profitability for surviving miners. Based on these assumptions, this model creates a “step chart,” which is a useful illustration of conceptualizing reality, but smoother, more linear changes would better reflect actual applications. For consistency, this analysis makes the following claims: · The Bitman S17 represents next-generation mining rigs, while the Bitmain S9 represents legacy mining rigs. Currently, the percentage of next-generation hashing to legacy hashing represents 61.38% and 38.63% of the total network hashing, respectively. The electricity cost for each miner in the layer is uniform and based on the average kWh rate of all miners in the layer. Therefore, in this analysis, the break-even cost of each miner in the layer is equal, and all shut down when this price is violated.

During the analysis period, no new miners joined the network.

The percentage of S17 and S9 mining equipment in each layer varies according to the distribution in the following table:

Why we are confident in these claims:

Blockware Solutions, LLC is one of the largest distributors of Bitcoin mining rigs in North America. We have customers and partners in the following regions: United States, Canada, Mexico, Venezuela, Paraguay, South Africa, Iceland, Sweden, Norway, British Columbia, Germany, Eastern Europe, Kazakhstan, Russia, UAE, Iran, Mongolia, China, Japan and Australia. Our extensive reach: customer base, strategic partners, business partners and network account for more than 20% of the total network hash rate.

We have held working meetings and peer reviews with top mining pools and the largest ASIC manufacturers to deeply understand the distribution of hashrate percentages, electricity rates, and mining rig models in each region.

We visited a 30+ MW mining farm in Chengdu, China, as well as operations in hydropower-rich regions of upstate New York and the Pacific Northwest.

Customers and partners in Sichuan Province, China, Venezuela, Kazakhstan, West Texas, Upstate New York, and the Pacific Northwest all have sub-3c electricity, but most mine entirely with older mining rigs. They have no incentive to upgrade to next-generation mining rigs because their low electricity rates reduce the benefits of more efficient mining rigs and are not high enough to justify the significant cost of upgrading to next-generation mining rigs.

6. $10,000 Bitcoin: Healthy Profit Margins at Each Tier

When Bitcoin was trading at $10,000, every layer of miners enjoyed a healthy profit, especially the S17 mining rigs. However, for layer 8 miners, the profit of the S9 mining rigs was close to the shutdown price. Even at $10,000 BTC, 96.3% of the Bitcoin generated by the S9 in layer 8 needs to be sold to pay for electricity.

Based on the above scenario, miners must sell at least 39.12% of the mined Bitcoin (equivalent to $211,225,815) per month to pay for electricity costs. This means that new cash deployed by investment funds and holders must reach $211,225,815 per month to match the fiat outflows generated by miners to finance their operations. The selling pressure from miners is consistent, while the new funds raised by investment funds and holders are driven by sentiment and vary depending on the stage of the market cycle.

Bitcoin at $ 7,500 : Busting the Myth “Miners’ Breakeven Price is the Price Bottom”

As the price of Bitcoin falls, miners experience profit compression. As a result, they are forced to sell a larger percentage of BTC to cover electricity costs (income is decreasing, but expenses remain the same). Let’s check tier 6, 7, and 8 miners mining with S9s: As the price of Bitcoin approaches and falls below the breakeven price for miners, miners are now operating at a loss. They must sell all of their mined Bitcoin, plus additional BTC reserves to cover electricity costs. This puts additional selling pressure on the market in addition to newly mined Bitcoin – the opposite of price support.

8. Understand the actual and theoretical operating results

Many people believe that when miners reach breakeven, they can shut down and never lose money. This is a misconception that is badly misunderstood. Contractual obligations and failed money management often cause miners to operate at a loss. This forces miners to sell more Bitcoin than they mine. Depleting Bitcoin inventory and creating additional selling pressure on the market: Miners have negotiated contracts with utility companies to reduce electricity rates, but these electricity rates are subject to minimum electricity usage thresholds. Therefore, some miners will find themselves operating at a loss for a certain period of time because they must continue mining to meet minimum usage requirements; otherwise, they will lose out in the long run. They cannot simply shut down for a week or a month (when it is unprofitable) and wait for Bitcoin to rebound. Many miners put their mining rigs into hosting. These hosting contracts lock miners in for a period of 1 to 2 years at a fixed monthly fee per mining rig (determined by electricity costs). If the miner does not make these monthly payments, the hosting party can confiscate the mining rig. As a result, many miners will bear the risk of mining at a loss for several months to avoid defaulting and losing their expensive mining rigs. Miners become speculators. Miners are human and therefore are not immune to human psychology factors. Many miners try to implement guidelines on when and how much Bitcoin to sell. Many miners may sell all of their Bitcoins weekly, monthly, or may only sell enough BTC to cover their electricity costs when they receive it.

Unfortunately, when the price of Bitcoin rises, miners tend to turn into speculators, hoping to take advantage of the upswing. We shared the results of an analysis with one of the largest OTC facilitators in crypto. In September 2019, we discussed how some of the OTC facilitator’s miner clients deviated from their scheduled liquidation plans and chose to hold mined Bitcoin during July and August - believing that Bitcoin would continue to rise. However, the price of Bitcoin peaked in late June, and these miners had to sell at much lower prices in late September and October. Such a situation accelerated the Bitcoin sell-off, as the additional selling pressure generated by liquidating Bitcoin inventory was not only generated from newly mined Bitcoin. Bottom line: When the Bitcoin price was $10,000, only 39.12% of the total monthly Bitcoin mined had to be sold to cover electricity costs. Once Bitcoin fell to $7,500, profit margins for all miners fell and caused S9 mining rigs to operate at a loss for Tier 6, 7, and 8 miners. As a result, 53.18% of the total monthly Bitcoin mined needed to be sold to cover electricity costs.

9Miner shutdown roadmap

10 Bitcoin price at $7,500 – before the halving

There are many inefficient older miners mining Bitcoin (Tier 3-8 running S9). These miners exert the most selling pressure on Bitcoin because they need to sell most of the mined Bitcoin to pay for electricity. Tier 3-8 miners running S9 also have the highest breakeven price. They represent the current pressure point in the mining network, which is putting downward pressure on the price of Bitcoin.

11 Bitcoin price at $ 5,000 – before the halving

In the event that Bitcoin continues to fall towards $5,000, S9 mining rigs on Tiers 6, 7, and 8 will have to shut down. This results in a favorable difficulty adjustment, which raises the breakeven price for all surviving miners. However, despite the benefit of the difficulty adjustment, Tier 4 and Tier 5 miners running S9s will still lose money at a Bitcoin price of $5,000. The presence of S9s on Tiers 4 and 5 represents a new pressure point in the mining network, which creates greater vulnerability for the Bitcoin price. These S9s will follow the Miner Capitulation roadmap discussed earlier: they will begin to consume their Bitcoin inventory to pay for electricity until they become bankrupt and are forced to shut down – thereby increasing the selling pressure on Bitcoin until they shut down.

12 Bitcoin price at $ 5,000 – after inefficient miners shut down

After losses continued long enough, Tier 4 and Tier 5 miners running S9s were forced to shut down - which resulted in a favorable difficulty adjustment for the surviving miners. The S9s that shut down in Tier 4 and Tier 5 accounted for 14.5% of the total network hashrate. This means that after the shutdown, 14.5% of the new Bitcoins previously mined by Tier 4 and Tier 5 S9s will be redistributed to the surviving miners. This redistribution will increase the breakeven price for the surviving miners and alleviate the selling pressure on Bitcoin as the profit margins for the surviving miners will increase. Now, Strong Hands (more efficient miners) are accumulating newly mined Bitcoins. The minimum selling power percentage for miners has been reduced from 69.60% to 51.49%.

13 Bitcoin price at $ 5,000 – after halving

In this scenario, a post-halving price of $5,000 would see a healthy cleanup of the network, allowing the best position in Bitcoin to reach new highs again (even a price of $8,000 would provide substantial cleanup). The May 2020 halving will reduce the rewards issued to miners by 50%. Mining revenue denominated in Bitcoin will be reduced by 50%. In order to stabilize mining profits, the price of Bitcoin must rise so that miners receive the same mining revenue denominated in USD. This is critical because miners need to finance their electricity bills. Since all S9s above 2.5c (tiers 2 to 8) will be operating at a loss, and s17s above 6.5c (tiers 7 and 8) will also be operating at a loss, a large number of miners will face huge losses and be forced to shut down.

14. $5,000 Bitcoin – Post-Halving – Inefficient Miners Shut Down

Satoshi’s Network Stabilization Mechanism: Understanding the Difficulty Gravity Factor on Miner Profitability If Bitcoin remains at a low price level for 2-4 months after the halving, many miners operating at a loss will be forced to shut down. After all the miners operating at a loss shut down, the surviving miners will see a significant increase in profits. We will witness network chaos in the short term, but once the inefficient miners shut down, the difficulty adjustment will return to stability. Difficulty: The Bitcoin protocol has a self-correcting mechanism that stabilizes the profitability of the mining network to ensure that miners are provided with enough incentives to continue to maintain the network operations. Miners are the backbone and security layer of the Bitcoin blockchain. The difficulty mechanism ensures that efficient miners are incentivized to continue to perform. This is one of the most underestimated and lesser-known phenomena when it comes to Bitcoin mining. If the mining network experiences marginal compression, the least efficient miners will be picked off layer by layer. With inefficient miners shut down, the network now requires more time to mine blocks because there is less hashing to solve blocks on the network in a timely manner. If the network does not solve the obstacle within 10 minutes, a favorable difficulty adjustment will be made. The share of rewards that once went to the miners that shut down is now distributed to the miners that remain on the network. This is considered a favorable difficulty adjustment. This process will continue until profitability returns to normal, or even profitable for the surviving/most efficient miners. Mining is tied to viability. Difficulty adjustments will reduce the impact of Bitcoin price corrections on miners whose operations are sufficient to survive.

15 Knockout before the outbreak - Hit the triple

1. Halving – Improving Supply-Side Economics: Many market participants speculate on the future of Bitcoin. It is certain that by mid-May, 50% of the potential selling pressure will be eliminated as the Bitcoin mining incentive is halved. A 50% supply reduction will reduce the Bitcoin supply by a modest but continuously decreasing amount, which is entirely determined by the code of the Bitcoin protocol. This is a positive catalyst for the price of Bitcoin.

2. Improved demand-side economics due to positive sentiment towards the halving: An economist could say that Bitcoin is worthless because it is currently too volatile to be an effective store of value and too slow to be an effective payment platform. A Bitcoin maximalist could say that Bitcoin is digital gold because it is scarce. Ultimately, the market determines the price of Bitcoin.

Historically, Bitcoin has entered the halving and continued an uptrend/bull cycle (always with multiple severe corrections along the way). Most market participants deeply understand these historical trends. One can claim that the halving is priced in, but this is unprovable unless you can confirm with the majority of market participants that they have deployed cash positions and hit price targets. Opinions vary, and most market participants have a certain amount of cash positions. Everyone thinks about the halving and creates positive emotions on the demand side. This psychological positive emotion will cause market participants to anticipate and prepare to deploy cash positions towards the upward momentum. Everyone sees the halving trend, and everyone has missed out on a significant rise in Bitcoin at some point – this is why Bitcoin has more holders than any other asset. Holders don’t want to miss out again. This is a market, and markets are driven by human psychology. Before the halving, the human psychology of Bitcoin market participants was biased towards bullishness. This created positive emotions on the demand side of Bitcoin.

3. An opportunistic environment through debt acquisition: After the Bitcoin network experiences a significant or sustained favorable difficulty adjustment, the probability of a Bitcoin price bottom increases (https://bitcoin.blockwarepool.com/mining-data). This is because newly mined Bitcoin is now being distributed and accumulated by the most efficient miners with healthy balance sheets. The amount of Bitcoin (in Bitcoin) received by the surviving miners is proportional to the amount of Bitcoin distributed to the shut-down miners. These rare, profitable opportunities allow the surviving miners to accumulate a large amount of Bitcoin.

A new stimulus is quickly gaining acceptance among many market participants. Through centralized and decentralized lending platforms, miners can take out debt by pledging their mined Bitcoin in exchange for cash or stablecoins. Instead of selling Bitcoin, miners can now hold their Bitcoin to cover the cost of electricity, configuring contracts, purchasing more mining equipment, or further expanding infrastructure. This dynamic reduces the selling pressure from the network, which we believe will be an important catalyst for Bitcoin prices to rise.

When more Bitcoin is accumulated by strong hands, it is likely to be held for a long time, and the equivalent of removing supply from the network is established. These experienced miners have seen miners shut down before and have a large amount of Bitcoin on their balance sheets. When many people believe that the price is lower, they choose to hold their Bitcoin. Debt in the market will become another tool for miners with a large amount of Bitcoin to hold their Bitcoin during price adjustments, which will alleviate selling pressure and accelerate bottom corrections. Although this may be a source of stimulus to the network, how to end this mechanism still needs to be cautious, because debt usually ends unfavorably in the case of excessive speculation.

Combining the above three forces, one can expect to create a powerful multiplier effect as the economic conditions on both the supply and demand sides of Bitcoin prices fundamentally improve. This is the main reason why the halving is bullish for Bitcoin.

Bitcoin Rise to $ 7,500 – Post-Halving – How Miner Shutdowns Accelerated the Bottom

After miners shut down (capitulate), newly mined Bitcoin will be distributed to the most efficient miners, which will cause the least selling pressure on the Bitcoin market, as these miners are well above their breakeven price. Just like the friction of miners shutting down when Bitcoin falls, there is the same friction of miners turning back on when Bitcoin rebounds. Many miners may be months behind on electricity, hosting fees, or land leases, and cannot reopen without paying multiple missed months. This makes it easier for prices to rise, and as prices rise, a smaller percentage of newly mined Bitcoin needs to be sold to cover electricity costs (which remain constant) because the surviving miners are so profitable.

When the price rises, miners who shut down cannot immediately restart. This is similar to the friction experienced by miners who lose money when the price falls and cannot immediately shut down. When the price of Bitcoin rises after a major difficulty adjustment, it creates a favorable environment for efficient miners to accumulate a larger share without shutting down.

17 Bitcoin’s Rise to $10,000 – Post-Halving – How Miner Shutdowns Accelerated the Bottom

Friction prevents inefficient miners from restarting in time. As a result, newly mined Bitcoin rewards are accumulated by efficient miners, so the minimum selling pressure of newly mined Bitcoin continues to decline. When the Bitcoin price is $10,000, the minimum selling pressure percentage of miners drops to 23.33%.

The following comparison best illustrates how healthy shuffling can be achieved by driving inefficient miners off the market and reducing potential selling pressure on the network:

18 Cycles Repeating: Bitcoin at $10,000 – Halving – Rebound after a Tough Correction

After a long enough rise in the price of Bitcoin, inefficient miners can switch back on. This results in an unfavorable difficulty adjustment as more miners compete for the same amount of Bitcoin. This causes the minimum percentage of miner sales pressure to increase from 23.33% to 51.49%.

This is a great example of the pull of difficulty, except we see margin compression due to unfavorable adjustments to the difficulty as miners join the network. The difficulty increase stabilizes the mining network and provides enough incentive to maintain Bitcoin's security layer. Over time, the profit margins remain high enough for loyal, efficient miners to remain profitable despite fluctuations in Bitcoin's price. Eventually, the difficulty increase will eliminate those inefficient miners, but when the price of Bitcoin appreciates significantly, even inefficient miners can enjoy healthy profits. Many people fear the halving, but if you understand miner psychology and how game theory will drive behavior, efficient miners should welcome it before and after the halving. Miners with the most efficient mining equipment below version 6.3c will feel the pain, but will still survive. Bitcoin is naturally subject to selling pressure from miners, who raise funds at the price of Bitcoin. Less funds will be needed to enter the market after the halving to offset the selling pressure from miners. As a result, investment funds and coin holders are more able to stabilize the downward pressure on the price by injecting enough new funds into the system and achieve long-term price appreciation.