How do miners affect the price of Bitcoin?

Original title: Miners and Bitcoin Prices

(Roses in a Japanese Vase, Van Gogh)

Preface: Bitcoin market participants include investment funds, coin holders and miners, among which miners are the cornerstone of the Bitcoin network, ensuring the continuity and security of the network. Miners currently mine 54,000 bitcoins per month, and there is selling pressure, especially when the price falls, the selling pressure is greater. However, Bitcoin has a difficulty adjustment mechanism. No matter how much hash power is, the number of bitcoins that miners compete for in a certain period of time is certain. As the price of Bitcoin fluctuates, this leads to the phenomenon of inefficient miners surrendering or inefficient miners making profits in the Bitcoin network. This phenomenon in turn accelerates the rise or fall of Bitcoin prices, which is also the reason for the fluctuation of Bitcoin prices. Understanding the game between miners is one of the keys to understanding price fluctuations. The author of this article is Blockwaresolutions, translated by "SOTI" from the "Blue Fox Notes" community.

Many analysts believe that the break-even price of Bitcoin miners’ production costs creates a floor for Bitcoin. This assertion is inaccurate. In fact, as the price approaches the miners’ production costs, the sell-off of Bitcoin tends to accelerate. There is constant selling pressure on the price of Bitcoin, which comes from miners. Price support is actually based on miner capitulation and a net reduction in hash power on the network, which facilitates difficulty adjustments. Understanding the game mechanics of miners is critical.

The cost of producing Bitcoin for miners mainly comes from electricity costs, because 95% of the operating costs of miners come from electricity consumption. Miners need Bitcoin to remain at a certain price so that the Bitcoin income they earn is higher than the electricity consumption. Miners with the lowest electricity costs have a clear comparative advantage.

We will analyze the following:

Bitcoin Network:

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

Peeling off the different layers of the mining network.

How the next generation of mining machines will level the playing field — keeping high-electricity miners engaged in the game.

Debunking the myth – “The breakeven price for miners is the floor price”.

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

Difficulty: Satoshi Nakamoto’s ingenious network stabilization mechanism — understanding its gravity.

How miner capitulation is accelerating Bitcoin’s path to the bottom.

The three main types of Bitcoin market participants

Investment funds - hedge funds, venture capital funds, family offices and other institutional investors. They almost exclusively adopt a "long" strategy and rarely go short. Basically, they have a long-term bullish bias, but they also have the ability to exit their positions and walk away at any time if their beliefs are challenged.

Hodlers - People who seek to maximize their Bitcoin holdings and accumulate coins over the long term. Hodlers have a long-term bullish view and are less sensitive to price fluctuations than investment funds. However, like investment funds, hodlers can exit their entire position at any time and leave.

Miners are the backbone of the Bitcoin network. Miners have a stronger belief in Bitcoin than investment funds and coin holders. They have a longer horizon. They invest in assets with a longer life cycle that cannot be used for other purposes and cannot be quickly liquidated at fair market value.

ASIC mining machines have a life cycle of 3+ years and can only be used to mine sha-256 protocol coins (almost mainly Bitcoin). Bitcoin mining equipment has a life cycle of 5+ years and is usually a reorganized warehouse designed specifically for cooling mining machines. On average, it takes miners 18 months to break even after investing money in mining machines, facility expansion, and electricity expenses. Miners are the main force of selling pressure in the Bitcoin network. They receive newly issued Bitcoins, which they must sell to fund the capital expenditures and operating expenses of their mining operations.

Selling pressure from miners

Today, approximately 54,000 new Bitcoins are mined each month. If Bitcoin trades at $10,000, that equates to $540,000,000 worth of new Bitcoin supply released to miners each month. Miners must sell a significant portion of the 54,000 Bitcoins to pay for electricity. Miners that consume higher electricity costs must sell a larger portion of their Bitcoins to cover their electricity costs. Most capital outflows on the Bitcoin network are driven by miners.

How the next generation of mining machines will level the playing field

The dynamic has changed over the past 8 months due to the release of next 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 miner has the hashing power of 4 S9 13.5T miners. Layer 1 & 2 miners used to account for a larger percentage of the network hash rate, but they have little incentive to upgrade to the next generation miners due to their lower power consumption.

Older generation miners, such as the S9 13.5T use 16nm chips, while the S17 Pro 50T uses 7nm chips. Innovations in chip technology make electricity less relevant because fewer watts are consumed per terahash. Next generation miners reduce the financial impact of higher electricity costs. Conversely, low electricity costs reduce the impact of the relative disadvantage of less efficient older generation miners.

For Layer 1 & 2, the opportunity cost of Bitcoin/balance sheet depletion in exchange for lower production costs by upgrading their mining machines is not very attractive based on the proportion of old mining machines that are still working on the network. As long as other layers are using old mining machines, Layer 1 & 2 will remain competitive with old mining machines. Mining is about viability and needing to be more competitive than peers. As future hash power from next-generation mining machines in Layer 3-8 approaches 100%, Layer 1-2 will be forced to upgrade. The halving will likely trigger this event.

As electricity costs increase, the opportunity cost of depleting Bitcoin reserves/balance sheet to invest in the purchase of next generation mining machines is rapidly becoming more attractive. In May 2019, forward-thinking miners began to anticipate the risk of S9 shutdowns due to the 2020 halving. As a result, Layer 3-8 has actively led the hardware upgrade cycle of next generation mining machines in the past 8 months, while Layer 1 & 2 continue to use old S9 mining machines. The next generation mining machine upgrade cycle has increased the network hash rate by 80% and increased the network hash rate represented by Layers 3-8, while diluting the share of Layer 1 and 2 in the total network hash rate.

This therefore goes against the predictions of environmentalists who were vocal about the Bitcoin network, which was predicted to consume excessive energy as it exceeded a certain hash rate, but, as mining machines are becoming more efficient, the network’s energy consumption has dropped significantly.

Understanding Bitcoin Miner Behavior

The analysis below shows the selling pressure caused by the profit margin compression of miners operating at different electricity prices, and the relief of selling pressure (the impact of difficulty) that follows once unprofitable miners shut down. (Blue Fox Note: The adjustment of difficulty due to the decrease in computing power) We present a simulation based on game theory, which shows the behavior and decision-making of miners in various situations. Please note that these are not targets for Bitcoin prices, but are intended to illustrate the impact on the mining network when Bitcoin is at a specific price level before and after the halving.

In this simulation, all miners within the “miner layer” use a single average KWh rate. This simplification incorporates the number of miners shutting down at each Bitcoin breakeven price threshold. As miners shut down, this creates a waterfall, amplifying the subsequent adjustments in network difficulty and profitability for surviving miners. Because of these assumptions, this model creates “step charts” that are good for illustrating conceptual reality, but a smoother, more linear progression would better reflect actual applications.

For consistency, this analysis makes the following assumptions:

*Bitmain S17 represents the next generation of mining machines, while Bitmain S9 represents the old generation of mining machines. The hash power ratio of the next generation of mining machines and the old generation of mining machines currently accounts for 61.38% and 38.63% of the total network hash power.

*Each miner in the stratum has a uniform electricity cost, and all miners are based on an average kWh rate. Therefore, for this analysis, the break-even cost of production for each miner in the stratum is assumed to be the same, and they all shut down when the price falls below it.

*During the analysis, it is assumed that no new miners join the network.

*The ratio of S17 and S9 mining machines in each layer will change based on the distribution in the following table:

Why we are confident in these assumptions:

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

* We held working meetings and conducted peer reviews with top mining pools and the largest ASIC manufacturers to gain insight into the distribution of hashrate, electricity costs, and mining machine models in each region.

* We visited a 30+ MW mine in Chengdu, China, as well as operations in upstate New York and the Pacific Northwest that have abundant hydropower.

*Customers and partners in Sichuan Province, China, Venezuela, Kazakhstan, West Texas, Upstate New York, and the Pacific Northwest all have electricity rates below 3c, but most are almost all mining with older generation miners. They have little incentive to upgrade to the next generation of miners because they have lower electricity rates, which reduces the benefits of more efficient miners, and the huge cost of upgrading to the next generation of miners has not been attractive so far.

$10,000 Bitcoin: For every tier, there are solid profit margins

When Bitcoin was trading at $10,000, miners at every layer enjoyed considerable profits, especially for S17 miners. However, for Layer 8 miners, S9 miners were close to shutdown prices. Even at $10,000, 96.3% of Bitcoin mined by S9 in Layer 8 would need to be sold to cover their electricity expenses.

Based on the above, miners must sell at least 39.12% of their mined Bitcoins (equivalent to $211,225,815) per month to cover their electricity costs. This means that new cash invested by investment funds and coin holders must reach $211,225,815 per month to match the fiat outflows provided by miners for their operations. Miner selling pressure is constant, while the funds raised by investment funds and coin holders are driven by sentiment and will change according to changes in market cycles.

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

As the price of Bitcoin falls, miners experience profit compression. As a result, they are forced to sell a larger percentage of their rewards to cover their electricity expenses (revenue is decreasing while fees remain the same).

Let's check for miners operating S9s in Layers 6, 7, and 8: As the price of Bitcoin approaches and penetrates the breakeven price for miners, miners are now operating at a loss. They must sell all of their mined Bitcoins, plus some of their reserve Bitcoins to cover their electricity costs. This introduces more selling pressure in the market, meaning that in addition to newly mined Bitcoins, there are also old coins that need to be sold - the opposite of support.

Understand actual operating results vs. written operating results

Many people believe that miners can simply shut down their rigs when the breakeven price is reached and never lose money. This is a very serious misconception. Contractual obligations and failed fund management often cause miners to operate at a loss. This forces miners to sell more Bitcoin than they mine; depleting Bitcoin inventory funds will bring additional selling pressure to the market.

Miners negotiate contracts with power plants to reduce their electricity costs, but these rates are based on minimum electricity usage. Therefore, some miners find themselves mining at a loss during certain periods because they continue to mine to meet the minimum electricity usage requirements, otherwise they will lose the long-term low electricity prices. When they are not profitable, they cannot simply shut down for a week or a month and wait for Bitcoin to rebound.

Many miners send their mining machines to hosting companies. These hosting contracts lock miners in for a fixed monthly fee per machine for a period of 1 to 2 years (determined by electricity costs). If the miner fails to make these monthly payments, the hosting company can seize the mining machines. As a result, many miners mine at a loss for many months to avoid defaulting and risking losing their expensive mining equipment.

In this way, miners become speculators. Miners are human beings and, therefore, cannot help but be influenced by human psychology. Many miners try to enforce the timing and quantity guidelines for selling Bitcoin. Many miners may sell Bitcoin weekly, monthly, or perhaps just enough to cover their electricity costs after receiving it. Unfortunately, when Bitcoin rebounds, miners tend to become speculators in the hope of taking advantage of the rebound.

We share analysis with one of the largest OTC desks in the crypto space. In September 2019, we discussed how some OTC miner clients deviated from their planned liquidations and chose to hold the Bitcoin mined in July and August - they believed that Bitcoin would continue to rise. (Blue Fox Note: At that time, the highest price of BTC rose to $13,000, which was the high point in 2019) Bitcoin peaked in late June, and these miners had to sell at much lower prices in September and October. Such a situation accelerated the sell-off of Bitcoin because it increased the selling pressure from its Bitcoin inventory, not just the newly mined Bitcoin.

Summary: When the Bitcoin price was $10,000, only 39.2% of the Bitcoin mined each month needed to be sold to cover their electricity costs. Once Bitcoin fell to $7,500, the profit margins of all miners decreased, which caused the S9 miners in Layer 6, 7, and 8 to operate at a loss. As a result, 53.18% of the newly mined Bitcoins were sold.

Miner surrender roadmap

Bitcoin price at $7,500 – before halving

Many inefficient old generation miners are still mining Bitcoin (Layer 3-8 running S9). These miners exert the greatest selling pressure on Bitcoin because most of the Bitcoin they mine needs to be sold to cover their electricity costs. Among Layer 3-8, the S9 miners running also have the highest break-even price. They represent the current pressure point in the mining network, which puts downward pressure on the price of Bitcoin.

Bitcoin price at $5,000 – before halving

In the event that Bitcoin continues to fall to $5,000, S9 miners in layers 6, 7, and 8 will have to shut down. This results in a favorable difficulty adjustment and improves the break-even price for all surviving miners. However, despite the benefits of the difficulty adjustment, at a Bitcoin price of $5,000, S9 miners operated by miners in Layers 4 & 5 will operate at a loss. S9 in Layers 4 & 5 represents a new pressure point in the network, which brings greater vulnerability to Bitcoin prices. These S9 miners will follow the miner capitulation roadmap mentioned earlier: they will begin to consume their Bitcoin inventory to pay electricity bills until they go bankrupt and are forced to shut down, which increases selling pressure on Bitcoin until the shutdown occurs.

Bitcoin at $5,000 — after inefficient miners shut down

After operating at a loss for long enough, the S9 miners operating in Layer 4 & 5 are shut down - which leads to a favorable difficulty adjustment for the surviving miners. The S9 miners in Layer 4 & 5 account for about 14.5% of the network hashrate. This means that after the shutdown, about 14.5% of the newly mined Bitcoins will be redistributed to the surviving miners (formerly belonging to the S9 miners in Layer 4 & 5). The redistribution will improve the break-even price for the surviving miners and reduce the selling pressure on Bitcoin because the profit margins of the surviving miners will increase. The newly mined Bitcoins are now accumulated by the "strong hands" (more efficient miners). The minimum selling pressure of miners has dropped from 69.60% to 51.49%.

Bitcoin at $5,000 — Post-Halving

In this case, by halving Bitcoin at $5,000, the network will undergo a healthy cleanup, allowing the best position for Bitcoin to reach a new high again (even a price of $8,000 will provide substantial cleanup) (Blue Fox Note: The so-called cleanup here is essentially to remove some less efficient miners and reduce selling pressure)

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 Bitcoin price needs to grow so that miners can get the same mining revenue denominated in USD. This is critical so miners can finance their electricity costs. This will bring extreme miner capitulation, as all S9 miners above 2.5c electricity (Layer 2-8) will run at a loss, and miners running S17 (Layer 7 & 8) above 6.5c electricity will also run at a loss, which puts pressure on them to shut down.

Bitcoin at $5,000 — post-halving — after inefficient miners shut down

Satoshi Nakamoto’s ingenious network stability mechanism: understanding the gravitational factor of miners’ profit margins

If Bitcoin remains at a low price for 2-4 months after the halving, many miners will be operating at a loss and they will be forced to shut down. After all the loss-making miners shut down, the surviving miners will experience a significant profit relief. We will have short-term network chaos, but once the inefficient miners shut down, the network will return to stability after the difficulty adjustment.

Difficulty: The Bitcoin protocol has a self-correcting mechanism that stabilizes the profitability of the mining network to ensure that miners are incentivized to continue securing the network. Miners are the backbone and security layer of the Bitcoin blockchain. The difficulty adjustment mechanism ensures that efficient miners are incentivized to do their part. This is one of the most underrated and little known phenomena when it comes to Bitcoin mining. If the mining network experiences a compression in profitability, the least efficient miners will be phased out. With inefficient miners shut down, the network now takes longer to mine blocks because less hashing power is available to solve the network block puzzle in a timely manner. If the network does not solve a puzzle within 10 minutes, there will be a favorable difficulty adjustment.

The share of rewards that were once earned by the miners who shut down is now redistributed to the miners who remain on the network. This is considered a favorable difficulty adjustment. This process will continue until profit margins normalize, or even become extremely profitable for the survivors/most efficient miners. Mining is about survival. Difficulty adjustments will reduce the impact of Bitcoin price corrections on miners, as miners operate efficiently enough to survive.

The shock before the breakout – hitting the triple combo

1. Halving - Improvement of supply-side economy

Many market participants speculate on the future of Bitcoin. It is certain that by mid-May, 50% of the potential selling pressure on Bitcoin will be eliminated as the newly issued mining reward is halved. Reducing the issued supply by 50% will reduce the supply of Bitcoin by a modest but continuously declining amount, which is entirely determined by the Bitcoin protocol code. This is a positive catalyst for the price of Bitcoin.

2. Halving triggers positive sentiment leading to improvements in the demand-side economy

Economists may 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. Bitcoin maximalists may say that Bitcoin is digital gold because of its scarcity properties. Ultimately, the market will determine the price of Bitcoin.

Historically, Bitcoin has entered a halving period that has led to a sustained uptrend/bull cycle (always with multiple severe corrections along the way). Most market participants deeply understand these historical trends. People will say that the halving is already priced in. However, this cannot be proven unless you can confirm that most market participants have already invested their cash in it and reached their price targets.

Opinions are not unified, and most market participants have a certain amount of cash positions. Everyone will think about the halving and generate positive emotions on the demand side. This psychological positive emotion will allow market participants to anticipate and actively prepare cash positions, driving the upward trend.

In this case, everyone sees the acceleration of the halving and at some point, may have missed the significant rally in Bitcoin. This is why Bitcoin has more holders than any other asset. Holders refuse to be burned again and miss out on the amazing run. This is the market, and the market is driven by human psychology. Before the halving, the human psychology of Bitcoin market participants tends to be bullish. This brings positive sentiment on the demand side of Bitcoin.

3. Taking advantage of opportunistic circumstances through debt acquisition

After the Bitcoin network experiences a significant or sustained favorable difficulty adjustment, the likelihood of a Bitcoin price bottom increases. This is because newly mined Bitcoin is now distributed to the most efficient miners who are accumulating Bitcoin and have healthy balance sheets. The amount of Bitcoin (denominated in Bitcoin) received by the surviving miners is directly proportional to the amount of Bitcoin distributed to the shutdown miners. These rare, profitable opportunities will allow the surviving miners to accumulate a large amount of Bitcoin.

A new stimulus is rapidly gaining acceptance among many market participants. Through centralized lenders or decentralized lending platforms, miners are able to access the lending market by pledging their mined Bitcoins, which can be used to obtain cash or stablecoins. Now miners can hold their Bitcoins instead of selling them, but can still afford electricity bills, hosting contracts, purchase more mining machines, or further expand their infrastructure. These dynamics reduce the selling pressure on the network, which we believe will be an important catalyst for Bitcoin price appreciation.

When more Bitcoin is accumulated by "strong hands", they may hold it for a long time, which is equivalent to removing part of the Bitcoin supply from the network. These experienced miners have witnessed the capitulation of miners and accumulated a large amount of Bitcoin on their balance sheets. When they think the price is lower, they will choose to hold Bitcoin.

By entering the lending market, miners gain additional tools to hold large amounts of Bitcoin during price corrections. This reduces selling pressure and accelerates the bottom correction. Although this can be a source of stimulus to the network, how it ends needs to be cautious, as the end of the debt may be problematic in the event of excessive speculation.

Combining the above three forces, one can expect a strong multiplier effect as the supply-side and demand-side economics of Bitcoin prices fundamentally improve. This is why the halving leads to bullishness on Bitcoin prices.

Bitcoin Price Rally to $7,500 – Post-Halving – How Miner Capitulation Accelerated the Bottom

After miners shut down and capitulate, newly mined Bitcoin is distributed to the most efficient miners, which will minimize selling pressure on the Bitcoin market because these miners are well above their breakeven price. Just as there is friction for miners to shut down when Bitcoin sells off, there is friction for miners to come back when Bitcoin rebounds.

Many miners may need to spend months to settle electricity, hosting, or land lease fees, and if they miss several months of fees, they cannot restart. This makes it easier for prices to rebound, and as prices rise, the surviving miners will need to sell a portion of their newly mined Bitcoin to pay for electricity (which remains unchanged) because of their high profit margins.

Miners that have shut down cannot turn on their machines at the same time as the price of Bitcoin rises. This is similar to the friction experienced when the price drops, where miners operate at a loss and cannot shut down immediately. When the price of Bitcoin rebounds after a major difficulty adjustment, it creates a favorable environment for efficient miners to accumulate a larger share without shutting down.

Bitcoin Rally to $10,000 – Post-Halving – How Miner Capitulation Accelerated the Bottom

There is friction that prevents inefficient miners from restarting their machines in a timely manner. As a result, newly mined Bitcoin rewards are accumulated by efficient miners, so the minimum selling pressure from newly mined Bitcoin continues to decline. As the price of Bitcoin reaches $10,000, the minimum selling pressure percentage of miners drops to 23.33%.

The following comparison provides a good illustration of how healthy cleanup can be by removing inefficient miners and reducing potential sell pressure on the network:

The Cycle Repeats: Bitcoin at $10,000 — Post-Halving — Difficulty Adjusted Rally

After a long period of price appreciation, inefficient miners were able to turn their machines back on. As a result, this led to an unfavorable difficulty adjustment as more miners competed for the same amount of Bitcoin. This caused the minimum percentage of selling pressure from miners to rise from 23.33% to 51.49%.

This is a great example of difficulty gravity, except we see adverse difficulty adjustments as miners join the network and this leads to compression of marginal profits. Difficulty stabilizes the mining network and provides enough incentive to maintain Bitcoin’s security layer.

Over time, despite Bitcoin price fluctuations, the profit margins are high enough to provide a profit for loyal, efficient miners. Eventually, the difficulty will weed out inefficient operations, but when the Bitcoin price rises significantly, even inefficient miners can make a significant profit in a short time frame.

A lot of people are worried about the halving, but if you understand the psychology of miners, and how game theory will drive behavior before and after the halving, efficient miners will love this. Miners with less than 6.3c electricity with the most efficient mining machines will feel the pain, but can survive.

Bitcoin naturally has selling pressure from miners, which reduces the price of Bitcoin. After the halving, less fiat will be needed to offset the selling pressure from miners. As a result, investment funds and coin holders will be more able to stabilize the downward pressure by injecting enough new fiat into the system and achieving long-term price appreciation.