[Q&A at Zhikuang University] The income from mining is not very high, so why are miners willing to invest in mining?

The most profitable thing in the blockchain industry is to hoard coins. A bull-bear cycle may increase by 100 times from the bottom to the top. If mining is treated as an industrial behavior, that is, the coins mined every day are sold on the same day, even in a bull market, the mining income is generally only about 3 to 5 times.

Compared with cryptocurrency speculation, the threshold for mining is relatively higher. Mining includes a series of things such as the purchase, transportation, hosting, and operation and maintenance of mining machines, which is much more troublesome than buying Bitcoin directly in the market. So why do many people still choose mining instead of buying Bitcoin directly?

Mining can also become a financial behavior. Using mining as a way to obtain Bitcoin and hoarding the mined coins may have more cost advantages than buying coins directly on the market, and there is a chance to obtain higher returns.

01
Mining in the first half of 2019 and before can obtain Bitcoin at a lower cost

There are two ways to get Bitcoin: one is to buy it directly in the market, and the other is to mine it. If mining is used as a means to obtain Bitcoin, in the first half of 2019 and for a long time before that, mining has a cost advantage over buying Bitcoin directly. Here are two typical examples:

1. In the early stage of industry development, geeks mined for arbitrage

On August 7, 2012, FriedCat and David conducted an IPO (now called IC0) on the GLBSE exchange, issuing Asicminer shares with a total share capital of 400,000 shares, 59% of which was held by FriedCat (Bitfountain), with an issue price of 0.1BTC/share and a total of 163,962 shares issued. Based on the exchange rate at the time, about RMB 1 million was raised. In July 2013, the stock price of FriedCat rose to 5BTC/share, with a stock return of more than 50 times, and about 140,000 BTC was distributed to shareholders.

Wu Jihan invested 1,000 BTC at the time. If we ignore the stock price increase and only consider the dividends, in less than a year, the Bitcoin investment dividends are more than 8 times the initial investment amount. If the share appreciation is added, the investment income is as high as 100 times.

In the early days of the industry, the Bitcoin mining market was not fully competitive and traditional capital had not yet entered. The main participants were professional players who understood technology. The threshold for participation was very high, and Bitcoin had not yet been halved. Professional players had a very significant advantage in the cost of acquiring Bitcoin over ordinary people.

2. As the industry develops, professional miners can still obtain high profits

With the development of the mining industry, many new people have entered the industry and miners have become polarized. Professional miners still have cost advantages through mining rather than directly purchasing Bitcoin.

We simulated buying mining machines to participate in mining when the price of Bitcoin was at its low point (corresponding to December 2018) to see the actual benefits. In December 2018, the price of Bitcoin once dropped to $3,200, the spot price of S9 (13.5T) mining machine was RMB 600, and the total network computing power was 40EH/S.

In order to simplify the model, it is assumed that the monthly computing power growth rate is the same, which will not have a significant impact on the overall revenue results. The average monthly computing power growth rate is about 8%. In addition, the electricity cost of the mining machine is calculated at 0.4 yuan per kWh (including hosting fees, etc.), and the power consumption of the mining machine is calculated at a rated power of 1.35KW. The monthly electricity cost is 390 yuan. The following results are obtained:

illustrate:
1. The simplified calculation model does not provide accurate data, but it is basically consistent with the actual situation;
2. The difference between the two algorithms of cumulative payback rate 1 and cumulative payback rate 2 is that 1 is based on selling the monthly coin output at the market price at the end of each month (data source: Coinmarketcap, USD/RMB exchange rate is calculated at 7); 2 is based on the cumulative sales at the end of the month when the payback rate is calculated;
3. The residual value of the mining machine is not included;
4. Take the initial computing power of 15EH/S in December 2017, and calculate the computing power based on an increase of 8% every month.

According to the cumulative payback rate 2, the payback rate in the fifth month is 175%. As of August 2019, the output of coins alone has earned more than 8 times the profit, and the price of mining machines has increased by more than 4 times. Investing in mining in a bear market, when the price of coins rises, the price of mining machines also rises, and you can definitely get more profit than buying coins.

Note: This data is calculated up to August 2019.

But the cost advantage of mining Bitcoin is gradually decreasing or even disappearing.

3. The ability to mine Bitcoin is decreasing

The continued surge in computing power and the halving of Bitcoin output have made Bitcoins obtained through mining no longer cheap. Taking May 2019 as the dividing line, after May 2019, the Bitcoins miners have invested in mining are likely to be less than the coins they would have directly bought with the same amount of money.

1) The number of mined bitcoins continues to decrease

The initial issuance reward of Bitcoin was 50 Bitcoins per block, which was then halved approximately every four years. The current reward per block is 12.5 Bitcoins, and it is expected that Bitcoin will be halved again in May 2020, when the reward per block will be only 6.25 Bitcoins.

Another source of income for miners - the miner's fee for packaged transactions - has been relatively low except for a very short period of time during the bull market, and can be basically ignored.

2) Continued increase in computing power

The rapid development of mining machine manufacturing has greatly released the production capacity of mining machine manufacturers, and continuously iterated new mining machines with better performance. The investment of high-performance new mining machines has made the computing power of the entire Bitcoin network higher and higher. In the past year, the computing power of the entire network has increased by nearly 3 times, and the output of coins per T computing power is constantly decreasing. From the big trend and the two factors of the decrease in the output of coins per T and the increase in the price of coins, the economic effect of each mining machine is decreasing. When the income from mining output is not enough to cover the electricity cost of mining, the life of the mining machine is over.

The halving effect and the continuous increase in computing power have made it increasingly difficult for miners to mine Bitcoin. From my personal experience, the S17pro I launched in May 2019 was more cost-effective than buying coins directly, including the residual value of the mining machine. However, the mining machines I bought later are difficult to mine back the amount of coins I bought directly at that time.

02
Why are miners willing to invest in mining?

The ability to mine bitcoins is getting weaker and weaker, so why are there so many people mining? Why is the total network computing power as high as 110E and still growing?

1. The influx of traditional capital

At present, the static payback period of mainstream mining machines is about one year (excluding the income from hoarding coins). Old investors in the cryptocurrency circle, who are used to hearing stories of getting rich by hundreds or thousands of times, may think that the payback period of mining is too slow. However, for traditional capital and its practitioners, mining is still a highly profitable industry:

“If there is a 10% profit, capital will be used everywhere; if there is a 20% profit, capital will be active; if there is a 50% profit, capital will take risks; for the sake of 100% profit, capital will dare to trample on all human laws; if there is a profit of more than 300%, capital will dare to commit any crime.”

P2P financial management with an annualized rate of return of about 10% has attracted a large number of people to invest, not to mention the mining industry with an annualized rate of return of over 100%. It is foreseeable that capital from outside the industry will continue to flow into the mining industry.

2. Mining is a good asset hedging method

1) In the cryptocurrency world where the market is changing rapidly, it is very difficult to buy at the bottom and sell at the top. Once you are washed out, it is very scary. You may miss a bull market and miss out on a rise of dozens or even hundreds of times. However, continuous output of coins by mining can keep you from getting out of the market forever.

2) Mining will bring a steady stream of cash flow. For the cryptocurrency players, it is very painful to make a profit at the wrong position. Mining business with its own cash flow attribute can save lives at critical moments.

3) Mining is a business that is very easy to leverage off-market, and the economic model of mining is very easy to understand. Friends and relatives around you may not recognize Bitcoin, but they are very interested in mining, a business that pays back in about a year.

The combination of mining and hoarding coins can obtain high returns more safely, so many large miners continue to invest in mining.