An article explaining mining and coin prices

There are still more than 4 months to go before the Bitcoin halving. Discussions on the mining industry and coin prices have heated up again on the Internet. Most of them are nonsense, and a small number of stakeholders are avoiding the main issues. I will just talk about it here based on what I know. Criticisms and corrections are welcome.

1. Basic Logic of Mining

As shown in the figure, blue represents capital flow and red represents product flow.

Simply put, miners need to buy mining machines from mining machine manufacturers, pay electricity fees to mining farms, and pay management fees to mining pools. They pay a relatively rigid legal currency cost, and then get Bitcoin to sell, and they expect to get some profit (whether it is Bitcoin or legal currency). Now the mining industry has some combination products such as cloud computing power, or some new financial tools, but the logic is essentially unchanged.

If you understand this diagram, many misunderstandings will not arise.

II. Interpretation of Hot Issues

1: Will mining machine manufacturers increase the price in order to sell mining machines?

Obviously not.

(1) Mining machine manufacturers can only obtain excess profits in a bull market by taking advantage of the contradiction between "strong demand for mining machines" and "limited production capacity of mining machines". From the perspective of mining machine manufacturers, there is no need to pull up the market in a bull market, and there is no money to pull up the market in a bear market.

(2) The production rules of Bitcoin are that the output per unit time is fixed, which is a stock game. If you increase the computing power, I will lose the profit. Therefore, the profits of mining machine manufacturers need to be used to invest in research and development and tape-out, and continuously improve the energy efficiency of their products to ensure that they will not be eliminated. This is similar to the LCD panel industry, which must continuously update production lines. You can understand this by looking at BOE's financial report.

(3) Even if a mining machine manufacturer is rich and willful, this approach is obviously not feasible, considering that pumping the price will allow other mining machine manufacturers (competitors) to free ride and share the profits from pumping the price and selling mining machines.

2: Will the entry of new miners boost the price of the currency?

No.

If the mining cost is higher than the price of the currency, the mining industry will shrink, and if the mining cost is lower than the price of the currency, the mining industry will expand. This is a truth that even elementary school students should understand. The scale of the mining industry is affected by the price of the currency, but it cannot affect the price of the currency in reverse, because the output of Bitcoin is constant, and the expansion and contraction of the mining industry can neither affect the supply of Bitcoin nor the demand for Bitcoin.

3: Where did the funds brought by new miners go?

Pay attention to the capital flow in the first figure above. If we look deeper, we can see that a small part of the funds entering the mining industry is given to mining service providers as fees. This part is the profit of mining farms, mining pools, and mining machine manufacturers. A larger part is given to the semiconductor supply chain (such as TSMC), and the largest part is given to power plants.

To put it bluntly, the bulk of the funds newly entering the mining industry have been earned by TSMC and power plants. For example, the S17 sells for about 6,000 yuan, and the wafer inside it costs at least 3,000 yuan (and there is a possibility of tape-out failure).

4: Are mining machines roughly equivalent to call options?

It is not equivalent to that mining machines are restricted by many factors.

However, if you must regard the mining machine as a call option, then you must also regard the mining machine manufacturer as the party selling the call option, that is, the bearish party. The two offset each other and equal 0. In general, the statement that the mining machine is approximately equal to a call option does not make sense.

5: Will mining accidents occur during halving?

It depends on how you define this mining accident. The mining industry itself is a process of continuously eliminating backward production capacity.

If the output of Bitcoin is halved, and the price of the currency does not rise or falls, the miners with high costs will shut down their machines. Corresponding to the current situation, all kinds of modified S9s will be eliminated first. After the S9 is eliminated, the computing power of the entire network will decrease. I roughly calculated that based on the electricity fee of 0.38 yuan/kWh, the shutdown price of new machines such as S17/M30 will be further reduced to less than $2,500 (corresponding to the price of 5,000 dollars after halving). Bitmain’s latest policy is to buy mining machines and give options, which means that the bottom has been supported at around $5,000 (RMB 35,000). This is the reason.

In the worst case, the mine may encounter some problems, because electricity is a long-term contract, and the mine is a fixed investment. If a large area of ​​​​the machine is shut down, these two costs are not easy to deal with. But with tools such as options and futures, large-scale mining accidents are actually difficult to happen. So when you see these miners happily buying new mining machines at the mining conference, don’t think they are stupid. They know that if they have new mining machines, they can eliminate others, and if they don’t have new mining machines, they can only be eliminated by others.

Of course, we need to observe how the mining industry uses some financial tools. If we blindly expand our production scale by increasing leverage, some miners may face a break in their capital chain under extreme risks. If we use financial tools to protect against extreme risks, then there will be no major problem.

Editor-in-charge: Tang Jing