What risks do you need to assess when choosing Bitcoin cloud mining?

Original title: "Viewpoint | Cloud computing power: another option for investing in Bitcoin"
Author: Blockchain financial services agency Altonomy

Institutional investors are increasingly interested in digital currencies, and most investors enter the digital currency investment field through over-the-counter transactions or index funds. However, many institutional investors want to seek new investment methods to avoid the cumbersome transaction steps and huge income fluctuations of traditional digital asset investments while ensuring expected returns. For these investors, cloud computing products have become an effective alternative.

Due to the rapid iteration of mining chip technology, the exponential growth of single-machine computing power, and the difficulties in the actual operation of mining farms, most institutional investors are cautious about self-operated mining. Cloud computing products can obtain Bitcoin stably without worrying about daily expenses and actual operating expenses (such as hosting and electricity bills), so they are favored by institutional investors. Although the cloud computing industry has been hit by various negative news, the continued enthusiasm of institutional investors and the emergence of professional service providers have improved the credibility of this field.

So, what exactly is Bitcoin mining? What are the advantages of cloud computing compared to self-operated mining farms? And how should institutional investors choose cloud computing partners?

The history of Bitcoin mining

Looking at the development history of the Bitcoin mining industry, its technical complexity is no longer what it used to be. From the time when digital currency was born, ordinary home computers used CPUs to mine, to the second-generation Bitcoin mining machines using GPUs to mine, using the multi-core parallel processing mechanism of graphics cards to obtain higher computing power. Then in early 2013, field-programmable gate arrays (FPGAs) were first used in digital currency mining. Although FPGAs failed to achieve large-scale application due to high costs, "logic blocks" once again improved machine performance. It was not until 2016 that Bitmain mass-produced the first generation of ASIC mining machines, the Ant S7, marking the entry of Bitcoin mining into the ASIC era.

ASIC miners are optimized for the SHA256 algorithm, maximizing computing efficiency. Most ASIC miners are produced by domestic mining machine manufacturers such as Bitmain, MicroBT and Cannan. These manufacturers design their own chips, which are then outsourced to traditional semiconductor industry giants such as Samsung and TSMC. They then complete post-processing and assembly processes such as PCB design, cooling system and casing, and finally produce finished products. The huge computing power advantage of ASIC miners has eliminated almost all old versions of miners on the market. Although the "halving of Bitcoin mining revenue" may further reduce the efficiency of mining, mining companies with the most advanced mining machines and industrial-grade mines will continue to remain profitable.

Historical comparison chart of Bitcoin computing power and US dollar price (from the Internet)

In addition, similar to traditional manufacturing plants, operating these mining machines requires a suitable hosting location. With the innovation of computing power technology, mining farms are also constantly upgrading and optimizing. Electricity costs, transportation costs, and the activity of the secondary market are all factors that need to be considered in the mining process. In recent years, emerging hosting service providers have been committed to upgrading infrastructure in order to gain greater competitive advantages in the process of industrial integration. These efforts have greatly enhanced the operational capabilities of mining farms and improved the overall level of the Bitcoin mining industry to meet the needs of institutional investors.

Unique operational risks

Running a Bitcoin mining business faces similar risks to traditional labor-intensive businesses such as manufacturing, but also has its own unique challenges. These risks include:

Procurement channels : Mastering the procurement channels for the latest models of mining machines is more important than anything else. The relationship with the mining machine manufacturers will directly affect the miners' ability to cope with Bitcoin price fluctuations and adjust production according to changes in mining difficulty, thereby affecting their profitability. Therefore, it is crucial to establish and maintain a solid relationship with mining machine manufacturers.

Geographic location : The risks that need to be addressed vary depending on the location of the mine. Risks include: local political and business environment, power supply, site safety and labor costs. Gaining geographical advantages is critical to ensuring the sustainability of mining operations.

Operation management : The management and maintenance experience of the hosting site operators will directly affect the operation of the mining machines, and thus affect the mining efficiency and profitability of the mine.

Screening for the right mine takes time, financial resources, and luck. It requires investors to have a deep understanding of the digital currency ecosystem, close relationships with suppliers, and experience monitoring operations remotely. These entry requirements are daunting, so some investors eager to get into the mining industry have found better ways to profit.

Cloud computing power: a mining product with zero operating costs

Cloud computing frees investors from the burden of operating a mining farm and guarantees roughly the same return on investment. Cloud computing services can also tailor products to meet the different needs of institutions or retail investors. To better understand the return rate of cloud computing, you can compare it with fixed income products such as coupon bonds.

The fixed income portion of a bond, the coupon, is similar to the bitcoins earned from mining. The main difference is that the principal is returned after the bond matures, while the mining machine depreciates linearly as the market value fluctuates. Cloud computing power provides investors with an investment option to continuously receive bitcoin income with zero operational risk and have ownership of the underlying asset. Institutional investors can add to their portfolios based on their advantages:

• Get profit opportunities during market anomalies (coin price increases and lagging computing power improvements)

• Providing investors with a completely different investment return combination

• Effective long-term investment in Bitcoin by obtaining daily mining income

• Zero operating cost, no need to consider large initial investments and risks such as procurement, hosting, and long-term power supply

Market risks still exist

Cloud computing eliminates operational risk for investors, but market risk still exists. Market risk consists of two factors: Bitcoin network difficulty (which determines the number of Bitcoins that can be mined with a fixed computing power) and Bitcoin price (which determines the cash income from mining Bitcoin). Since mining plants with lower profit margins often shut down mining machines to stop losses, these two factors continue to affect each other.

As shown in the figure below, since the Bitcoin futures markets of CME, Bitmex and OKEX have good liquidity, hedging Bitcoin price risk is possible. However, in the current market, there is no financial derivative product that can hedge Bitcoin network risk. But this is exactly the mining risk that investors expect.

Concerns about high volatility of returns

High volatility of returns has always been one of the biggest concerns for all parties investing in digital currencies. For institutional investors, the volatility of mining returns is significantly lower than the volatility of spot Bitcoin prices (see the figure below). Even if mining machines continue to depreciate due to technological advances, their residual value can still partially resist the risk of falling coin prices.

Bitcoin mining profit and Bitcoin price in USD historical comparison chart (from the Internet)

The benefits of low return volatility are obvious to institutional investors who have tried over-the-counter trading or invested in digital currency index funds.

How to choose a cloud computing partner

Cloud computing has been questioned in the past due to the presence of some bad apples. This is why you should carefully select your partners before comparing products. Institutional investors should use the following factors as evaluation criteria:

Price per T : The unit price of cloud computing power. The cheaper the unit price, the higher the return for investors.

Investment size : Contract duration and tokenization method: These terms can be tailored to the needs of different investors. Compared with retail investors, institutional clients usually receive discounts due to large orders and long lock-up periods.

Reputation : The operation of the mining farm and the distribution of profits are all completed by the company that issues the cloud computing power product. Therefore, the reputation of the company will also affect the credibility of the product.

Managed mining farm security : Site maintenance, personnel training and management, monitoring tools, and network security will all affect mining efficiency.

*TH: Terahash

There are many factors to consider before investing in cloud computing power, and each institutional investor has its own unique needs. As more and more institutional investors turn their attention to alternative assets, and digital currencies continue to enter the mainstream alternative trading market, cloud computing power business will continue to flourish and become a new investment option for more and more institutional investors.

Risk Warning: This article only represents the views of Altonomy and does not constitute investment advice.