Where are we in the mining cycle?

Rather than thinking in terms of ups and downs, think in terms of transitions and corrections.

—Howard Marks, Chairman of Oaktree Capital

Written by: Leo Zhang
Compiled by: Zhan Juan

Since the price of BTC rebounded from a long winter, the demand for mining hardware has been growing. Bitmain , once the barbarian at the gate of the Bitcoin industry, is now facing a shortage of Bitcoin mining machines. The mining giant's new generation of 7nm BTC miners is completely sold out. Their latest products, the S17e and T17e, sold out within a minute of the pre-order opening.

Bitmain isn’t the only manufacturer with long lines out front. A rising star is MicroBT , a company founded by the former chief engineer of the Antminer S9, whose flagship Whatsminer series has eclipsed Bitmain’s sales. At last week’s Chengdu New Era Mining Summit, it was announced that Whatsminer had delivered 100,000 Whatsminer M20s/M21s since May, and that production is expected to exceed 200,000 by the end of September .

However, the growth rate of mining machine production still cannot keep up with the increase in Bitcoin prices. There is always a delay when computing power responds to price changes. This is because manufacturers' production capacity is naturally constrained by upstream suppliers. Original equipment manufacturers (OEMs) such as Bitmain and MicroBT are only designers of ASIC chips, which are chips specifically used for hashing algorithm calculations. The actual production of chips is carried out in highly advanced integrated circuit manufacturing plants such as TSMC and Samsung .

Source: Bitinfochart

Custom ASICs incur high one-time engineering costs . Chipmakers spread these costs over the chips they produce in large quantities, which is why they buy wafers in large quantities at a time. These orders typically take nine weeks or more to complete.

The time between ordering and delivery makes it extremely difficult for OEMs to predict demand and develop forward-looking business plans in advance. During the bull run in late 2017, no manufacturer had enough inventory to meet the rapidly growing demand. All mining machines were trading at a high premium in the secondary market. As a result, OEMs misjudged the overheating of the market at the time and produced too many machines. Bitmain and its competitors had to slowly digest their inventory in 2018. In the second half of the year, they even sold mining machines at a loss. This is why in 2018, even though the price of Bitcoin fell throughout the year, its computing power did not stop climbing until the end of the year.

According to rough estimates, Bitmain has only managed to deliver about 40,000 S17 mining machines so far. This fairly popular model uses chips based on TSMC's 7nm process . This is the most advanced process in the world, and only TSMC can do it. Chip manufacturers give priority to big customers such as Qualcomm, Huawei, and Apple, and meet their needs for 7nm chips first. On the other hand, MicroBT uses Samsung's 10nm process . It is not as advanced as TSMC's 7nm chip, but it is cheaper and much easier to produce. However, Samsung remains a bottleneck for MicroBT due to the growing production of 5G mobile phones.

Last month, Bitmain placed a large order with TSMC to increase production by 10,000 wafers per month starting in November. The order was allegedly paid 100% in advance in cash. Each 12-inch, 7-nanometer wafer can cut about 3,000 chips, so 10,000 wafers should be enough to produce about 201,000 S17 Pros (about 11.7 Exabytes). This means that by the second quarter of 2020, Bitmain Antminers alone will be able to produce 55-65 Exabytes . Assuming the price of the currency does not fall sharply again, the existing network hash rate is about 85 Exabytes, plus Bitmain's new order, plus the output of other manufacturers, Bitcoin's hash rate may double before the next halving event.

The soaring hash rate has driven down miners’ ability to make money. What does this mean for miners’ production costs? The only variable that mining farm operators can really manage is the price of their electricity.

Taking the Antminer S9 as an example, the following is the Bitcoin production cost under different electricity costs:

Data source: coinmetrics.io

More than half of the world’s computing power is concentrated in a few provinces in China. For miners in these regions, April to October is like a holiday, because local hydropower in the spring and summer brings a large amount of cheap electricity supply, basically reducing the electricity bills of miners to negligible levels . Last year, Sichuan Province suffered the worst rainy season in 57 years, but many mining facilities are built in these areas, and some even suffered a catastrophic disaster.

A local mine in Sichuan, China was recently destroyed by heavy rainfall in the area.

However, once the dry season arrives, electricity costs will rise sharply. In October 2018, around the end of the flood season, the price of BTC fell from $6,000 to $3,000, and it became quite uneconomical to use the previous generations of machines with high electricity costs. Many old mining machines were eliminated, transferred overseas, or sold to miners with more resources at extremely low prices.

During the last dry season, wild price swings gradually pulled overheated hashrate back to breakeven levels. Because each mining operation has a slightly different cost base and each mining farm has a different risk tolerance, we can only estimate the composition of market production costs by observing how the ecosystem responds to these cycles at a high level.

We are currently in a phase of the cycle that is very similar to the fall of 2018: the bull run has sparked huge interest in mining hardware, and hardware manufacturers are having trouble meeting the community’s needs. As the flood season ends, the price of Bitcoin continues to move sideways.

in conclusion

Using the parameters of the latest mining machines, predicted hashrate growth, rising electricity prices, and reward halving, it is possible to predict production costs; using the numbers mentioned above as input values, we can safely say that the production cost of Bitcoin will rise significantly .

If the price of BTC plummets from current levels, we will likely see a repeat of the winter of 2018: large numbers of Antminer S9s will eventually be retired, newer machines will be sold at discount prices, mining operations will be consolidated, and similar "death spiral" reports will appear in the media again.

All of these events are normal and a natural part of the Bitcoin mining cycle.

Note: The above calculations do not include mining pool fees, maintenance costs, and hardware purchase expenditures. Actual production costs are much higher before the initial capital expenditure is fully broken even.

Disclaimer: Iterative Capital holds Bitcoin.

According to Block123.com, Iterative Capital was founded in 2016 and mainly operates two businesses: a large-scale cryptocurrency mining investment fund and an OTC cryptocurrency trading brokerage. The company has offices in New York, New Jersey, Los Angeles, London, Beijing and Hong Kong. It is a global liquidity provider and has mining facilities in the Eastern and Western Hemispheres. Its trading business i2 Trading is a licensed MSB and MT in the United States, and can trade in US dollars, British pounds, Hong Kong dollars and other legal currencies.