A Panorama of the Cryptocurrency Mining Industry

As of July 2019, Bitcoin miners generate more than $6 billion in annual revenue, including mining rewards and transaction fees.

In the cryptocurrency space, providing secure mining and related hardware for Bitcoin and other cryptocurrency projects is often overlooked. However, due to its connection with the exchange sector, mining is actually one of the core markets that generates considerable revenue.

In this post, I will share an overview of the Bitcoin and crypto mining space, the underlying hardware that supports mining, and the ecosystem landscape, as well as dive into the revenue and market size of this space.

How Cryptocurrency Mining Works

Proof of Work (mining) is the process of adding new transactions to the Bitcoin blockchain and reaching agreement (consensus) on the correct order of these transactions.

My favorite analogy is to think of this process as a Sudoku puzzle: a puzzle that requires a lot of mental effort to solve, but once solved, it’s easy for others to verify that you actually found the correct answer.

There is a good video on Youtube that can help you understand more intuitively how blocks are created, how they are chained together, how transactions are added to the blockchain, and how mining plays a central role in this process. (https://youtu.be/_160oMzblY8)

Essentially, miners, or computers distributed around the world, compete to solve a computationally intensive puzzle to verify the next block in the blockchain (and the underlying transactions within it) . The first miner to solve this puzzle gets a reward (coinbase reward + transaction fees) . Once this new block is found, all miners on the network can verify that the block is correct and move on to solving the next block in the chain.

The role of miners in the Bitcoin and crypto ecosystem

All the computers in the world competing to solve the next puzzle make up the mining ecosystem. All of this computing resources is one of the core elements that provide the security that underpins Bitcoin.

Through this network, Bitcoin participants can expect to:

• Their transactions will be confirmed on the Bitcoin blockchain.

• Their transactions will be processed in the correct order (preventing double spending) .

• The history of the Bitcoin blockchain will remain unchanged (immutability) .

In return, miners are compensated with newly minted bitcoins (the coinbase reward) , plus transaction fees associated with each transaction. If participants want stronger guarantees about when their transactions will be added to the Bitcoin blockchain, they can increase the amount they are willing to pay when setting the fee for their transactions.

Hardware used for mining

While it was profitable to mine bitcoin using consumer-grade central processing units (CPUs) in the early days of the bitcoin network, doing so has become impractical as the bitcoin network has grown to its current size.

The Bitcoin ecosystem is dominated by application-specific integrated circuits (ASICs) . For most other cryptocurrencies, graphics processing units (GPUs) and field-programmable gate arrays (FPGAs) are the main form factors. There are also some coins that use the same hashing algorithm as Bitcoin (SHA256) and are compatible with Bitcoin mining ASICs.

Mining Ecosystem Panorama

Here is a panoramic view of the mining industry, from chips to end-user services:

Chip Manufacturing

TSMC and Samsung are the two core semiconductor foundries that produce all the silicon wafers used in mining hardware. Taiwan, in particular, holds a dominant share of the chipset supply chain.

For example: NVIDIA , AMD, Xilinx , Bitmain and Cannan all use TSMC as their core production lines.

Packaging, testing, assembly

Once the wafers are finished, you need to test them, cut them up, package them into final chips, and test them again. This entire process is usually handled by OSAT companies (outsourced assembly and test companies) , the two largest of which are Taiwan's ASE Group and Amkor Technology .

Integrated circuit design and manufacturing

Companies that design and sell chips are often called fabless chip companies, leaving the manufacturing to chip manufacturing and OSAT companies).

In the GPU field, the two largest manufacturers are Nvidia and AMD. In the FPGA field, the largest manufacturer is Xilinx. And in the ASIC field focused on the crypto industry, the top three companies are Bitmain, Canaan, and MicroBT, the manufacturer of Shenma mining machines (also known as Pangolin Miner) .

In addition to these three manufacturers, there are other IC design companies in this field, including: Ebang , Innosilicon , Bitfury, Obelisk, etc.

Miners and mines

Once the chip is produced, it can be used to mine cryptocurrencies. ASICs are designed specifically for mining a certain algorithm (most typically SHA256 and Bitcoin) , while GPUs have more flexibility.

Miners include: people mining with one machine, small mining operations (5-10 machines) , medium-sized mining farms (10-100 machines) , large mining operations (100-1000 machines) to industrial-scale mining bases (1000+ machines) .

The largest operation I have heard of so far is 100,000 mining machines distributed across multiple geographical locations.

In addition to designing chips, some manufacturers also mine themselves, such as Bitmain, Canaan, and Microbit. Bitmain publicly discloses their "self-mining" records every month.

Mining operations of any size can point to a mining pool (more on this later) , or if they are large enough, they can mine on their own - aggregating all their hashing power to find blocks directly without mixing their hashrate with other miners.

It is arguable that mining chip manufacturers may use their machines to mine before selling them, but if you do have a device that generates revenue, there is no reason to leave it sitting idle in a warehouse until you can sell it.

Mining pools (single-currency and multi-currency)

For individual and non-industrial miners, it is more economically reasonable to join a mining pool than to mine on their own. A mining pool aggregates the hash power of many miners to smooth the return curve for each miner. The mining pool is responsible for optimizing all the hash power, running the mining records, collecting and distributing the rewards, and charging an additional fee for the service.

Some mining pools focus on specific cryptocurrencies, such as Spark Pool, which mainly mines ETH and Grin, while others cover all major cryptocurrencies, such as AntPool, F2Pool, CoinInPool, Slushpool, etc. All of these mining pools started out focusing on one cryptocurrency, usually Bitcoin, and have since expanded to cover all forms of cryptocurrency.

One of my favorite analogies is that mining pools can be thought of as office lottery pools. By pooling the lottery tickets of all colleagues in the office together, everyone (miners) has a better chance of winning the reward (block reward) .

At the same time, when using a mining pool, you have to trust that their service reports both accurate earnings and the accurate number of votes each person in the pool has. In terms of transparency, there are services such as PoolWatch that track and compare reports from different mining pools.

Hash Power Market

As a miner, in addition to using your own hashing power for mining, you can also choose to sell your hashing power to others. Usually, this is done on a trading market, the largest market is called NiceHash . There is a smaller P2P market called Mining Rig Rentals .

On these markets, people can sell and buy computing power for various types of cryptocurrencies on any given set of mining algorithms.

People buy computing power for many reasons, chief among them being that it is an on-ramp to the cryptocurrency highway.

Too often, people use hash power to speculate on various cryptocurrencies, for example, buying SHA256 hash power and using it to mine Bitcoin SV (BSV) instead of Bitcoin. This is a bad business…

Cloud Mining

Cloud mining is a service where consumers can directly purchase hash power contracts without having to operate any hardware themselves. It is similar to a computing power market on top of cloud mining services, usually operated by a central provider.

The two largest companies in this field are Genesis Mining in the United States and Bitdeer in Asia. Again, similar to the above, one of the main reasons users buy hash power is to get into the cryptocurrency field quickly. With this method, people can use fiat currency to buy Bitcoin and other cryptocurrencies directly without going through an exchange.

Smart Miner

Smart miners are an emerging category. The background is that mining is a complex job, and participants need to understand hardware, networks, energy, hash rate predictions, specific algorithm optimization, etc. The most critical thing is that all these inputs are constantly changing every day, and new long-tail cryptocurrencies are constantly appearing and disappearing.

Smart miners like Honeyminer aim to optimize all of these factors so that both consumer and professional miners can earn as much as possible with the hash power they have.

Two other similar products are HashFish and Cudo Miner .

In a short period of time, these products have gathered a significant amount of hash power on the supply side of the market.

Mining market size and revenue overview

The crypto mining industry generates more than $8 billion in annual revenue.

Revenue comes from two sources: block rewards and transaction fees included in each block on all proof-of-work blockchains. Based on the latest data on mining rewards released by CoinMetrics on June 25, 2019, here are the weekly, monthly, and annual revenue run rates for mining.

In the cryptocurrency mining space, Bitcoin still dominates , with the Bitcoin network alone generating 75% of mining revenue.

This also matches Bitcoin’s market cap dominance, which accounts for 60% of the total market capitalization of all cryptocurrencies as of July 1, 2019, according to CoinMarketCap.

However, the total revenue generated by the mining industry is directly tied to the price of the underlying cryptocurrency, and therefore maps to the underlying cryptocurrency market, making it difficult for Wall Street to understand the valuations of companies in the industry. We will go into this in more detail below.

Understanding the profitability of mining

The total revenue, total costs, and profitability of mining participants depend on several key factors.

Capital Expenditure (Capex)

For miners, the main capital expense is the cost of the mining machine itself, plus the cost of all the facilities/buildings required to operate it.

For example, if you want to buy 10,000 of Bitmain’s latest S17 models, it would cost $16 million at retail price. Large miners can get special discounts; however, when mining machines are in short supply, it is difficult to even guarantee supply, let alone negotiate prices.

That’s before you even take into account the costs of building mining facilities, which have grown from a hobby activity to truly professional, industrial-scale operations.

Operating Expenditure (Opex)

For miners, the main operating expense is the daily electricity bill to power the machines.

For example, if you run 10,000 Bitmain S17 mining machines 24 hours a day, 7 days a week, and if the energy cost is 5 cents per kilowatt-hour, your electricity bill will be $36,000 per day, or about $13 million per year - and that's just to power the mining machines.

Average electricity costs vary widely, depending on where you are and what source of electricity you use.

Miners are inherently incentivized to find the cheapest energy in the world, which is why Coinshares estimates that 75% of the Bitcoin network’s energy comes from renewable sources, primarily hydropower.

In addition to the electricity costs of the mining machines, other operating costs include: cooling, labor, maintenance, security, and general facility operations. A general rule of thumb is to roughly estimate current operating costs by 1.5 times the energy cost.

According to our example above, a mining farm running 10,000 Bitmain S17 mining machines has a rough estimate of the cost as follows:

• $16 million capital expenditure + $3 million (import taxes) + $4 million (facilities + security)

• $20 million operating costs (per year)

• $67 million in potential revenue (based on today’s Bitcoin price) .

This is just a rough estimate, just to illustrate the scale of factors that miners need to deal with. The true cost will be highly dependent on your geographical location and built-up factors, etc.

However, these factors are always changing based on market factors, which we will discuss below.

Market factors affecting the industry

While operating costs and capital expenditures are two factors that miners can control, various market forces are ultimately at work and they largely determine the profitability of mining.

Miner costs and available supply

Unlike many traditional products, mining manufacturers (Bitmain, Canaan, Shenma Mining Machine, etc.) will adjust the price of mining machines according to the profitability of the mining machines (Bitcoin price) .

During periods of massive pullbacks, the value of both the underlying cryptocurrency and the mining machines themselves can fluctuate wildly. During periods of craziness, entire secondary markets are dedicated to buying more hardware, and older machines become profitable again.

Generally speaking, I always want the price of a machine to be close to the fair value that the machine is generating at that point in time.

On top of that, mining hardware is often in limited supply, especially newer machines. Take the Bitmain S17 for example, these are completely sold out. I spoke to some people on the team and they don’t expect supply to resume until November at the earliest.

Hash Power

The chance that a miner will solve the next block is proportional to their share of the computing power of the entire Bitcoin network (for simplicity, let's use Bitcoin as an example) .

To use a perhaps somewhat simplified example to illustrate this, if you are a miner controlling 1% of the Bitcoin hashrate (compared to Bitcoin’s overall hashrate) , then you have the potential to earn 1% of the total rewards of the Bitcoin network.

However, Bitcoin's overall hash rate is always changing, so the profitability of each miner depends on how many miners enter or leave the ecosystem. The Bitcoin protocol has an internal method for adjusting the difficulty level (for more information, see here: https://en.bitcoin.it/wiki/Difficulty) .

Bitcoin Price

Because block rewards are paid in the cryptocurrency of that blockchain. For example, if you are mining Bitcoin, the block rewards you receive will be paid in Bitcoin. Therefore, the reward amount is directly tied to the price of Bitcoin itself.

The higher the price of Bitcoin, the higher the value of the mining reward. Since you are mining, you are fundamentally long the cryptocurrency you are mining because your profitability depends on it.

One of the main reasons why Bitcoin has become the dominant cryptocurrency is its transparent, public and fair supply schedule. Since the genesis block, Bitcoin has a fixed supply schedule - the total supply of Bitcoin is capped at 21 million.

Mining is how new Bitcoins are created and released into the world. Today, the reward for each Bitcoin block is 12.5 Bitcoins; however, this reward decreases every 210,000 blocks. At block height #630000 (estimated to be around May 24, 2020) , this reward will drop to 6.25 Bitcoins - this is called a halving event.

To understand how previous halving events have affected Bitcoin and other cryptocurrency networks, you can refer to CoinMetrics' excellent blog post, which combs through previous halving events. (https://coinmetrics.substack.com/p/coin-metrics-state-of-the-network-43a)

If you want to learn more about Bitcoin’s supply schedule and what happens after all Bitcoins are created, you can read these two posts about Bitcoin’s supply and overall security budget:

Article 1: https://en.bitcoin.it/wiki/Controlled_supply

Article 2: https://blog.picks.co/bitcoins-security-is-fine-93391d9b61a8.

In short, the price of Bitcoin and the supply schedule of Bitcoin greatly influence the profitability of mining itself.

The most memorable information

After digging deeper into the world of cryptocurrency mining, my main conclusions are as follows:

• Although the mining industry and the underlying hardware are often overlooked, they play a very important role in blockchain networks.

• Hash rate = cryptocurrency = money. For many, hash rate is the key gateway into the world of crypto.

• Just as we saw the financialization of Bitcoin, I expect we will see a similar financialization of hash rate.