The economics of Bitcoin mining

Editor’s note: This article comes from Lanhu Notes (ID: lanhubiji), author: Amrinder Dhindsa, source: medium.com, translated by “Li Xihe” from the “Lanhu Notes” public account community.

Preface: Will a fall in Bitcoin prices necessarily be accompanied by a fall in mining hash rate? Not necessarily. The mining costs of different miners are different.

The price of Bitcoin has dropped from its peak of $20,000 to $6,500 in eight months (translator's note: it has fallen to around $35 million today), a drop of more than 80%. However, during this period, the hash rate has increased from 15EH/s to 45EH/s, a three-fold increase. (Translator's note: When the price fell from $6,500 to $3,500, the hash rate fell sharply, but after the difficulty adjustment, the hash rate has recently begun to recover, and currently has a 20% increase)

The conventional wisdom in the cryptocurrency mining industry is that hash rates rise as prices rise, and conversely, fall as prices fall. This is because as prices rise, more miners are attracted to join the network to earn block rewards. As prices fall, miners whose marginal cost of mining is higher than the price of Bitcoin begin to withdraw, which causes the hash rate to fall.

As expected, the hash rate does increase as the price increases, but counterintuitively, sometimes the price drops and the hash rate continues to increase rapidly.

Why are more miners joining the network even as the price of Bitcoin falls?

The current block time is 10 minutes, and the winning miner will receive a block reward of 12.5 bitcoins. The probability of winning is proportional to the percentage of the miner's hash rate to the total network hash rate.

The main operating cost of Bitcoin mining is the electricity cost of the mining hardware. Since the cost of electricity varies around the world, the marginal cost of mining is different. It is also worth noting that most mining machines (ASICs) are produced by a few companies in China.

According to current estimates, the marginal cost of mining one bitcoin in the United States is about $4,700, while in China it is only about $3,000, and it is easier to buy mining machines in China. Even if the price of bitcoin is $6,500, most amateur miners are already unable to make ends meet, and as the price drops, they are gradually withdrawing from the mining market.

However, for professional miners who own ASIC mining farms, they still have good profits even at such a low price. And as long as the price of the currency is still above their marginal mining cost, they are willing to buy more ASIC mining machines. The marginal mining cost of Chinese miners is around $3,000, so their mining motivation is still strong.

Since the current block reward is 12.5 bitcoins every ten minutes, if we calculate at a price of $6,500, any expansion of Chinese miners will come at the expense of miners with higher marginal costs.

If other conditions remain unchanged, this phenomenon will continue until the marginal cost of mining is equal around the world.

Considering the economic mechanism, as the price of Bitcoin falls, mining infrastructure will become more and more centralized. In theory, mining will move to places with the lowest unit cost of electricity, but in reality, most mining infrastructure will be centralized in China, because in China, a large number of efficient ASIC mining machines can be directly purchased, and the marginal cost of mining is also one of the lowest in the world.

Therefore, we can foresee that the hash rate may continue to rise even if the price of the coin falls. Higher marginal costs will cause some miners to be eliminated, and the more efficient miners who remain will occupy a larger market. The price of the coin may fall below the minimum mining cost; at this point, the hash rate will fall as the price of the coin falls. At the same time, some miners may continue to mine for a while at a loss, and then decide to gradually shut down the hash power.

The trend toward extreme centralization can only be slowed by increasing competition among ASIC manufacturers, which would likely result in more and better ASICs becoming available elsewhere in the world. Even with such competition, miners will gradually move to parts of the world where electricity is cheaper (an effect that may be normalized by socioeconomic or political factors).

Therefore, Bitcoin mining is a relatively free market, with more efficient miners gaining more market share while sacrificing the market share of less efficient miners.

One final point to note is that the design of the Bitcoin protocol ensures that even if a single miner controls 100% of the hash rate, that miner will still have a stronger incentive to mine honestly in the network than to conduct a double-spend attack.