The impact of the cryptocurrency price crash on miners

summary

Cryptocurrency prices have fallen significantly over the past few weeks. This article analyzes the impact of the price drop on the mining industry. Since November 2018, the Bitcoin hash rate has fallen by about 31%, equivalent to the hash rate of about 1.3 million Bitmain S9 machines. It can be seen that many miners are struggling; however, not all miners have the same mining costs, and as cryptocurrency prices fall, higher-cost miners will be the first to shut down their machines and be eliminated.

Overview

Since November 2018, the price of Bitcoin has fallen by about 45%, while during the same period, the mining volume on the Bitcoin network has fallen by about 31%. According to our estimates, this is equivalent to about 1.3 million Bitmain S9 mining machines being shut down. Therefore, the mining industry is currently under considerable pressure due to the falling price of cryptocurrencies.

So far, the price drop has resulted in two large Bitcoin difficulty adjustments, one of 7.4% on November 16th and another of 15.1% on December 3rd. The 7.4% adjustment was the largest adjustment since January 2013, and the 15.1% adjustment was the largest adjustment since October 2011. The following chart contains data on the daily blockchain workload, and therefore reflects changes in the overall network mining difficulty.

(Bitcoin daily workload vs. price drop, source: BitMEX Research, Poloniex)

Daily mining income and costs

As shown in the chart below, Bitcoin mining revenue has fallen from $13 million per day in early November to around $6 million per day in early December. This drop in incentives has been even more dramatic than the drop in Bitcoin’s price due to the delay in the difficulty adjustment. In the six-day period ending December 3, the number of blocks produced per day fell 21.8% from the expected 144 as miners left the network before the difficulty adjustment. So, in the short term, mining incentives fell 21.8% in addition to the impact of falling cryptocurrency prices.

(Bitcoin daily mining revenue and expected electricity expenditure - million US dollars, source: BitMEX Resaech, Poloniex; Note: Assuming electricity cost is $0.05 per KWH, assuming the mining machine specification is Bitmain S9 model)

(Bitcoin Cash ABC daily mining revenue and expected electricity expenditure - million US dollars, source: BitMEX Resaech, Poloniex; Note: Assuming electricity cost is $0.05 per KWH, assuming the mining machine specification is Bitmain S9 model)

(Daily Ethereum mining revenue and expected electricity costs — in millions of dollars, source: BitMEX Research, Poloniex; Note: assuming electricity costs of $0.05 per KWH, assuming 200W produces 32Mh/s)

Miner Profit Margin

The chart below shows that prior to the recent price crash, the industry’s gross profit margins were around 50% (assuming electricity costs are the only variable cost used in calculating gross profit margins), while after the price crash this figure dropped to around 30% for Bitcoin and 15% for Ethereum.

(Miner profit margins, source: BitMEX Research, prices from Poloniex)

Ethereum Mining Profitability

During this period, Ethereum’s hash rate has only fallen by 20% (equivalent to about 1.5 million high-end graphics cards), which is much less than Bitcoin’s, while its price has fallen more significantly than Bitcoin’s, at 54%. Therefore, Ethereum’s gross profit margin has fallen more significantly, but it is not clear why this happened.

Some potential reasons are as follows. It could be that Ethereum miners are more hobbyists and less profitable, or that Ethereum miners enter the market with higher gross margins than Bitcoin, so they are less willing to monitor the network and shut down mining machines. As data shows, Ethereum miners' gross profit margins are now significantly lower than Bitcoin, falling to 15% in the past few days, so the above situation may change (Note: This analysis only includes electricity costs, when other costs are included, miners may be operating at a loss).

Bitcoin Cash ABC Mining Profit Margin

As shown in the above chart, Bitcoin Cash ABC’s gross margin turned negative after the split into two cryptocurrencies, Bitcoin Cash ABC and Bitcoin Cash SV. The two camps have been mining at a loss as they compete for the blockchain with the most work. On November 25, ten days after the fork, the profitability of mining Bitcoin Cash ABC quickly climbed to the same level as Bitcoin. This seemed to indicate that the “hash war” was over, but it later proved to be almost completely meaningless, as the end of the war had no noticeable impact on the value of the cryptocurrency.

As the latest data in the table below shows, the total workload of both parties is getting closer again, which may put both parties back into the situation of mining at a loss.

(Source: BitMEX Research, prices from Poloniex)

The flaws of the above analysis

The above gross margin analysis is not complete. While the revenue figures may be accurate, the only cost included is electricity. Obviously, miners have other costs, such as the capital investment in the machines and the cost of maintaining them and setting up the machines. Therefore, the chart below shows that the industry is highly profitable when only electricity costs are considered, but the recent price crash is likely to mean that all miners are mining at a loss. This shows that miners have invested too much in equipment and have already achieved a negative return on investment.

No flat electricity cost

Another key point not reflected in the above analysis is the variation in electricity costs. The above chart assumes a uniform cost of $0.05 per KwH; however, not all miners have the same electricity costs.

As we mentioned above, 31% of the hashrate was shut down during this period, and logically those miners with the highest electricity costs should be the first to shut down their machines. Therefore, the average cost of electricity on the network should have dropped significantly over the past month.

The chart below illustrates the above scenario, assuming that electricity costs are normally distributed with a standard deviation of $0.01 per Kwh, and that miners with higher costs will shut down their machines first. While this assumption may not be accurate, and energy prices will not be normally distributed across the mining industry, it illustrates a point at a macro level, and it may also be more accurate than the above chart.

According to this analysis, the average Bitcoin mining gross margin has only dropped from around 50% to 40%, meaning that the rest of the miners are faring much better.

(Bitcoin mining gross profit margin example, source: BitMEX Resarch, price from Poloniex)

When assessing the potential negative impact of a price drop on Bitcoin, analysts sometimes forget that not all miners have the same costs. It is these cost differences that ensure the network continues to operate smoothly despite sudden and significant price drops and the difficulty of mining being adjusted.

What caused the price crash?

There has been considerable speculation about the cause of the price crash, with some saying miners were selling Bitcoin to finance the costly hash war for Bitcoin Cash. Crypto intelligence monitoring platform Boltzmann told us that their platform had detected a massive sell-off of Bitcoin by miners on November 12, days before the Bitcoin Cash split.

Boltzmann detected that miners’ net Bitcoin sales “were 17.5 standard deviations away from the 3-month mean.” Upon further analysis, it appears that these miners may have been members of Slushpool.

(Bitcoin miner net flow and price, source: Boltzmann, 12-hour summary of miner net flow)

Conclusion

While it is true that miners selling Bitcoin to fund losses in the Bitcoin Cash hash war was a catalyst for the price drop, we believe its impact is easily overestimated. Since we are in a bear market, prices are falling regardless of news or investment flows.

Furthermore, in a bear market, it seems that prices will fall in the absence of news or bad news, while good news is often ignored by the market, while in a bull market the opposite is true. We believe that even if miners sell Bitcoin before the Bitcoin Cash split, prices will weaken. In the face of the cryptocurrency market, investor sentiment management is king.

This could be a very tough time for the mining industry. However, for lower-cost miners, our fundamental analysis suggests that the situation may be better than people expect. If miners purchased their equipment from Bitmain at below cost, they may still be in a profitable position even after including depreciation and other overheads.