Although mining is in a loss-making state, the number of mining companies has increased sharply

Throughout 2018, the cryptocurrency market experienced its fourth worst correction in its 10-year history, with the value of Bitcoin falling 69% from its all-time high of $19,500.

Despite a sharp drop in the price of Bitcoin (BTC), which has severely affected miners’ revenues, the Bitcoin network’s hash power has continued to increase over the past 10 months, increasing from 15 million TH/s to over 50 million TH/s from January to October.

As blockchain analyst Barclay James has found, the breakeven cost of mining Bitcoin at 35 million TH/s is about $6,900. The formula James uses takes into account the hash power of the Bitcoin network, the hash power of ASIC Bitcoin miners, and the efficiency of each miner in producing Bitcoin:

units = global hash power ÷ unit hash power ÷ unit efficiency

Considering the mining cost of Bitcoin, when its hash power is currently around 35 million TH/s and the value is $6,400, the breakeven cost of Bitcoin is between $7,000 and $8,000. This means that Bitcoin miners are facing losses when producing Bitcoin at $6,400. The motivation to continue production is entirely dependent on their future expectations of Bitcoin prices, which they believe will eventually rise in the coming months.

For miners outside of China, especially in the mountainous Sichuan region known for some of the cheapest electricity supply in Asia and a frigid climate that naturally cools cryptocurrency mining equipment, the cost of mining Bitcoin is even higher.

Barkley James's paper reads as follows: "China has some of the cheapest electricity prices in the world, and average temperatures that are consistent with temperate regions. This is important because cooling is one of the largest expenses in the mining industry. Additionally, the country's overall lower operating costs also give it a competitive advantage. In fact, an estimated 70% of global hash power is currently in China, with the majority of that located in the Sichuan region.

Bitcoin miners have been mining the dominant cryptocurrency and incurring huge losses since June. The fact that BTC’s hash rate has continued to rise throughout the 2018 bear market suggests massive activity in the global cryptocurrency mining sector, with miners confident that the industry will recover as the year comes to an end.

Bitmain sells mining machines at a discount

BitMEX Research, the research arm of major digital asset exchange BitMEX, revealed in its paper in August that Bitmain, the dominant conglomerate in the bitcoin mining sector, has been selling its latest bitcoin ASIC miner, the Antminer S9, at a lower price.

In 2017, Bitmain sold more than 1 million Antminer S9s. Another 700,000 were sold in the first quarter of 2018. The researchers said they calculated the gross profit margin reported by Bitmain in 2017 and the implied costs of each miner. Bitmain set a negative profit margin of 11.6% for its main product, the Antminer S9.

The researchers said such low profit margins for Antminer S9 miners, combined with the miner’s sudden increase in sales in the first quarter of 2018, suggest the company has adopted a strategy to outperform competitors by undercutting the price of its products.

“These low prices are likely a deliberate strategy by Bitmain to outperform its competitors by undercutting them. In our view, this was one of the main driving forces behind the decision to IPO. If successful, the IPO could add further firepower to continue this strategy.”

And eliminate any advantages that competitors may have through an initial public offering (IPO).”

The article also suggested that the company may simply have too many Antminer S9 miners in inventory.

In June 2018, Bitmain was criticized for shipping dusty Antminer S9 miners. Some miners accused the company of sending old or second-hand ASIC miners to customers. In response, Bitmain said that all miners who received defective or affected Antminer S9s would be fully compensated.

“Any product may be imperfect, and there will be shortcomings in the process of business development. We have also compensated miners who received mining equipment with insufficient computing power, and these equipment are now operating normally.”

Whether a company’s decision to sell its mostly low-profit margin ASIC miners is due to competition or to clear inventory, the end result is that more efficient and high-performance ASIC miners are brought to the global mining industry, leading to an increase in the hash power of the Bitcoin network.

Samsung and GMO Emerge

Bitmain’s dominance is under threat

In the first quarter of 2018, Bitmain’s profits were twice as much as Nvidia, the world’s largest graphics card maker. Nvidia’s net profit was $550 million, while Bitmain’s profit from January to March was $1.1 billion.

Bitmain’s lucrative business model and its high profits have led to two of Japan and South Korea’s most influential technology groups, GMO and Samsung, to enter the global cryptocurrency mining equipment market.

GMO has launched its own ASIC miner with competing specifications compared to Bitmain’s Antminer S9. Samsung Electronics has partnered with some foundries and some mining industry startups in Suwon, South Korea, to produce cryptocurrency ASIC miners.

When Samsung Electronics first announced its decision to join the global cryptocurrency market, the company stressed that it was still uncertain whether it could improve the company's revenue overall. However, given that the company has successfully penetrated into insurance, fintech, electronics manufacturing, automobile manufacturing and shipbuilding over the past few decades, the company's focus in establishing a mining company is to get involved in emerging industries such as cryptocurrency.

Samsung Securities analyst Hwang Min-sung said in January: "Samsung Electronics may increase revenue through ASIC chip manufacturing, but it is difficult to predict that the company's mining joint venture will have a significant impact on the company's revenue as the foundry accounts for only a small part of the company's semiconductor manufacturing plants."

Since then, Samsung has actively expanded its mining business as market demand has grown. Samsung's uncertainty about cryptocurrency mining suggests that the company is unwilling to commit to the industry unless it believes that the market has great short-term and long-term growth potential.

Most recently, Samsung signed a deal with Canadian crypto mining company Squire, which raised $19.5 million in August to develop cryptocurrency mining equipment, and to produce ASIC miners on behalf of the Canadian company.

Around the same time, Taiwan Semiconductor Manufacturing Co. (TSMC), the world’s largest independent chipmaker, lowered its growth target for cryptocurrency mining from 9% to 6.5%.

The group said that weakening demand for cryptocurrency mining has led the company to lower its growth targets for the sector. However, it is unclear whether the report was written specifically for Bitmain, given that TSMC is the manufacturer of Bitmain’s ASIC miners, or other manufacturers in the industry.

“However, further weakening in demand for cryptocurrency mining also had a negative impact on our business. As a result, we estimate that our growth rate in 2018 will be around 6.5% in US dollar terms, which is close to the growth of the foundry industry but slightly lower than the 7% - 9% outlook we gave at our last meeting.

New mines are opening all the time

Despite disagreements between Samsung and TSMC over the need for cryptocurrency mining, two multimillion-dollar mining facilities have opened in Armenia and Colorado in the past few days.

According to local Armenian media reports, on October 19, a $50 million digital asset mining facility was put into operation, with 3,000 ASIC miners participating in the mining of Bitcoin and Ethereum. In the next few months, 120,000 ASIC miners are expected to join the factory.

The mine was created by local real estate company Multi Group Concern (MGT) and Malta-based technology company Omnia Tech International company with support from the government and local authorities.

Plans to build the facility were initially announced in April, when Omnia Tech founder Robert Velghe said the two companies intended to invest more than $2 billion in mining and crypto-related businesses in Armenia.

“We will also help Omnia Tech to establish a fintech park and a data exchange center in Armenia. We intend to build a new blockchain-based information project development center here, which will turn Armenia into a high-tech platform.

On October 25, MGT, the largest mining equipment operator in the United States, announced that it would build another large-scale mining facility in Colorado, equipped with 6,300 Bitmain S9 miners. Currently, MGT already operates 6,800 Bitmain S9 miners and 50 GPU Ethereum miners in the country.

MGT COO Stephen Schaeffer stressed that despite the drop in Bitcoin prices, the company intends to burn its boats and look for opportunities, which in this case is to mine Bitcoin.

The current state of regulation in the mining industry

Many of the world’s largest economies are implementing practical regulatory frameworks to promote the growth of mining companies. Authorities in South Korea, Japan, and the United States have welcomed the use of low-cost energy to operate mining facilities. Countries such as China and Russia, which have vague regulations on cryptocurrencies, have also taken a neutral stance on mining.

China has banned nearly all cryptocurrency-related businesses and activities over the past 15 months, including trading, activities and over-the-counter (OTC) investments. However, it has opened up two use cases for cryptocurrencies: processing transactions and mining digital assets.

Several local governments in Russia have also been open to cryptocurrency mining, leading various initiatives to convince large mining companies to open mining farms in the country.

In August, Dmitry Yalo, deputy governor of the Leningrad region, said at the opening of a new mining facility in Russia that the region plans to attract more mining centers in the coming years with lower electricity prices, qualified personnel and a more naturally cold climate to cool down ASIC miners at no extra cost.

Impact of the US-China Trade War

The conflict between China and the United States is starting to affect Chinese chipmakers and mining equipment manufacturers, including Bitmain. A 27.6% tariff on the Antminer S9 has made the company’s products significantly more expensive for buyers outside of Asia.

Previously, Bitmain was able to ship Antminer S9 miners without being subject to tariffs because the product was classified as a data processing machine. The sudden imposition of tariffs on motor equipment, including data processing equipment, has created an inefficient ecosystem for ASIC manufacturers in China.

The U.S. tariffs on China come as President Donald Trump has expressed concern about a lack of reciprocity between the two countries.

For years, China has been able to ship products to the United States with near-zero taxes, so much so that Amazon’s vice president of global policy, Paul Misener , once said:

"It costs nearly $6 to ship a one-pound package from South Carolina to New York; it costs $3.66 from Beijing to New York."

South Korea and Japan remain unaffected by the tariffs, and Samsung and GMO are expected to continue their success in the global mining sector as both countries have established workable regulatory frameworks.

For now, despite a sharp drop in the prices of major cryptocurrencies, demand for cryptocurrency mining remains relatively high, as evidenced by the rise in the Bitcoin network’s hash rate and the expansion of operations by Samsung, GMO, and Bitmain.

Major regions have established positive regulatory frameworks for cryptocurrency miners and companies, which could lead to an increase in investors setting up mining facilities as investors expect the crypto market’s valuation to surge significantly in the coming months.