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With the recent influx of wintery weather in Texas, crypto miners have been powering down the operations of Texas mines to help ease the burden on the state’s power grid. This recent storm saw Riot Blockchain shut down 99% of its operations at its Texas mine. With the challenges posed by the ERCOT grid, many are concerned whether the grid can handle and support the intense energy requirement needed for crypto mining.

But cold weather aside, Bitcoin mining is facing a major test of its viability and profitability this quarter, which will have implications for the BTC price as well. Bitcoin (BTC) miners are facing dwindling fortunes. That’s according to recent data that shows BTC mining profitability touching its lowest on February 4, 2022.

Recent analysis places BTC mining profitability at $0.167 per one terahash per second (1THash/s). In contrast, the coin’s mining profitability was $0.282 per THash/s at the same time last year.

“Using BTC as an example, as the price of the coin rises, profitability rises but not as much as you’d expect since more miners come online and the network difficulty spikes as a consequence,” said Jeff Gao, CEO of Cypherpunk Holdings. “Similarly, a fall in BTC price reduces profitability but that’s somewhat cushioned by miners  – the most inefficient ones first) leaving the network – thereby reducing the network difficulty. NT difficulty, if you will, is like an automatic stabiliser that partially offsets the impact of coin price directionality.”

Power also plays a part. Miners seek out the cheapest sources of power first – many of these sites are wind and hydro owing to proximity to a freely available resource (like a river in the case of hydro) and to govt subsidies. Power is typically in the 1.5 to 4.0 cents per KWh range but can spike which it has in recent times due to the LNG crunch in Europe and the tight gasoline market in the US.

What’s more concerning is the emergence of crypto mining as a service aimed at the retail end. Mining outfits are bootstrapping as they go in terms of taking funds from investors to acquire miners on their behalf and deploying them to energy and mining pools.

“The problem is securing energy”

“The problem is securing energy – managed mining services are struggling to find long term leases and if they cannot renew site leases on a rolling bases then all the rigs get stranded,” says Gao. “Check out what happened to CryptoStar. They contracted up to 30MW of power from Avila Energy (based in Alberta Canada) and forward sold 10MW of that to a client before the ink fully dried. I actually spoke to the incoming CEO of Avila – CryptoStar is leveraged with off balance sheet items and their cash position isn’t as strong as shown on their FS. They fell behind on payments to Avila (owing to poor cashflow management) and purportedly still owe Avila at least 1.5M CAD in unpaid invoices.”

A combination of supply crunch and cavalier ‘growth at any cost’ cowboy mentality in the managed mining sector is fuelling the volatility. “I’m neutral to wary on crypto mining – it’s crowded and there are too many cowboys,” Gao notes. “In fact, the only counterparty I would be comfortable dealing with is probably Blockstream – they only cater to institutional clients with >1MW capacity.”

But the most decisive parameter is effective life given the significant CAPEX required to purchase the miners. Ignoring depreciation and amortisation, the gross yield on BTC mining is around 35% p.a using a reference price of 50K BTCUSD. The cooling tech has an outsized effect on the effective life of the rig.

Causes and effects of declining BTC mining profitability

A drop in the BTC mining profitability casts a dark shadow on the crypto ecosystem. First, it has resulted in shrinking miners’ margins opening the door for potential exits. Should that happen, BTC enthusiasts could be staring at slower transaction times. That’s because the exit would present a gap in the digital asset’s mining power.

Analysts have linked this drop to two factors. First is the rise in the crypto’s mining difficulty or hash rate. This difficulty reached an all-time high of over 26 trillion mid-last year, making it difficult to verify blocks.

Secondly, BTC’s price has dropped from last year’s ATH. This, plus the high electricity costs necessitated by higher hashing rates, eats into the miners’ margins.

How did we get here?

Between May and the end of June 2021, the BTC mining profitability levels have declined. From highs of $0.42 per THash/s on 2 May, the figure dropped to around $0.22 in mid-June before plummeting to $0.17 on 27th June. 28th June saw an upswing in the metric. Improved fortunes saw it attain the $0.306 mark. It then peaked at $0.377 on July the third. And after dropping to $0.228 on 20th July, it began rising again

Market observers adduce the growth in profitability around this time to China’s crypto crackdown. The crackdown led to the halving of BTC’s hashrate. And this, coupled with BTC’s surging value, shored up miners’ fortunes. The metric maintained an upward trajectory, hitting $0.464 on 23rd August. Another downturn brought it to the $0.274 level on 28th September 2021. Two further peaks on 17th October and 9th November subsequently gave way to the downward trend.

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With power prices now soaring across the world, and driving inflation ahead of them, Bitcoin miners are going to have to come up with some imaginative solutions to keep mining.

Passive air cooling

Mining rigs are typically loaded into a modified or custom built modular container (e.g. a shipping container) and spaced accordingly to allow airflow. This necessitates some exposure to the elements as you cannot create a closed loop system if you need air intake and exit to do the heat transfer work for you.

Rigs using these setups typically last 3-5 years before you need to dispose of them. There is some salvage value as the rigs are probably still operational but at a reduced enough compute to not make the marginal cost of electricity worth the effort. Assuming a salvage value of zero, the internal rate of return on mining is around 3.5 – 5.5% per annum after accounting for D&A. In other words, a bad deal.

Hydro cooling

There are some exciting developments in this space. However, the current hydro cooling tech involves using water (with a high specific heat capacity) as the primary coolant to transfer heat from the rigs. This is done using a dedicated cooling loop built into the mining rig e.g. Bitmain’s upcoming S19 Pro Hydro.

The form factor isn’t much different so rig density is unaffected, but the unit cost per rig has increased such that, hash for hash, it’s equivalently priced relative to an air-cooled rig. The benefit is from the extended useful life which is expected to be 5+ years. The lack of precedence means we don’t have empirical data to measure effective life reliably as yet but 7.5 years is probably a good median estimate based on data center analogues.

Phased immersion cooling (1 phase and 2 phase)

Two phase immersion cooling is the gold standard for the time being. The ASIC boards that do the hashing are dunked in a dielectric fluid (an oil-based solution) with a lower boiling point than water and evaporates as the boards heat up. There is much more maintenance in phased immersion than other forms of cooling and the dielectric fluid is much more expensive than water. The particles in the fluid also cause microscopic lacerations on the boards over extended periods of time but that’s a slow cycle effect. Immersion cooling pushes the useful life of the miner out to 10+ years (15yrs is a good median estimate).

Make sure you catch The Armchair Trader’s seminar on mid-rate cryptocurrency market data at the London Trader Show on 25 February. We will be on in the afternoon.

Related

Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Stuart Fieldhouse

Stuart Fieldhouse

Stuart Fieldhouse has spent 25 years in journalism and marketing, including as a wealth management editor for the Financial Times group, covering capital markets and international private banking, and as an investment banking correspondent for Euromoney in Hong Kong. He was the founder editor of The Hedge Fund Journal.

Stuart has worked at CMC Markets, supporting the re-launch of its global financial spread betting and CFD trading platforms. He is also the author of two books on trading, published by Financial Times Pearson. Based in The Armchair Trader’s London office, Stuart continues to advise fund managers, private banks, family offices and other financial institutions.

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