First Published on @IOSG Medium on Aug 12, 2020
The upstream of the Bitcoin industry mainly composed of mining industry participants such as individual miners, mining farms, mining pools, and Bitcoin mining machine manufacturers. FPPS (The Full Pay-per-Share) for miners includes mining rewards and transaction fees, while PPS (Pay-per-Share) only includes mining rewards. Transaction fees can change at any time and increase when the network is congested. In the case of Bitcoin mining rewards being halved, miners’ reliance on transaction fees becomes greater. In general, the miner market is a self-balancing market, so there will be no long-term mining disasters. The impact of miners on the price of bitcoin is mainly determined by the pressure of their sales of bitcoin rewards.
The key economic factors behind mining
1. Bitcoin price/reward: If the price of BTC is too low or the reward decreases, the income generated by the mining machine may not cover the electricity bill which means miners need to temporarily shut down the machines or sold in the second-hand market.
2. The computation power of the entire network: The computing power of the entire network mainly depends on the capital interest in entering the mining machine industry and the performance of future mining machines. If BTC price is stable and the computing power of the entire network increases (such as the launch of a new mining machine on the market), then it may still cause the elimination of outdated mining machine, thus unable to recover the capital cost invested in the mining machine. Judging from the current market of mining machines, the income of ASIC mining machines has stabilized. ASIC mining machines refer to mining machines that use ASIC chips as the core of computing power. ASIC is an electronic circuit designed for a specific purpose. Since ASIC chips are customized for specific calculations, the efficiency can be much higher than that of general-purpose computing chips such as CPUs. At present, the main chip manufacturers are Samsung and Taipower. The new mining machines mainly use 7-nanometer chip technology, while the 5-nanometer chip is still under testing, and mass production is unlikely in the short term. Therefore, the profit of the mining machine using 7nm chips will gradually stabilize in the next few years, and it will be the most sought-after mining machine model.
When the total network computing power reaches H*, the revenue generated by the mining machine will not be able to cover the electricity bill. The computing power consumption ratio (C/w) of the mining machine shows the overall performance of the miners. The higher the computing power consumption ratio, the larger the corresponding H*.
The current computing power is showing a steady upward trend, so the higher the computing power consumption ratio of the mining machine, the longer useful life there will be. Therefore, when the currency price is stable, mining farms tend to buy the most advanced equipment to eliminate low-efficiency mining machines. It can be seen that as long as the upstream industry can continue to introduce new equipment with higher efficiency, it will receive orders.
According to Blockware’s research, as far as Bitmain’s mining machines are concerned, the current mining industry is approximately composed of 38.65% s17 and 61.38% s9 mining machines. We compared the current (end of May 2020) breakeven point of the three generations of Bitmain mining machines and the breakeven point on May 11, 2020 (before the halving), and studied the impact of the halving on Bitcoin miners. In addition, we also analyzed the income of miners in different electricity fee intervals:
In the case of an electricity fee of US$0.052 per kWh, we can see that the Bitcoin halving does not have a significant impact on the most advanced s19 mining machine, because as long as the BTC price does not fall below $3,860, s19 will continue to make profits. But for the s9 mining machine, the situation is different. Before the halving, miners will continue to make a profit as long as BTC price does not fall below $6,672. After the halving, BTC price will need to reach US$10,453 to maintain breakeven. According to Blockware’s research, the current mining industry consists of approximately 38.63% of s17 and 61.38% of s9 miners. If we take a weighted average according to this ratio, we can see that the breakeven price before the halving is $3,863, after the halving, it breakeven price changed to $7,272. For all miners to make a profit, the electricity fee needs to be $0.04/kWh and the BTC price needs to be $8,500 and above. For the most advanced s19 mining machine, at the current $0.05-$0.06/kWh average electricity price, it can be profitable as long as the Bitcoin price is $4,500 and above. For the current average mining pool configuration, under the average electricity cost, miners can still make a profit as long as the BTC price is greater than $5,000,. Therefore, we can see the following after the halving:
Old miners (s9) are basically unprofitable, so miners need
After all the shutdown of old mining machines, the computing power of the entire network will decrease, the profitability of miners will increase, and new miners will enter and start a new cycle. Therefore, the entire mining industry is a self-balancing market, and systematic crises will not cause disaster. By drawing the break-even curve, we can see the BTC prices and electricity cost at different break-even points under the current computing power:
Through profit and loss analysis, we found that:
The current view that Bitcoin halving will cause the price to rise is mainly explained based on the two dimensions of the stock to flow model and the sales pressure of miners.
1. Stock to flow model
The leading indicator of Stock to flow is the ratio of stock to capacity (stock/annual output). It explains the scarcity of an asset. The larger the s2f, the scarcer the assets (the stock becomes larger and the output becomes smaller). As after the halving of Bitcoin, the reward becomes smaller, and therefore the s2f ratio of Bitcoin will become larger.
The above figure shows the relationship between the valuation of the Bitcoin price through the s2f model and the actual price of Bitcoin. We can see that the actual price of Bitcoin and the model price have a certain degree of correlation, but we think it cannot directly explain that the rise in the price of Bitcoin is caused by the decline in supply:
2. The selling pressure of BTC miners
The behaviour of miners can be interpreted from the following perspectives:
Miners can only make stable profits when the price of Bitcoin remains at a high level for a long time. Short-term price increases/falls cannot have a huge impact on the entire mining industry.
The impact of this halving on miners should follow the below logic:
Therefore, we see that the Bitcoin miner market is a self-adjusting equilibrium market. Perhaps the low-efficiency miners still hold a positive attitude, thinking that they can wait until the computation power decreases and the difficulty decreases to make a profit again. However, only when they withdraw from the market, the computing power can then be reduced. Therefore, the market will keep low-efficiency miners under liquidity pressure until they leave the market. At that time, the market computing power will be rebalanced, the difficulty will be readjusted, and the mining market will enter a new cycle.
Since the selling pressure is no longer a variable, a stable factor naturally cannot be a determinant of fluctuating prices.
3. The halving is more of a proof that the Bitcoin mechanism can work as designed
The fundamentals of secondary market prices are still based on the relationship between supply and demand. The net outflows or inflows from the market are the direct factors affecting prices. We can see that the news of Bitcoin’s halving is an absolute hot spot in the industry.
We can see that the search for Bitcoin halving on the Internet has rapidly increased. People’s attention to the event will bring greater net inflows to the market. Therefore, we believe that the main impact of the halving on the price of Bitcoin is:
Miners generally sell bitcoin through exchanges. If we analyze the data from January 2017 to January 2020, we can see that more than a quarter of all BTC received by exchanges came from mining pools. Therefore, miners must be extra careful when selling bitcoin rewards, because their actions may lead to a massive sell-off in the market.
Since bitcoin miners need to sell their bitcoins at the right price in exchange for fiat currency to cover costs, we can know that miners tend to build inventory during bear markets and reduce inventory during bull markets. The following figure also proves this:
Recently, on June 3, 2020, the price of Bitcoin fell by 8% within 5 minutes of the beginning of US trading hours, from $10,137 to $9,298. But the miners continue to sell their bitcoins:
We saw that on June 3 miners mined 844 bitcoins but sold 920 uncolored bitcoins, which caused the MRI index to exceed 100%. This shows that miners believe that the market is still strong and supported, and the sales of uncolored Bitcoin also shows that miners are optimistic about the current market price. If we observe the unsold uncolored bitcoins (January 2009 to January 2020), we will find that the highest inventory of bitcoin miners occurred on March 11, 2011, when there were 2,593,051 Unsold bitcoins. The increase in Bitcoin’s inventory from 2009 to 2010 was mainly due to the fact that it was very easy to mine Bitcoin at that time, and then the Bitcoin inventory began to gradually decline.
Therefore, MRI actually reflects to a certain extent that there are strong quotations in the market that make miners willing to sell their bitcoins.
When the bid is reduced, the MRI will also decrease, and the inventory of uncolored bitcoin will increase. In fact, MRI reflects the demand for Bitcoin, and high MRI reflects the strong market demand to a certain extent. We believe that miners are smart participants. In an equilibrium market, they will consume the BTC inventory when the market is strong.
In summary, mining as a core component of the Bitcoin industry has a greater impact on the early price of Bitcoin**. In the future, they will still be one of the most important players in the Bitcoin ecosystem. However, due to the continuous increase in the market value of Bitcoin, more external factors have an increasing influence on its price**. For example, the secondary market becomes more active. At the same time factors such as increased institutional interest in Bitcoin have laid the foundation for Bitcoin to become a mainstream asset.
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