With the price of bitcoin tending to increase, the gap between its market price and production costs is growing wider. Just as there are various factors that influence exchange rates, production costs can vary wildly depending on location, energy, hardware and software costs. Mining is mostly about efficiency, while price depends on supply and demand.
Braiins, which operates the world’s first mining mine, SlushPool, and produces software specifically to help miners boost their efficiency, contributed this article to help understand the inner workings of the mining business. Read on to find the underlying value of Bitcoin at source, how it translates into profit for miners, and the competitive landscape, now and in the future.
Like any asset, the cost of buying one bitcoin at a premium comes on top of the cost of producing one bitcoin. Mining technology is specialized and expensive, which means it’s risky to set up as the asset’s price is unstable. Electricity costs also vary depending on location, making the business very competitive, with profit margins much tighter for some than others. At the time of writing, miners are coming off a short period of increasing profitability as the dominant, energy-powered Chinese competitors move their engines between regions due to the end of the rainy season. This year, the migration caused a 16% mining difficulty, one of the largest reductions ever seen, demonstrating the influence these massive mining operations can have; what does this concentration of hashrate mean to the rest?
Funds such as the Grayscale Bitcoin Trust, which reportedly went on track to hold 500,000 bitcoin by the end of the year, have been buying bitcoin at a rate greater than the speed at which they are mined. So how does the emergence of these big buyers, including publicly listed companies like Square and MicroStrategy, affect the mining industry?
From the point of view of zooming out, the fact that more and more private organizations and companies are entering Bitcoin seems to have a positive impact on the price of BTC, which in turn has a positive impact on miners. At the same time, the role of miners in the market decreases every 4 years because of the halves, as issuing new coins accounts for a smaller proportion of the liquid supply. This is good, because it means that miners are less likely to cut BTC’s price when they sell to cover their costs and less likely to stop price rises when institutional and retail demand grows.
When we redirect focus to the big companies involved in the mining industry itself, competition is fierce, making the question even more significant. Chinese miners have had major competitive advantages since the ASIC era began in 2014, gaining first access to new hardware due to manufacturers located there. Now that such large companies and investors have such strong interest in Bitcoin, miners in Europe and America are gaining better access to capital and forming closer relationships with manufacturers, which in turn helps them increase their operations more effective than was possible years ago.
Ultimately, the emergence of institutional funding helps drive hashrate redistribution in the West. So, from a mining decentralization perspective, it’s very good. However, it also brings some other potential disadvantages, such as introducing KYC procedures attached to hashrate, and censoring transactions from blacklisted wallets, for miners to comply with government regulations. While this is inevitable to some extent, Braiins is already working to preserve the unauthorized nature of Bitcoin’s censorship and censorship resistance with the mining protocol introduced last year, Stratum V2.
When large mining farms go offline, the total hashrate plumbers are global. To account for this, the Bitcoin network has a mechanism in place that reduces the average hashrate needed to dig a block, otherwise known as difficulty, to ensure that blocks continue to be produced at the same greater rate or less. Any reduction in network difficulty results in a proportional increase in mining revenue for the remaining miners. Typically, difficulty only decreases after the price of Bitcoin drops significantly, forcing inefficient miners to close ASICs (specialized mining computers) that are no longer profitable.
This time, that wasn’t the case because the price of Bitcoin had been rising, so miners were able to mine more BTC after the difficulty reduction and, as a bonus, that BTC was also worth much more in currency fiat. For miners who have been struggling to survive with thin margins since halving in May 2020, this is a huge relief.
Since the bear market began in 2018 and especially after halving, the difficulty has been increasing much faster than the price. As a result, month-over-month Bitcoin miner profitability has looked something like this.
Now that the price has begun to rise rapidly, the rate of hashrate coming online and the difficulty of increasing cannot keep up. So instead of profit and profits continuing to decline over time, they instead increase, making the outlook much stronger.
This particularly large piece of profitability for miners in November is due to the close of the rainy season in Sichuan, China. Miners operating there to benefit from cheap hydropower had to relocate their engines for winter and spring. Unfortunately for other miners, that means most of the hashrate will be coming back online in the near future, so the lower difficulty will be short-lived.
However, the price rise will continue to boost miners’ profits in the following months even after all of Sichuan’s hashrate comes back online elsewhere, as long as the price is not falling back to October levels.
As mentioned above, the concentration of hashrate in China is due in large part to the presence of leading hardware manufacturers such as Bitmain and MicroBT. This means that Chinese miners have first access to the machinery, lower shipping costs, no international taxes or tariffs, and better connections to support ASIC repair teams and services. This has caused concerns in the community about centralization, especially as it takes place in a country that sees heavy government involvement across all industries.
At Braiins, we have sought to reduce mining centralization concerns in two ways. It all started in 2017–2018, when Bitmain had the hidden AsicBoost and the Antbleed fiascos. (To sum it up for those who don’t know, hidden AsicBoost was able to increase hidden performance in the Antminer S9 which enabled mining to be around 13% more efficient. Antbleed was a hidden backdoor in the Bitmain enabled firmware Bitmain to remote control and close ASICs.)
At the time, MicroBT was not such a strong player and Bitmain dominated the market, so these events were very worrying. The first thing Braiins did in response was to develop Braiins OS, launching it in 2018 as the first open source firmware for SHA-256 ASICs with open AsicBoost enabled. Essentially, this meant that anyone could get the 13% performance boost to their ASICs for free, while also being able to see our full source code and verify that there were no hidden trunk lines.
Earlier in 2020, Braiins took another important step forward by developing an enterprise version called Braiins OS +, which includes automation to further boost performance, making mining more competitive and transparent, offsetting the advantage of the supply chain that has benefited Chinese miners for years. To illustrate this, you can see how the cost of mining a single Bitcoin changes, even when using the same ASIC (Antminer S9), depending on the firmware it runs.
Since Braiins OS + can help miners boost profitability without investing in the newest and most expensive hardware, it has been significantly adopted and continues to grow rapidly. With regard to centralization of mining concerns, this is important for two reasons:
- Fewer machines run Bitmain firmware, which has a history of hidden features and backdoors.
- Ultimately, a new Stratum V2 mining protocol built into the OS will give miners the ability to choose which transactions are included in blocks, known as Job Negotiation, instead of mines choice, bringing more power to individual miners.
For the majority of non-mining Bitcoiners who are concerned about devolution, this second point is most important. Some changes to Bitcoin Core will be needed for the Job Negotiation aspect of the protocol to be usable, but thousands of miners are already using Braiins OS + with Stratum V2, and they will all be able to help increase Bitcoin decentralization with Job Negotiation once Bitcoin Core updates have been done.
Overall, the mining industry is trending in a positive direction, with North America emerging as the new frontier for enterprise mining operations. China’s share of physical hashrate is expected to decline in the coming years, and competition in hardware manufacturing is also a positive development for the mining industry. The one area that doesn’t improve much is centralization of pits, as all the major mining pits except Slush Pool are located in China.
With the ever-increasing demand for BTC and the programmatic decline in supply issuance, the boom bust cycles typical of all nascent technologies are playing out just as expected for Bitcoin. Miners who think in 4-5 year timeframes and who managed to survive the bear market are set to get great margins in the months ahead. Hopefully, the adoption of Stratum V2 will help get the balance off of Chinese dominance, ensuring a more transparent, decentralized future for the mining industry.