Aug 12, 2020 00:41 AM | Ethan Vera

Bitcoin mining economics can be distilled down to three inputs: revenue, operating expense & capital expenditure. 


These three pillars can be used together to better understand a miner’s profitability using metrics such as IRR, NPV, ROI and payback period.


While the days of printing hundreds of dollars with a single Bitmain S9 are gone, there are still outsized returns available for the top quartile of miners. By leveraging expertise in equipment procurement, operating with low-cost power, deploying sophisticated profit-switching algorithms and more, miners can generate solid risk-adjusted returns, even in an increasingly uncertain macro-environment. 


Increasing Revenue


Of the three inputs, many miners believe that mining revenue is the most predetermined. Miners produce hashrate, and the value of that hashrate is largely outside of their control — it is primarily based on the networks in which they mine. However, there are a few levers miners can pull to increase their revenue.


Miners make a decision on where to liquidate their hashrate. In most cases, the miner decides which coin they would like to mine and which pool to sell their hashrate to. Some platforms are more profitable than others. In addition, some coins are more profitable to mine than others. Miners can leverage smart-switching algorithms to increase their overall profitability. 


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At any given time, the profitability between coins varies based on continually-changing variables such as network difficulty, coin price, transaction fees, market depth, and other factors. 


For example, today Bitcoin may be more profitable to mine than BCH and BSV. But tomorrow BCH could be the most profitable. Below is an example of the profitability swings in the Equihash mining landscape over a 12 hour period. 


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Another lever to pull is to increase the overall hashrate of a mining operation. One way to do that is to install custom firmware that increases the hashrate of a mining rig. For example, BOS+ can increase an S9 rig to 17+ TH/s, a 20% increase from its standard level. However, this also comes with higher lower efficiency and the potential to damage the hardware. 


Forecasting Revenue


Forecasting revenue is the hardest part of estimating the profitability of a mining investment because it requires a lot of your own estimation and assumptions.


Currently, the value of hashrate is equal to around $0.10 per TH/s per day. As measured on Hashrate Index, this is the weighted-value at which mining pools are paying miners for hashrate. 


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As history has shown, the value of hashrate experiences a consistent decline over time. As more hashrate gets added to the network, the existing hashrate loses some value. Since January 2016, the value of hashrate has decreased at an average rate of -0.06% per day.


There is a general model miners can build to forecast the value of hashrate. The model relies on the assumption that ASICs operate when it is profitable for them to do so. You can also build in pain thresholds for factors such as maintaining power commitments, locked-in hosting contracts, or money laundering. 


The amount of hashrate that is on the network (and hence difficulty) depends on the value of hashrate. But the value of hashrate depends on the amount of hashrate. This is a circular calculation, commonly used in models to forecast debt repayment, and it can be built out in Excel.


From there, miners need to make assumptions about new hashrate coming onto the market, the amount of hashrate for every existing ASIC, the electricity and operating expense costs for miners broken down into what type of hardware they use, coin prices, transaction fees and more. 


Building a model with this general architecture will allow a miner or investor to forecast the value of their hashrate in the future. 


Operating Expense


Undoubtedly the most imperative part of a mining operation’s long term success is their electricity cost. ASICs consume an immense amount of power, making electricity the majority of a miner’s operating expense. The best operators can run their facilities with a Power Usage Effectiveness (PUE) of less than 1.05, meaning that almost all electricity used is for running the rigs themselves. 


Reducing their electricity expense by even 1 cent saves miners almost ~$90k/MW a year in power costs. 


Miners have flocked to low-cost regions. In most studies, the global average electricity price used by miners is between 3-4 cents a kWh. Some of the best operators in Sichuan, Kazakhstan, and Texas are getting sub-2-cent power. 


Beyond power, it is crucial that miners deploy robust ASIC Management Software, custom firmware, and proper cooling technologies to reduce their overhead and energy consumption. 


Miners with low operating costs are insulated from large fluctuations in mining revenue. They can also purchase older equipment for very cheap and still run it profitably. 


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Capital Expenditure 


The largest barrier to entry for anyone looking to get into the mining space is the capital expenditure required for both setting up a facility and purchasing machines. 


Miners looking to jump straight into mining can host with a number of facilities across the world. But that still leaves a crucial part: equipment procurement.


The primary and secondary markets for mining hardware are incredibly opaque. Manufacturers are constantly changing the prices, specs and timelines on their website. They also have internal battles that can make actual delivery uncertain. Secondary markets exist in chat groups such as Telegram and Wechat, with no clear market pricing. 


The best operators in the space have experience dealing with both manufacturers and ASIC resellers, giving them a good position to acquire machines for lost cost. The experience and relationships required for ASIC purchases are a barrier to entry for people not already in the industry. 


Miners need to think through when they are purchasing machines in the mining cycle. There are periods where machines are cheap and their payback periods quick. Hashrate Index has a tracker for machine prices which can be used by mining operators to determine when to purchase machines in the cycle.


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Profitability Calculations 


As with any investment, it is crucial to factor in the potential risks and rewards of mining before making a decision.


The internal rate of return (IRR) is a discount rate that makes the net present value of all cashflow from a particular investment equal to zero. It reflects the average annual return over the lifetime of an investment. IRR is a powerful tool for capital investment decisions. 


Most importantly, IRR factors in the time value of money (opportunity cost). There are many investment opportunities both inside mining and outside. Instead of mining you could buy Bitcoin, buy equity, or even sit in USD. Each investment has different risk profiles, and so will naturally have different return expectations. The riskier the investment, the higher the expected return needs to be. This is known as the required rate of return (RRR).


There is no single RRR for all miners. Calculating RRR must be done at the individual level depending on a miner’s unique position. Experienced operators that have a low cost of power, good ASIC procurement, and access to relatively cheap capital will have a lower RRR than a miner entering the space for the first time. 


In conclusion, there are still outsized returns to be made in mining if operations are set up correctly and executed well. However, experienced operators will be at an advantage in an increasingly tricky environment to navigate.


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