Thursday, July 21, 2022

Mining News

In May I wrote Generally Accepted Accounting Principles, based on Paul Butler's The problem with bitcoin miners. Butler pointed out that mining company financials were based on depreciating their hardware in a straight line over five years, where in reality "The average time to become unprofitable sums up to less than 1.29 years". I summarized the problem:
In simple terms, this excess depreciation means that the company's real cost for creating income is much higher than they report, and thus their real profit as a continuing business is much less than they report, because they are not putting aside the money they will need to replace obsolete hardware.
This was written a couple of weeks after the Terra/Luna crash started on May 7th, triggering the current "crypto winter", too early to see the effect on miners. Now, as the contagion spreads and successive cryptocurrency companies file for bankruptcy, we are starting to see the knock-on effects. Below the fold, a collection of news about mining.

Lets start with the good news. Joanna Ossinger reports that JPMorgan Says Bitcoin Cost of Production May Be Down to $13,000:
Bitcoin’s cost of production has dropped from about $24,000 at the start of June to around $13,000 now, which may be seen as a negative for pricing, according to JPMorgan Chase & Co.

The drop in the production cost estimate is almost entirely due to a decline in electricity use as proxied by the Cambridge Bitcoin Electricity Consumption Index, strategists led by Nikolaos Panigirtzoglou wrote in a note Wednesday. They posit that the change is consistent with efforts by miners to protect profitability by deploying more efficient mining rigs, as opposed to a mass exodus by less efficient miners. They also say it could be seen as an obstacle to price gains.
Publicly traded miners have struggled along with digital assets themselves. Marathon Digital Holdings Inc. is down 76% year-to-date, Riot Blockchain Inc. has dropped 78% and Core Scientific has tumbled 86%.
The miners' valuations were based on the stratospheric margins they enjoyed as the progress of BTC "to the moon" starting in the fall of 2020 greatly outpaced the supply of new mining hardware, then fell as China cracked down in mid 2021, then recovered to peak on 7th November. The graph shows the rapid decline in miners' margins since then, culminating with the Terra/Luna collapse when mining briefly became unprofitable. The collapse of miners' valuations was clearly justified.

Miners need BTC to keep heading up. Note the period on the graph before it headed moon-wards when mining was barely profitable.The slight recovery in miners' margins may not last:
“While clearly helping miners’ profitability and potentially reducing pressures on miners to sell Bitcoin holdings to raise liquidity or for deleveraging, the decline in the production cost might be perceived as negative for the Bitcoin price outlook going forward,” the strategists wrote. “The production cost is perceived by some market participants as the lower bound of the Bitcoin’s price range in a bear market.”
On May 5th the Bitcoin hash rate was around 228M TH/s, and with the Terra/Luna collapse it has stopped its strong upward trend. It is now around 192M. If JP Morgan is correct that miners are "deploying more efficient mining rigs" then they can't be correct that an "exodus by less efficient miners" isn't happening. If more efficient mining rigs are flowing in to the market, then older less efficient rigs must be flowing out.

This is certainly what the team behind the Cambridge Bitcoin Energy Consumption Index believe. Their estimate of the total power usage of the Bitcoin blockchain has dropped 41% from 15.3GW before the Terra/Luna collapse to 9.1GW now, while the hash rate has dropped only 16%. So the average efficiency of the miners must have increased, which means that less efficient rigs have been turned off.

David Pan's Bitcoin Miner Woes Risk Getting Worse After Celsius Collapse confirms that this is what is happening:
The troubled crypto lender’s mining subsidiary also filed for protection from creditors late Wednesday. Celsius Mining said in the filing that it owns 80,850 rigs -- with 43,632 in operation -- and expects to run about 120,000 rigs and generate more than 10,000 coins by the end of this year.
It is likely that the 37,218 rigs Celsius has sitting idle are the older, less efficient and thus less profitable ones. I would expect that, in bankruptcy, Celsius will struggle to keep mining, let alone ramp up to 120K rigs. instead they will need to sell rigs to raise cash. But Pan reports:
The bankruptcy comes as the value of mining rigs plunges with Bitcoin prices in sharp decline. Some of the most popular machine models have fallen as much as 50% since the last bull run and miners are struggling to complete purchase orders they made several months ago.
What these reports don't mention is that flooding the market with older, less efficient rigs and thereby dropping their residual value means that they are depreciating even faster than the estimates from before the Terra/Luna crash, meaning that the problem Paul Butler identified in miners' financials is even worse than his description. He concluded:
Investors have been happy to provide capital to these companies, looking for anything in the public markets that provides some exposure to bitcoin, without paying much attention to what the companies are doing.

I don’t think it ends well.
So far, he is a prophet. These companies, which were essentially a bet that BTC would proceed "to the moon", were struggling to do anything but lavishly reward their executives when BTC was around $30K, but it is now around $20K. Not to mention that most of the rigs are in Texas and, as David Pan reports:
Nearly all industrial scale Bitcoin miners in Texas have shut off their machines as the companies brace for a heat wave that is expected to push the state’s power grid near its breaking point.
Not merely are their rigs depreciating far faster than before, but they aren't generating any income either. It may be summer, but regulatory winter is coming. Dani Anguiano reports in Energy use from US cryptomining firms is contributing to rising utility bills that:
The largest US cryptomining companies have the capacity to use as much electricity as nearly every home in Houston, Texas; energy use that is contributing to rising utility bills, according to an investigation by Democratic lawmakers.
The lawmakers solicited information from seven of the largest US cryptomining companies, including Stronghold, Greenidge, Bit Digital, Bitfury, Riot, BitDeer and Marathon, about their energy sources and consumption and the climate impacts of their operations. The data revealed that the industry is using a substantial amount of electricity, ramping up production and creating significant carbon emissions at a time when the US needs to drastically reduce emissions to combat the climate crisis.


David. said...

Amy Castor and David Gerard's Bitcoin mining in the crypto crash — the mining companies’ creative accounting is a comprehensive overview of the economics of mining in the "crypto winter":

"Bitcoin mining is a highly lucrative business as long as the price of bitcoin keeps going up — and as long as investors believe it will keep going up.

When the price crashes — and the price of bitcoin has halved since the start of the year — crypto miners face margin calls, they have to dump their bitcoins, and reality comes knocking."

David. said...

Bitcoin Miner Made Millions in Credits by Shutting Rigs During Texas Heat by David Pan shows how public-spirited the Bitcoin miners of Texas are:

"Riot Blockchain Inc. earned about $9.5 million in credits last month from shutting down its Bitcoin mining rigs at a Texas facility while the region weathered a historic heat wave.

The amount will be credited against the company’s power usage. The value of the credit is equal to around 439 Bitcoin. Riot also mined 318 coins during the month, according to the company’s monthly production and operations update.
While the power crunch sent electricity prices soaring and made Bitcoin mining operations unprofitable, some large-scale miners such as Riot were able to sell electricity purchased earlier at a lower price back to the grid with a premium."

Not merely were Texas consumers' "electricity prices soaring" they were also having to pay Bitcoin miners to not mine Bitcoin - a win-win situation!

But wait, there's more. The next day, David Pan reported that Bitcoin Gains Spur Miners to Turn On Rigs in Midst of Heat Wave:

"A rise in the price of Bitcoin has prompted some miners of the cryptocurrency to switch on more rigs over the last two weeks even with much of the US still caught in a heat wave that boosted demand for electricity.
While many Bitcoin miners shuttered operations as electricity prices soared amid the heat wave, the rebound in Bitcoin prices over the period boosted mining revenue and prompted more miners to turn back on their machines."

David. said...

Evidence of the depth of miner's financial problems comes from David Pan in Crypto Lender Tied to Chinese Rig Giant Throws Miners a Lifeline:

"Chinese Bitcoin mining rig giant Bitmain Technologies Ltd. has been selling machines to miners for about nine years. Now it’s helping to keep them afloat during the cryptocurrency market downturn through its ties with industry financier Antalpha.

Bitmain and its Antpool mining spinoff are working with Singapore-based Antalpha to offer low-interest loans to miners to help them reduce borrowing costs and repay nearly $4 billion in loans backed by equipment which have fallen in value along with the price of Bitcoin since it peaked in November.
To alleviate some of the pressure, Antalpha said some of its loans would not require margin calls and it would let miners delay payments to Bitmain for mining machines by allowing miners to use purchased rigs as collateral."

David. said...

US miner Marathon Digital Assets published their 10-Q for the 3 and 6 months to June 30, and it is dire. In the last quarter their revenues were $24.9M. Their cost to generate these revenues was $16.7M plus $24.7M in depreciation and amortization, for a total of $41.4M. So just on raw cost they lost $16.5M. Then they had to pay "general and administrative" expenses of $12.6M, and tax of $9.9M making the loss on running a continuing business $39M.

But there's more. Their losses on HODL-ing cryptocurrency totaled $207.3M, partially offset by selling $58.2M-worth of mining rigs. The bottom line is that they lost $191.6M in the quarter.

Results like these from miners, and the fact that the hash rate has recently a significant drop, explains why this paragraph from David Pan's article is important:

"To alleviate some of the pressure, Antalpha said some of its loans would not require margin calls and it would let miners delay payments to Bitmain for mining machines by allowing miners to use purchased rigs as collateral."

Bitmain is making loans that can't be margin-called and are secured against collateral that depreciates to zero over about 15 months! Bitmain is clearly scared; these loans will default unless Bitcoin heads moon-wards in a big way so miners start making money again.

David. said...

D. Andrew Owens testified to the Arkansas Public Service Commission and highlighted not just the environmental problems of Proof-of-Work mining, but also the credit risk they pose to the utilities that supply them with power:

"First, unlike data centers, which similarly involve significant electrical load, Crypto miners do not have to invest significant capital in state-of-the-art facilities because they are able to place their equipment in shipping container “pods”, which allow them to locate almost anywhere, typically close to an electric utility’s substation. These portable pods allow Crypto miners to relocate easily and quickly if economic conditions change, and as described below they do so frequently and without notice. As an emerging industry, Crypto miners often do not have credit history that demonstrates their financial viability for the types of significant infrastructure investments necessary to serve them."