Clouds Over The Mines

In early December 2022 when I wrote skeptically about the economics of Bitcoin mining in Foolish Lenders the Bitcoin "price" was around $17K. It has now climbed 153% to around $43K and, below the fold, I am still posting skeptically about the economics of mining.

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The first clue that the future for miners is clouded comes in Bitcoin Outlook Clouded by Falling Miner Reserves Ahead of April’s Halving by Sidhartha Shukla and David Pan:

Bitcoin miners are getting a jump on an anticipated decline in revenue from the so-called halving in April, when the blockchain’s network protocol will reduce rewards for verifying transactions by half.

Miner reserves — unsold Bitcoin held in digital wallets associated with the companies — have dropped by 8,400 tokens since the start of 2024 to 1.8 million, a level last seen in June 2021, according to data compiled by CryptoQuant. Analysts said the decrease indicates miners are selling tokens.

The somewhat misleading graph of the miners HODL-ings actually shows only a 2% drop in the number of BTC from the peak in August 2022. But the "value" of those HODL-ings has risen 75% from $44.8B to $78.5B. One way of looking at it is that the mining industry started August 2022 with 1.865M BTC and, in the 18 months since mined 821,250 BTC for a total of 2,686,250 but they now have only 1.825M BTC so they must have sold 861,250, or about 5% more than they mined. Nevertheless:

“Miners have begun to sell more of their coins to bolster balance sheets and fund growth capex ahead of tougher times for margins when block rewards are halved in April,” said Matthew Sigel, head of digital-asset research at VanEck. “After the halving, scale will matter even more.”

Before the great EFT pump, it was generally believed that the frantic efforts to pump BTC over $30K suggested that the mining industry's break-even point was around $30K. On 6^th October BTC was $26K and the hash rate was around 412M TH/s. Lets assume that the industry was breaking even at BTC=$30K and a hash rate of 412MTH/s, so the industry's costs were covered by 45K BTC/month or $1.35B/month. Assuming the increase in efficiency is roughly cancelled by less efficient operators entering, the hash rate is now 527 TH/s and so costs are around $1.73B. But income is around $1.94B/month so margins are around 12%.

After the halvening, income is 22.5K BTC/month. At BTC=$43K, this is $968M/month or 56% of current costs. To maintain a 12% margin, costs need to be cut to $852M/month, or 49% of current costs. Alternatively, if costs stay the same, the Bitcoin "price" needs to increase to $86K in April.

The industry isn't going to halve its costs in the next three months, and even massive printing of unbacked Tether isn't going to double the BTC "price", so "tougher times for margins" are certainly among the clouds overhead.

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I am not the only skeptic. Short-seller J Capital Research investigated Hut 8, a large public miner, and on January 18^th published The Coming HUT Pump and Dump. As the chart shows, it was effective. The report featured a list of 22 different red flags, focused mainly on the recent merger between Hut 8 (HUT) and U.S. Bitcoin Corp. (USBTC) and asking:

Why then did HUT pay $745 mln to acquire this company and its planned payments?

This is a good question, given that:

One person highly familiar with USBTC told us, “without the merger, [USBTC] would have done a structured bankruptcy.”

It wasn't as if Hut 8 didn't have problems of its own:

Hut 8’s North Bay mining facility has been non-operational for an extended period of time, and problems at its Drumheller facility “have been causing miners to fail.”

And the result of the merger is a company that:

has an industry-low efficiency rate and, post halving, will produce Bitcoin at a loss of close to $20,000 per Bitcoin at current spot prices.

In other words, the merged company can barely make money now and cannot survive when the industry's income is halved in less than 3 months. This all looks like rats leaving the sinking ship with whatever they can carry. An impression reinforced by David Pan in Bitcoin Miner Hut 8 CEO Exits Three Weeks After Short-Seller Allegations :

Hut 8 Corp., one of the largest publicly traded Bitcoin mining companies, named Asher Genoot to succeed Jaime Leverton as chief executive officer, three weeks after a short-seller released a report critical of its recent merger.

The transition is effective immediately. Genoot served as the chief operating officer and the president of US Bitcoin Corp. Miami-based US Bitcoin, which has large-scale mining facilities across the US including Texas, completed its merger with then-Canadian miner Hut 8 in late 2023.

The leadership transition comes amid increasing competition among the miners, a Bitcoin code update set to drastically reduce mining revenue in two months as well as the Jan. 18 report from short-seller J Capital Research alleging the merged company was a “pump and dump” waiting to happen. Hut 8 has disputed the claim.

Genoot has allegedly:

abandoned several failed start-ups.

His co-founder was USBTC's CEO and is now HUT's CSO/director and:

is a 30-year-old used-car salesman from Vancouver whose history is littered with involvement in SEC-defined pump-and-dumps, sporting share-price declines of 83%,

The key inputs for profitable mining are low-cost power and state-of-the-art chips to use it as effficently as possible. Clouds are gathering over both of them.

As regards access to cheap electricity, utilities are increasingly reluctant to provide it. Take, for example, Crypto mining company loses bid to force BC Hydro to provide power by Darryl Greer of The Canadian Press:

A cryptocurrency firm has lost a bid to force BC Hydro to provide the vast amounts of power needed for its operations, upholding the provincial government's right to pause power connections for new crypto miners.

Conifex Timber Inc., a forestry firm that branched out into cryptocurrency mining, had gone to the B.C. Supreme Court to have the policy declared invalid.

But Justice Michael Tammen ruled Friday that the government's move in December 2022 to pause new connections for cryptocurrency mining for 18 months was "reasonable" and not "unduly discriminatory."

BC Hydro CEO Christopher O'Riley had told the court in an affidavit that the data centres proposed by Conifex would have consumed 2.5 million megawatt-hours of electricity each year.

In the US, David Pan's US Bitcoin Miners Use as Much Electricity as Everyone in Utah shows that regulators are starting to worry:

Bitcoin miners in the US are consuming the same amount of electricity as the entire state of Utah, among others, according to a new analysis by the US Energy Information Administration. And that’s considered the low end of the range of use.

Electricity usage from mining operations represents 0.6% to 2.3% of all the country’s demand in 2023, according to the report released Thursday. It is the first time EIA has shared an estimate. The mining activity has generated mounting concerns from policymakers and electric grid planners about straining the grid during periods of peak demand, energy costs and energy-related carbon dioxide emissions.

“This estimate of U.S. electricity demand supporting cryptocurrency mining would equal annual demand ranging from more than three million to more than six million homes,” the report said.

Globally, this increase in demand is part of a bigger picture that is concerning, as Eamon Farhat reports in Electricity Demand at Data Centers Seen Doubling in Three Years:

Global electricity demand from data centers, cryptocurrencies and artificial intelligence could more than double over the next three years, adding the equivalent of Germany’s entire power needs, the International Energy Agency forecasts in its latest report.

There are more than 8,000 data centers globally, with about 33% in the US, 16% in Europe and close to 10% in China, with more planned. In Ireland, where data centers are developing rapidly, the IEA expects the sector to consume 32% of the country’s total electricity by 2026 compared to 17% in 2022. Ireland currently has 82 centers; 14 are under construction and 40 more are approved.

Overall global electricity demand is expected to see a 3.4% increase until 2026, the report found. The increase, however, will be more than covered by renewables, such as wind, solar and hydro, and all-time high nuclear power.

The first step towards stricter regulation is information collection which, as Kristoffer Tigue reports in Large cryptocurrency miners in US now have to report energy use to government has started:

The Biden administration is now requiring some cryptocurrency producers to report their energy use following rising concerns that the growing industry could pose a threat to the nation’s electricity grids and exacerbate climate change.

The Energy Information Administration announced last week that it would start collecting energy use data from more than 130 “identified commercial cryptocurrency miners” operating in the US. The survey, which started this week, aims to get a sense of how the industry’s energy demand is evolving and where in the country cryptocurrency operations are growing fastest.

“As cryptocurrency mining has increased in the United States, concerns have grown about the energy-intensive nature of the business and its effects on the US electric power industry,” the EIA said in a new report, following the announcement. “Concerns expressed to EIA include strains to the electricity grid during periods of peak demand, the potential for higher electricity prices, as well as effects on energy-related carbon dioxide emissions.”

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Bitcoin is not nearly as decentralized as advocates claim. It appears a third of the industry is in Texas and thus subject to both US regulators and concerns about Chinese ownership. Turner Wright reports that Bitcoin hash rate drops by 34% amid freezing temperatures in Texas:

A sudden freeze in Texas may have contributed to a 34% drop in the Bitcoin hash rate, as some miners were forced to curtail operations amid demand on the state’s energy grid.

Beginning on Jan. 14, temperatures in many parts of Texas dropped below freezing for one of the first times since a massive ice storm in February 2023. According to data from YCharts, the total Bitcoin network hash rate fell from more than 629 exahashes per second (EH/s) on Jan. 11 to roughly 415 EH/s on Jan. 15 — a 34% drop. The analytics site reported the hash rate increased to more than 454 EH/s on Jan. 16 as temperatures in Austin briefly rose above freezing during the day.

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It isn't just that Texas has maybe a third of the industry, it is also that the US industry is growing much faster than anywhere else. Figures from Luxor Logistics show that in 2023 the US consumed nearly two-thirds of all new mining rigs. The figures come from Chinese Bitcoin Miners Find a New Crypto Haven in Ethiopia by David Pan and Fasika Tadesse:

Ethiopia has emerged as a rare opportunity for all firms that mine the original cryptocurrency, as climate change and power scarcity fuel a backlash against the $16 billion-a-year industry (at Bitcoin’s current price) elsewhere. But it holds special appeal for Chinese companies, which once dominated Bitcoin mining but have struggled to compete with local rivals in Texas, the current hub.

The haven isn't without its own clouds:

It is also a risky gamble, for the companies and Ethiopia alike. A succession of developing countries like Kazakhstan and Iran initially embraced Bitcoin mining, only to turn on the sector when its energy use threatened to fuel domestic discontent. China’s reign as the epicenter of Bitcoin mining came to an abrupt end in 2021, when the government banned it. Dozens of companies were forced to leave.

Ethiopian officials are wary of the controversy that accompanies Bitcoin mining, according to industry executives who spoke on condition of anonymity to avoid jeopardizing government relations. Even after new generation capacity came online, almost half the population live without access to electricity, making mining a delicate topic. At the same time, it represents a potentially lucrative source of foreign-exchange earnings.
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The reliance on abundant power is also a major vulnerability because it can put miners in competition for electricity with factories and households, exposing them to political backlash.

When Kazakzstan imposed fresh curbs and taxes on miners, “it basically killed the industry,” said Hashlabs co-founder Alen Makhmetov. Two years after the clampdown, his 10-megawatt facility there is still sitting idle.

And in an era when rising temperatures wreak havoc around the world, Bitcoin mining is increasingly seen as a contributor to global warming that doesn’t serve any productive purpose — even though miners have claimed they’re increasingly tapping clean energy. A study by United Nations University published in October estimated that two-thirds of the electricity used for Bitcoin mining in 2020 and 2021 was generated using fossil fuels.

Developing countries aren't the only ones where miners face "domestic discontent". Anxiety, Mood Swings and Sleepless Nights: Life Near a Bitcoin Mine by Gabriel J.X. Dance reports on an example in Arkansas:

The Arkansas Data Centers Act, popularly called the Right to Mine law, offers Bitcoin miners legal protections from communities that may not want them operating nearby. Passed just eight days after it was introduced, the law was written in part by the Satoshi Action Fund, a nonprofit advocacy group based in Mississippi whose co-founder worked in the Trump administration rolling back Obama-era climate policies.

The law ins't popular:

A furious backlash has some lawmakers considering a statewide ban.

The Satoshi Action Fund over-reached:

Despite efforts to build bipartisan support, the Satoshi fund has succeeded predominantly in red states. But in Arkansas, where the state legislature is dominated by Republicans, it is conservatives who have led calls to repeal the law, including Senator Bryan King, a poultry farmer whose district includes a property purchased by one of the companies tied to the Chinese government. He said it was not fair that the Bitcoin operators received special protections under the law, which shields them from “discriminatory industry specific regulations and taxes,” including noise ordinances and zoning restrictions.

At least the Ethiopian mines don't emit much CO2, they run on hydropower:

The opening of the GERD project increased Ethiopia’s installed generation capacity to 5.3 gigawatt, 92% of which comes from hydropower, a renewable energy source.

Once GERD is fully completed, Ethiopia’s generation capacity will double, according to Ethiopian Electric Power. It charges Bitcoin miners a fixed rate of 3.14 US cents per kilowatt hour for electricity drawn from substations, Marketing and Business Development Director Hiwot Eshetu said in an interview.

While that’s similar to the average in Texas, rates in the Lone Star State can swing wildly, Luxor’s Vera said, making profits there less predictable. In Ethiopia, the price will fall once miners connect directly to power plants, according to Hiwot.

But if the utility can make money selling power to the mines right by the dam they have little incentive to build out the grid than could get the power to the unserved half of the population.

As regards the longer-term issue of access to state-of-the-art chips, it is important to note that the best mining chips are sold by Bitmain, a Chinese company, but manufactured at TSMC in Taiwan. There are two major risks here. The first is that the US appears determined to prevent China importing leading-edge chips and the equipment to make them. China remains at least a generation and a half behind TSMC and Samsung, and reportedly has poor yields on its leading-edge process. These restrictions could well prevent Chinese mining companies acquiring leading-edge rigs, and might cause TSMC problems in fab-ing Bitmain products.

Second, there is the looming threat of a Chinese blockade or even invasion of Taiwan. Of course, difficulties for Bitcoin miners are hardly the major impact if these threats are made good. One might think that, even if supplies of new mining chips were cut off, existing rigs would continue working. In the short term they would, but there is a long history of rigs being obsolete after about 18 months. So they aren't designed or operated for longevity.