We are half a week away from the Halving – can you feel it?

Today, let’s talk about miners, as they’re the primary one affected by the 50% reduction of BTC mined per block.

As we’ll constantly do throughout this piece, we first need to address price.

Many analysts suggest there is a price floor in Bitcoin created by the breakeven price of a Bitcoin Miners’ cost of production. This assertion is inaccurate.

In fact, selloffs in Bitcoin tend to accelerate as price gets closer to the miners’ cost of production. This is because there is a consistent sell pressure on the price of Bitcoin that stems from miners.

Price support is actually established by miner capitulation and a net reduction in hash power on the network, i.e., favorable difficulty adjustments.

This is why understanding game theory as it applies to the miners is critical to understanding how price is both affected by and affects mining rates.

It’s no surprise that a miner’s cost to produce Bitcoin is derived by their electricity rate — 95% of operating expense for a miner is electricity consumption. A miner will need Bitcoin to be at a certain price so the Bitcoin revenue they earn is greater than their electricity expenses. It’s should also be no surprise that miners with the lowest electricity rates have a significant comparative advantage.

Before we go on, let’s better understand miners by understanding the difference between the Three Primary Types of Bitcoin Market Participants:

1. 1. Investment Funds – Hedge funds, venture capital funds, family offices, and other institutional investors. They deploy almost entirely “long-only” strategies and rarely short. They typically have a long-term bullish bias, but have the ability to exit their positions at any moment and walk away if conviction is tested. 
   2. Hodlers – Long-term accumulators seeking to maximize their Bitcoin Holdings. Hodlers have a long-term bullish bias and are less sensitive to price volatility than the Investment Funds. However, like Investment Funds, Hodlers can exit their entire position at any moment and walk away.
   3. Miners – The backbone of the Bitcoin Network. Miners have more conviction in Bitcoin than Investment Funds and Hodlers. They have long time horizons. They invest in assets with long-term life cycles that cannot be repurposed nor quickly liquidated at fair market value. ASIC Mining Rigs have 3+ year life cycles and can only be used to mine Sha-256 Protocols (almost entirely Bitcoin). Bitcoin Mining Facilities have 5+ year life cycles and are typically restructured warehouses, specially designed for cooling mining rigs. On average, it will take a miner 18 months to breakeven after deploying capital to mining rigs, facility buildout, and electricity expenses. Miners are the main driving force of sell pressure on the Bitcoin Network. They receive all of the newly issued Bitcoin and they must sell Bitcoin in order to fund CapEx and OpEx for their mining operation.

Hopefully, you’re able to see that miners are both in the privileged position of creating and distributing new BTC, but also in a severely disadvantaged position regarding the price of BTC versus the other two market participant types.

Let’s dig deeper on that point.

Understanding Real Operational Results vs. On Paper Operational Results

Many believe miners can simply shut off when they reach breakeven and will never operate at a loss. This is a misconception that is grossly misunderstood. Contractual obligations and failed treasury management frequently lead miners to operate at a loss. This forces miners to sell more Bitcoin than they mined; depleting Bitcoin Treasury and bringing additional sell pressure to the market. Here’s why miners have to run rigid operations:

1. 1. Miners have negotiated contracts with the utilities to achieve lower electricity rates but those rates are contingent on minimum electricity usage thresholds. Therefore, some miners can find themselves mining at a loss for a given period as they must continue mining to meet their minimum usage requirement; otherwise, they will lose their long-term rate. They cannot simply shut off for a week or month (when unprofitable) and wait for Bitcoin to rebound.
   2. Many miners send their mining rigs to colocation facilities. These colocation contracts lock in a miner for 1 to 2-years at a fixed, monthly fee per mining rig (determined by an electricity rate). If a miner defaults on these monthly payments, the colocation facility can confiscate the mining rigs. As a result, many miners will mine at a loss for several months to avoid default and risk losing their expensive mining rigs
   3. Miners turn into speculators. Miners are humans and therefore are not immune to human psychology. Many miners attempt to implement guidelines for the timing and quantity of Bitcoins to be sold. Many miners may sell all their Bitcoin upon receipt, weekly, monthly, or may just sell enough to cover electricity expenses. Unfortunately, when Bitcoin rallies miners tend to turn into speculators with the hope of catching a rally. In September of 2019, some miners deviated from their scheduled liquidations and elected to hold mined Bitcoin during July and August – thinking Bitcoin would continue running. Bitcoin topped late June and those miners had to sell their coins later in September and October at much lower prices. Such scenarios accelerate sell-offs in Bitcoin as additional sell pressure from liquidating Bitcoin Treasury is created beyond just newly mined Bitcoin. 

To illustrate the position of miners and how they react to price, let’s look at an example:

When Bitcoin was at $10,000, only 39.12% of the total monthly Bitcoin mined needed to be sold to cover electricity expenses. But, once Bitcoin dropped to $7,500, profit margins for all miners decreased, and caused miners running the Bitmain S9 ASIC to operate at a loss unless they had extremely cheap electricity costs (<$0.05 kWh). As a result, when BTC dropped from $10K to $7.5k, 53.18% of the total monthly Bitcoin mined needed to be sold to cover electricity expenses.

So, this is all very interesting I’m sure — but what happens after the halving?

Well, let’s first understand the state of mining rigs.

How Next Generation Mining Rigs Level the Playing Field

There has been a dynamic shift in mining over the past 12 months due to the release of Next Generation Mining Rigs. Bitmain’s S17 Pro 50T consumes 50% more energy but produces 300% more hash power than the Bitmain S9 13.5T.

Under identical circumstances, just ONE S17 has the equivalent hash power of four S9 13.5T mining rigs. The miners with the cheapest electricity once represented a greater proportion of the network hash rate but they have much less incentive to upgrade to Next Generation Mining Rigs due to their low electricity rate.

The old generation, S9 13.5T, uses 16nm Chips, while the S17 Pro 50T uses 7nm Chips. The innovation in the chips makes electricity less relevant as less watts are consumed per terahash.

Here’s the important part:

1. 1. Next Generation Mining Rigs reduce the financial impact of higher electricity rates.
   2. Conversely, low electricity rates reduce the impact of the comparative disadvantage from inefficient, Old Generation Mining Rigs.

Effectively, even as BTC rises in price, older rigs and less efficient miners with more expensive electricity are pushed out as it becomes unfavorable to mine.

It goes without saying that mining is about survivability and being more competitive than your peers. As future hash derived from Next Generation Mining Rigs nears 100% of miners with more expensive electricity, those miners with the cheapest electricity will then be forced to upgrade to stay competitive. The Halving will likely be the trigger for this event.

Satoshi’s Ingenious Network Stabilizing Mechanism: Understanding Difficulty’s Gravitational Pull on Miners’ Profit Margin

What should be apparent is how the Bitcoin network is really a grand balancing act, especially when we look at miners and price.

But again, how the Halving translates to that balancing act — and ultimately the price — is what we really care about, right?

From the miner perspective, here are the three forces to I’d pay attention to following the Halving:

Improvement in Supply Side Economics – Many market participants speculate on the future of Bitcoin. What is certain is that come Mid-May, 50% of the potential sell pressure on Bitcoin will be removed as the newly issued mining rewards are halved. 50% less supply issuance will reduce the modest, but ongoing downward shift in quantity of Bitcoin supply. This is a positive catalyst for Bitcoin Price.

Improvement in Demand Side Economics – An economist can say Bitcoin is worth nothing as it is presently too volatile to be an effective store of value and too slow to be an effective payment platform. A Bitcoin Maximalist can say Bitcoin is Digital Gold because it has the property of scarcity. At the end of the day, the Market determines Bitcoin’s price.

This is a market and markets are driven by Human Psychology. The Human Psychology of the Bitcoin Market Participants, prior to Halving, is to lean bullish – especially given the macro situation. This creates positive sentiment on the demand side of Bitcoin.

Opportunities Capitalized By Debt – After the Bitcoin Network experiences significant or sustained favorable difficulty adjustments, the likelihood of a bottom in Bitcoin Price is enhanced. This is because newly mined Bitcoin is now being distributed to and accumulated by the most efficient miners with healthy balance sheets – allowing the survivors to accumulate copious amounts of Bitcoin.

Here’s why that’s important: There’s a new lever of stimulus developing. Through Centralized and Decentralized Lending Platforms, miners are able to access debt by collateralizing their mined Bitcoin in exchange for cash or stable coins. Now miners can hold their Bitcoin rather than selling it, yet still meet the obligations of electricity expenses, contracts, procurement of more mining rigs, or further infrastructure buildout.

This dynamic reduces sell pressure from the network, which I believe will be a significant catalyst towards Bitcoin price appreciation.

Combining these three forces, we can expect the creation a powerful multiplier effect as the supply side and demand side economics for Bitcoin (and its price) are radically improved. This is what makes Halving so bullish for the price of Bitcoin.

Miner Capitulation Accelerates Bottoms

Remember how we earlier we discussed that, at $10k BTC prior to halving, miners must sell a minimum of 39.12% of the Bitcoin mined ($211,225,815 equivalence) each month just to cover electricity expenses. This then means that new cash deployed by Investment Funds and Hodlers must amount to $211,225,815 per month in order to match fiat outflows generated by miners funding their operations. The miner sell pressure is consistent, while new capital raised by Investment Funds and Hodlers is sentiment-driven and varies based on stages in the market cycle.

For the immediate term, post-halving, there will be far less sell pressure on the network even with BTC at $10k. After the cleansing, there will be $148M less in monthly sell pressure due to operational expenses.

This is an excellent example of the gravitational pull of Difficulty, except we witness margin compression due to unfavorable difficulty adjustments from miners joining the network. Difficulty stabilizes the mining network and provides just enough incentive to maintain Bitcoin’s security layer.

Let’s look at this another way: how many miner will have to shut down after the Halving?

Again, we can start by looking at the profit vs. expense chart of BTC at $10K prior to the Halving:

Next, we can see how many miners, based on their electricity costs and their mining rig type, will be forced to shut down their mining after the Halving even with Bitcoin at a very healthy $10k:

It’s telling that even miners with S17 Next Generation Mining Rigs will become unprofitable if their electricity rates are too high.

Of course, the network will find a new equilibrium that would allow the less efficient miners to turn back on, but it should be apparent by now how the Bitcoin network evolves and adapts over time.

The Halving is just another day for a network that seeks balance above all. 

Over time, margins remain just plentiful enough for committed, efficient miners to remain profitable despite price fluctuations in Bitcoin. Ultimately, Difficulty will wipe out those operating inefficiently, but when the price of Bitcoin appreciates significantly, in a short timeframe, even inefficient miners can enjoy healthy margins.

Many fear Halving, but if you understand the psychology of the miner and how game theory will drive behavior, Pre and Post Halving, the efficient miners should welcome it. Miners with the most efficient mining rigs will feel pain but will survive. Bitcoin naturally has a sell pressure from miners that chips away at Bitcoin’s price.

Summed up: Post-Halving there is simply less fiat required to counterbalance the miner sell pressure. As a result, Investment Funds and Hodlers will be more capable of stabilizing the downward pressure by injecting new fiat into the system to achieve long-term price appreciation, i.e., less hash rate, higher price.

Tomorrow we’ll wrap things up on the Halving and look forward to the big event next Monday!