Economics of Bitcoin (2): Bitcoin mining: Chicken game and red ocean

Writer: James K Lee

New bitcoin creation is completely inelastic. Even if a miner installs as many mining rigs as possible, if the other miners install as many mining rigs, then the total bitcoin return will not increase at all. That is because total rewards to the miners are always capped at block reward plus transaction fees. Now, after the dusts have settled on bitcoin craze, the rules on the bitcoin mining have changed. The miners will have to play by the game theory.

With the creation of ASIC mining equipment, big corporate miners emerged with thousands of mining rigs, capable of handling thousands of kilowatts of electricity. With the big corporate miners, mining profitability has become the core factor in mining. Miners now have to consider depreciation on mining equipments, repair and maintenance, and electricity cost on their income statement for profits. Since bitcoin crashed from USD 20,000 to 6,000, many of the small miners with obsolete equipments and lacking economies of scale cannot even pay the electricity bill with mined bitcoins.

The largest determinant of bitcoin mining profitability is the price of electricity. Electricity makes up most of the variable cost, therefore many miners move to places with cheap electricity. If the bitcoin price movement stagnates, only large-scale miners with access to cheap electricity may survive.

Other than saving on electricity, the most surefire way of increasing mining productivity is to improve ASIC chips. ASIC chips, like any other semiconductors, are improving in energy efficiency constantly. While the first bitcoin mining ASIC chip had 1.3 GH per Joule, now can yield 22.2GH per joule, more than tenfold increase in energy efficiency. At the same time, these new equipments are quickly making old equipments obsolete.

The graph below visualizes the formula for mining efficiency. Most widely used bitcoin mining equipment, Bitmain Antminer S9, can be plotted on the graph. Bitcoin price of USD 6,400 and 10 cents per killowhatthour means 9 dollars of operating loss for Antminer S9. This does not include equipment depreciation.

However, newer equipment Ebang Ebit E11, given the same condition has operating return of 59 dollars per month. Given how fast the ASIC equipments became obsolete, one can speculate that the productive life of this equipment shall not be long. -not very profitable for miners.

The graph below clearly demonstrates the profitability problem. If the next halving of bitcoin block reward will cause a radical shift in profitability curve. Then the many existing mining equipments will not even mine enough bitcoin to pay for electricity bills. Unless miners collude to reduce competition, mining will not be profitable. If the bitcoin price does not exponentially increase over the many halving periods ahead, then the miners will have to play the chicken game.

As said on the previous article, transaction fee hikes will not replace block reward for miners. Transaction fee hikes will result in adverse effect for bitcoin adoption.

Thus, if the bitcoin price does not increase exponentially over series of halving events, the ecosystem will fail. (continued)


This report originates from and solely prepared by “Fair Square Lab”, and “Skytale investment”

The views and opinions expressed in this report may differ from the company’s opinion.