How to invest in Bitcoin mining?

Thinking of investing in Bitcoin mining? This article will outline some things you need to know about this industry.

We categorize all assets that produce hashpower in exchange for cryptocurrency, and synthetic contracts/financial instruments that mimic mining returns as part of the hashpower asset class.

The crypto mining industry attracts the attention of traditional and venture capital investors. With the advent of synthetic assets and hashrate-based financial instruments, there are more options for investing in mining. This indicates the maturity of the sector, but investors still lack the knowledge and experience to build the right investment strategy.

What options do those wishing to invest in mining have besides purchasing and connecting equipment to the network? Let’s look at them in more detail.

Equipment Markets

Mining is significantly affected by such factors as the quality characteristics of the equipment, the location of the mining farm and the conditions of power supply. The production of ASIC-miners includes many stages, including the development of chips, production itself, supply chain and maintenance.

Manufacturers usually plan to release new equipment by the rainy season in Sichuan Province, China, in May to maximize the demand from the miners. Most of the new products are sold out immediately. A small percentage goes to retail. Most devices are delivered to large miners and pre-order distributors. The new generation of ASICs are usually available about six months after the announcement.

Purchasing new devices from manufacturers is similar to buying oil contracts before the 1980s. The seller under the contract agreed to deliver the agreed quantity of oil as scheduled, but the price was unilaterally determined by the oil company.

After 2018, the producers of miners became more cautious in the management of product reserves. They only assemble the devices after the orders have been confirmed and aggregated. Buyers usually expect delivery within 2–3 months.

Many are forced to buy new equipment with premium from distributors. The price may vary greatly depending on the location of the distributor and product availability.

There is a fairly large secondary market for mining equipment. Purchasing it requires considerable experience. Deals are often done without an intermediary, and sellers understand the quality of the devices better than buyers. As a rule, used ASIC-miners have no warranty and often do not give the declared performance characteristics. In the secondary market, it is even more important to select reliable distributors and sign contracts that provide compensation in the event of late delivery or poor equipment quality.

It is well known that the market for mining equipment is illiquid. Some of the devices are easier to buy on the secondary market, as they have been manufactured longer and in larger quantities.

Mining equipment is a commodity. Machines with equal efficiency may have the same price from different manufacturers. But once they enter the secondary market, everything depends on supply and demand. That is why, despite the fact that MicroBT and Canaan have suppressed Bitmain in the past two years, the latter still dominates the secondary market.

Valuation of an ASIC miner

The price of mining devices is influenced by many factors, but most of all it depends on the profitability of the mining. Today, the most used estimate of the cost of machines, especially in China, is the number of days to break-even. This figure is easily calculated and intuitively understandable.

In detail:

• D — static days to break-even;
• C — upfront capital costs;
• P — current Bitcoin price;
• S — hashrate produced by purchased equipment;
• H — network hashrate;
• m — block reward (currently it is equal to 6.25 BTC);
• n — the current average transaction fee per block;
• k — efficiency (J/TH) of the equipment;
• r — the total electricity cost ($/kWh).

However, it is a static metric that cannot fix all the components of the device cost. Its two main components are income and price.

Before investing in mining, it is necessary to understand the structure of your costs and fix the unit costs for the entire life of the machines. The income is determined by the Bitcoin price, the network hashrate and the amount of reward for a block.

Synthetic hashrate

In addition to the complexity of financial evaluation, the purchase and operation of mining devices involves many operational risks. For retail customers, the process can be complex. A simpler way to invest in cryptocurrency mining is to use synthetic hashrate-based assets. Some of them are contracts for cloud mining. This is a primitive form of financial derivative that separates hashrate from the physical location of equipment.

Over the past years, countless projects in the field of cloud mining have appeared and disappeared invisibly. The dilemma of such proposals is that they are clearly aimed at retail investors, as large players prefer to work with equipment. But the evaluation of such contracts requires knowledge about the mining industry and experience in working with financial derivatives. This is the main reason why, despite the fact that the concept of cloud mining is theoretically the next natural step in the development of capital markets in the industry, most such projects are considered fraud.

Being immature and still a relatively small sphere, cloud mining suffers from a complete lack of market standards. Using data from the aggregator HoneyLemon Market, you can see that on different platforms there are completely different contract terms and prices:

By mid-July, most contracts were unprofitable. Due to the additional premium to the cost of hashrate generation, specific market conditions are required for cloud mining to be profitable. As a rule, after a long period of decline, the price trend turns into a rally (for example, April-May 2019). Then the demand for hashrate increases. Acquisition and installation of ASIC miners takes time, and purchasing contracts for cloud mining is a faster way to invest in mining.

Another hashrate-based synthetic asset is machine tokens. These are liquid tokens, which virtually represent a part of a mining device. Traders speculate on the volatility of the secondary market of machines, not the coins produced by the equipment. The concept has existed for some time, but the volumes of this market do not show any noticeable growth. The main reason is that the multidimensional nature of revenues from mining prevents speculators from forming a consensus on pricing these assets.

Experienced traders can structure portfolios of synthetic assets based on hashrates. For example, buy a long contract for cloud mining at the same time as a long position on hashrate futures and add a short position on BTC futures. There are many creative ways to structure portfolios with financial instruments. For funds and trading firms that do not want to operate their equipment, this is another opportunity to invest in mining.

In practice, creating a balanced portfolio is a task with many nuances. The hedging ratios of each instrument must be constantly updated. Management requires careful monitoring and frequent adjustments. There are many limitations, such as low liquidity and opaque pricing. Traders need to understand exactly what risks they need to take into account.

For miners, forward hash contracts are a new way of hedging risks. Similar to renting computing capacity on cloud mining platforms, forward contracts allow the miner to sell a fixed amount of hashrate over a period of time at the original price. In contrast to cloud mining, they usually offer more flexibility. But without a generally accepted benchmark, the forward market does not have an established pricing system. Each transaction becomes a negotiation, and the agent who carries it out inevitably assumes certain risks.

The number of such transactions will grow as more and more exchanges and financial services are integrating with mining pools.

Many people are interested in the flow of BTC from the miners, but a large stock of liquidity at the exchanges allows offering creative and potentially risky types of transactions to win this race.

Miners can set parameters to always sell their hashrate to pay for operating expenses. The counterparty receives the flow of coins produced by this hashrate from the pool. For example, a miner can pre-sell 100 TH/s for 30 days at the beginning of the month. Based on the expected increase in complexity and fees, the pool offers to pay 0.02 BTC in advance. The miner blocks in the production of 100 TH/s for the entire month, transferring production risks to the pool.

Binance, OKex and Huobi are actively expanding their pools. It is expected that other exchanges will follow their example or become partners with existing pool operators. Some financial and trading companies are also moving in this direction: Babel Finance is going to launch Ethereum Mining Pool (ETH), Three Arrows Capital is going to offer structured products through Poolin.

Specialized companies for investing in hashrate

Since most traditional investors and venture capitalists do not have the skills and experience to manage equipment or structure complex hash-based asset portfolios, they often invest in mining through specialized companies (SPVs). SPV managers buy and operate machines for the capital of the investors, and in return they take a share of the proceeds.

The way SPV managers manage the cash flow is extremely important. Critical to financial success is the development of a sound sales strategy to counteract changes in market conditions.

There are four typical strategies that can be considered under assumed conditions:

• Start date: 01.07.2009.
• Valuation date: 01.07.2020.
• Initial investment: $1 million.
• Number of devices: 4840 S9 units purchased at $206.6 per unit. Depreciation is calculated on a straight-line basis over a period of 18 months.
• Total hash rate: 67,761 TH/s.
• Total power consumption: 6,389 kW.
• Total electricity price: $0.04 per kWh.

Options:

1. Daily sell all produced BTC.
2. Sell BTCs to cover operating costs and fix net profit in USD.
3. Sell BTC to cover operating costs and depreciation of equipment.
4. Sell BTC to cover all operating costs.

These strategies represent different risk preferences for BTC and USD positions. The most profitable of them may not provide maximum return in another market environment. Depending on the manager’s objective (accumulation of BTC or return on investment in USD), the strategy may be adjusted in the right direction.

Mining companies with experienced traders can also sell rewards and buy back coins when the price falls below production cost, and use financial instruments (collateral lending, BTC futures, etc.) to protect against price risks.

There were many well-capitalized mining projects that failed due to mismanagement of trading positions. The infamous example is Gigawatt in 2018. According to court documents, the company’s assets were valued at less than $50 000 with liabilities of $10-$50 million at the time of bankruptcy.

Our cloud-based mining platform Hashmart.io offers you different investment options. You can buy a certain amount of hashrate at any moment to start receiving daily BTC reward based on your investment plan. Join us today!