The Capital
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The Capital

A Bear Market is the Perfect Test for Cryptocurrency Miners

Part of the brilliance of Satoshi Nakamoto’s invention (Bitcoin) is that built into the incentive structure for Bitcoin mining is an adaptability that makes mining for Bitcoin more difficult the larger the number of miners there are and easier when there are less miners. And prior to the prolonged bear market in cryptocurrencies, there was never an opportunity to test under real-world conditions how effective this adaptability would be, until now. From London to Lahore, cryptocurrency miners of every stripe are shutting down their mining rigs, as profitability of the activity is tested with a Bitcoin price held stubbornly below US$4,000. By some estimates, it costs US$5,000 to break even on Bitcoin mining, including overheads and depreciation costs, but such estimates are suspect at best because as the mining algorithm gets easier, older equipment becomes feasible again and power costs differ widely across geographical regions. Insofar as developed world power rates are concerned, at least at these levels, Bitcoin mining is unprofitable.

“Somebody call the fire marshal! We’ve got a code blue violation here!”

Meanwhile, cryptocurrency equipment manufacturers who had planned on splashy IPOs have also held back their plans, with China’s Ebang, Canaan and Bitmain, all touting billion-dollar valuations now all hanging in the balance, while Nvidia and Advanced Micro Devices, manufacturers of high-end graphic processing units (GPUs) have seen their shares take a beating on the fall in cryptocurrency prices. GPUs are favored by individual cryptocurrency miners and hobbyists for their greater affordability and ready accessibility. Nvidia has also since announced that it will no longer be investing in developing purpose-built cryptocurrency mining cards.

The Bitcoin hash rate — a measure of how much power miners are using — has also dived over 40% since its peak last August, implying that over 1.5 million Bitcoin mining rigs have seen their lights and fans go out — according to research from Tom Lee’s Fundstrat, who remains a Bitcoin bull.

But Nakamoto’s incentive structure appears to be working.

Bitcoin miners are also typically the largest sellers of Bitcoin as well (because power is still paid for with cash) and if they stop selling when prices fall, the price could be cushioned, providing a natural price floor. But the assumption is speculative at best. For one, evidence of collusion among Bitcoin miners is difficult to prove and even if there is collusion, just as in OPEC (the oil cartel which seeks to maintain oil prices), enforcement is an entirely separate issue altogether. But thanks to the decentralized nature of Bitcoin mining, no one miner (at least for now) is able to tank the price of Bitcoin in order to exit the market. And there’s also plenty of incentives not to do so. For instance, if one Bitcoin miner, with ample cash reserves is looking to put all the other miners out of business to crash the price and then gain market share of mining, such a move on their part would be obvious in an instant and would immediately attract outcry from market participants on the over-concentration of hash power within a centralized few. Such a move would undermine the value of Bitcoin, the very commodity that they were trying to control to begin with. It is in the subtle incentive structures of Bitcoin that Nakamoto’s invention really shines. Ultimately, it still pays to play by the rules.

Dan’s office lunch boxes started to look more and more suspicious.

And because the mining process is getting easier as more and more Bitcoin miners pull out, those that can weather the storm can potentially enjoy profits in the future again. Alternatively, miners sitting on the sidelines may be drawn in — it may require less power at current rates to mine a Bitcoin.

With Bitcoin prices (despite the slight bump in as many days) continuing to stay depressed, there has also become increasing pressure to develop more energy-efficient ways to mine the digital asset. To date, miners and developers had been more concerned about bread-and-butter issues, but now that Bitcoin mining may be entering an existential-crisis, the motivation to move development along has grown more pressing.

For now at least, Bitcoin’s inbuilt mechanism that caters for rising and falling competition in the mining of Bitcoin seems to be working, with all its attendant economic implications — and it is at least in that aspect that Nakamoto got it right — understanding the psychology of the market, economic incentives and the human psyche.

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Patrick Tan

Patrick Tan

CEO & General Counsel of Novum Alpha, a quantitative digital asset trading firm with regulated funds catering to accredited and institutional investors.