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Why You Shouldn't Worry About the Drop in Mining Rewards

January 20, 2022
min. read

A bitcoin miners profitability study conducted by The Block, a highly respected New York analysis and news brand in the digital assets space, showed that in 2021 miners earned $15.3 billion in revenue, which amounted to 206% growth year-on-year. As noted in the chart below, estimated mining revenue peaked in March, when miners brought in some $1.75 billion, including $167 million in transaction fees.

Due to the positive sentiment, trading volumes in 2021 also increased significantly, exceeding last year's highs in January by 138% and reaching $917 billion. The growth of trading volumes continued to May price highs, reaching $2.2 trillion. In the second half of the year, volumes gradually recovered after the crackdown on mining in China from $651 billion in July to $1.4 trillion in November.

In addition to trading volumes and the market price of bitcoin, another important indicator of the market state is  the bitcoin network hashrate, that is, all the computing power involved in Bitcoin mining. All three parameters influence each other in one way or another: volumes push the price up or down, price movements provoke fluctuations in the hashrate, which in turn also affect the price and volumes, etc. At the same time, it is already quite difficult to determine which of the parameters is more fundamental. For example, at first glance, market volumes look secondary, but the institutionals coming on the market and the trading volume growth with them, occurs due to the fundamental factors of bitcoin adoption at the corporate level, regardless of its hashrate or price.

Somehow or other, the income of bitcoin miners fluctuates along with changes in price, hashrate and trading volume. In general, there is no particular problem that the income of miners is a variable value. The problem is, mining may become unprofitable for some players when the market is in an extreme state, since their equipment costs will be commensurate with income, or even exceed it. In this case, the only reasonable step would be to turn off the equipment in order to wait for a more favorable situation, which, in turn, will reduce the hashrate of the network. If the disconnecting equipment process becomes systemic, as, for example, in May, when the migration of Chinese miners began, a hashrate slump will lead to significant price fluctuations, and consequently to fluctuations in the mining income of those who remain in the game.

So, how dangerous can a drop in mining income be considered, how to treat it correctly and how can you protect yourself from reaching the point of zero profitability, much less falling even lower?

Three types of Bitcoin mining

There are three types of bitcoin mining. Classic mining is the ownership and management of a mining farm. Cloud mining is the purchase of a hashrate rental contract from a service provider.The third type is mining by stacking hashrate tokens, in other words, profitable farming in DeFi using special digital assets that allow you to receive mining income in bitcoins.

Classic mining, that is, mining on physical equipment,   is seen as the most vulnerable for small players in the case of a market deep drawdown. The small company owner, like any other, bears all the costs of its maintenance, but cannot compete with large players who optimize costs due to volume. There is indeed a situation where mining becomes simply unprofitable. A lot depends on the cost of electricity, rental of premises and the composition of expenses in general, so those who have higher costs suffer first, and, above all, in terms of electricity consumed.

It is known that the strongest players use electricity at a price of about $0.025 per 1 kWh, which allows them to remain profitable at a bitcoin price above $ 3000. Such players include the largest mining pools, which would not be such if they did not work in such favorable conditions for themselves. The average pool price is $0.04 - $0.08 with a profitability point of about $10,000/BTC. Weak players are content with a price of $0.1 and above, which guarantees them a break-even of $25,000/BTC. However, profitability depends not only on costs, but also on the overall hashrate of the network. The higher the hashrate, the more power is required to maintain the efficiency of calculations. In other words, the more players work in the market, the more expensive mining is, the higher the profitability point for each.

When a critical event occurs, when the bitcoin exchange rate goes too low (or, hypothetically, the hashrate is too high), the mining equipment is turned off, and the earned bitcoins are fully or partially withdrawn to the exchanges, since the regular source of income disappears. This leads to a hashrate drop, an increase in trading volumes and a drop in price. Within the global market trend, such events can lead to an avalanche-like shutdown of the hashrate, followed by the withdrawal of part of the earned funds to the market, which will lead to an even greater reduction in prices. This will continue until a certain equilibrium state (bottom) is found, when everything earned is sold, and the hashrate has decreased so much that mining gets a second wind due to a significantly lower profitability point. Then the growth story begins anew. In fact, the farmer's task is to avoid accumulating debts during work and minimize the costs of farm downtime (for example, for renting premises). A prolonged "crypto-winter” can deprive him of all his earnings and lead to the need to sell off equipment, fallen in the price even more catastrophic by that time.

Cloud mining customers are exempt from the costs of maintaining equipment, since all costs are already taken into account in the contract. By renting a hashrate, a cloud miner receives computing power for use, paying the supplier for all services and fees with a good premium. Otherwise, it would make no sense for the farm owner to rent his hashrate out, since he is already guaranteed income from mining. A cloud miner, as well as a classic one, can count on an increase in daily rewards only if the increase in the bitcoin price compensates for the share diluting of the leased hashrate in the total network hashrate. In all other cases, the income will inevitably fall throughout the entire term of the contract. Also, the cloud miner shares the risks of the classic miner behind it, which provides a cloud service. In the worst case scenario, the service can be disconnected from mining without a refund of the paid contract value. In this sense, the classic debt-free miner is even in a more advantageous position, since it can sell equipment at least. In the worst case, a cloud miner loses everything at once, and in the general case, it depends on contractual obligations, descriptions of force majeure conditions and the provider reputation.

In the third case, when mining income is accrued from hashrate tokens, the user is not tied to a contract with a specific term and can manage his asset depending on the market situation. For example, under favorable circumstances, he can buy tokens on the open market, increasing daily rewards, and he can sell them in the opposite situation. The hashrate tokens holder will not have to get rid of the equipment, since he does not have it, as there are no expenses for its maintenance and debts accumulated in this regard. Also, he will not have to endure the expiration of the cloud mining contract if the daily income is equal to the management fee, or even falls below. The hashrate token does not have a point of profitability, it is essentially a coin that has its own value, and in addition, generates daily income. If the profit has become insignificant, the coin can always be sold, but it will never drag the holder into the negative, on the contrary, allowing you to easily wait the "bad times" out.

In this case, the client is backed by a large data center with physical equipment (or even a pool) and a provider that issues tokens. In general, mining income from staking hashrate tokens also demonstrates a gradual decline for classical reasons, as well as due to the share diluting of each holder as their number increases. This is typical for all liquidity pools in DeFi because in the early stages, the entire income of the pool is divided among a small number of participants and gradually decreases as new ones come. However, in contrast to this, the project can always increase its own hashrate by adding new computing power and the corresponding issue of hashrate tokens, which will lead to a proportional increase in the mining income of each holder. Here, as elsewhere in business, a lot depends on the scaling capabilities, quality and reputation of the project, and for a deep understanding of its potential, it is necessary to carefully study the White Paper.

The table below shows the average return from three types of mining as of the end of 2021. The Minto BTCMT token is used as one of the most profitable on the market in 2021 as an example of a hashrate token.

So, mining income cannot be constant and depends on mining form and the market phase. A significant drop in mining revenues can be really critical only for classic miners, since they bear the costs of maintaining physical equipment, which downtime can be too expensive.

Cloud mining clients bear less risks, but the probability of a decrease in their income is much higher than growth, besides they are limited by the contract terms.

The third type of miners using hashrate tokens is seen as the most independent. In this case, not only is there no dependence on equipment, but there are also no contract terms, since tokens are bought and sold on the open market. Mining comes down to owning a special digital asset that has sufficient liquidity to effectively manage it depending on market conditions. Thus, the drop in mining income may bother the hashrate token owner only from the point of view of “lost profits”, which, as shown above, reflects only a not quite clear idea of the mining processes complexity.

Market phases change one another, the bitcoin exchange rate rises and falls, but one thing remains unchanged. Mining will not stop in the next hundred years, which means that its profitability will grow, involving more and more participants in the process. This simple consideration works in all markets, because markets are needed to reflect the assets growth for which these markets are created, whereas any fall is just a necessary correction phase for continued growth.

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