HomeServicesCompanyInsightsCareersContactE-Banking
Sign up for our newsletter
Receive insights on the current developments at SEBA and stay ahead of the curve with our well-founded in house research papers.
First name
Last name
Email address
Continue
Thursday, 13 August, 2020
The Digital Investor

Bitcoin Mining as a Business

Abstract

Our analysis shows that increased bitcoin mining equipment efficiency has reduced the time it takes to breakeven, even at lower bitcoin prices. Sensitivity to operational conditions such as bitcoin price and electricity cost has been reduced at the cost of increased capital expenditure. Investors should bear in mind that despite the attractiveness of acquiring bitcoin at a cheaper-than-market cost, bitcoin mining has many nuances and is a full-time business. Our discounted cash flow analysis shows that starting a bitcoin mining business may be a lucrative decision at this stage.

Introduction

Bitcoin mining has come a long way since it launched in 2009. The cumulative revenue from bitcoin mining as of 4 August 2020 was just shy of USD 19 billion, with approximately USD 2.8 billion in revenue to date in 2020 alone. As bitcoin mining becomes increasingly sophisticated, our article investigates the viability of a mining business in the future. To do that, we first examine the development of mining profitability since the industry’s inception.

The first section of this article analyses how the mining industry has evolved to tackle high sensitivity to bitcoin price. In the second section, we present different ways of gaining exposure to bitcoin mining. Finally, the last section of the article examines the viability of a bitcoin-mining business using discounted cash flow analysis.

Why should investors care about bitcoin mining or the hashrate of the bitcoin network?

Investors who are long on gold tend to explore ways to gain exposure to gold mining. Similarly, investors who are long on bitcoin have begun to explore ways to gain exposure to the hashrate of the bitcoin network, as hashrate measures mining activity. Note that hashrate also indicates how secure a blockchain is; a higher degree of security increases the value of bitcoin (BTC). The higher the hashrate, the costlier it is to attack the network.

How did we get here?

In the early days of bitcoin, you could mine bitcoin on any computer. Those who mined a block received 50 BTC as a reward. Bitcoin is a proof of workproof of worklink1 system; probabilistically, those who put in the most work receive reward. As bitcoin began to gain traction, miners devised more efficient ways of mining bitcoin, meaning that everyone had to work harder to obtain the same number of bitcoins. As stated in our piece Digital Investor - Bitcoin halving: The battle of hard and soft moneyDigital Investor - Bitcoin halving: The battle of hard and soft moneylink1, bitcoin halvings occur approximately every four years. Mining efficiency needs to double to ensure that profitability remains the same (ceteris paribus). CPU mining replaced GPU mining1, the latter was replaced by FPGA mining2. The first ASIC3 mining machine was launched by Canaan in 2013 and had a 130-nm chip. Recent ASICs have a chip size of approximately 7 nm4. As some miners employed specialised machines to mine bitcoin, others had to evolve as well. Increasing efficiency meant not only improving mining machines but also optimising operations to keep costs in check. Thus, hobbyists lost their share to sophisticated miners. New ways of mining rendered the old ways obsolete, and the entry barrier for solo miners grew.

BTC is often the only source of miners’ income. As operational expenditure (Opex) is in fiat currencies, miners are heavily reliant on BTC price to continue supporting the bitcoin network. Gradually, mining equipment manufacturers and miners have optimised equipment and operations to reduce price sensitivity. As a result, capital expenditures (Capex) have increased and operational expenditures have decreased as shown figure 1.

Figure 1: Decrease in operational expenditure at the cost of increasing capital expenditure

Source: Hashrateindex, SEBA Research

As bitcoin price volatility is detrimental to miner revenue, the mining industry has made efforts on all fronts to reduce the sensitivity of BTC price, endeavouring to make the break-even on capital and operational expenditure as early as possible. To understand how mining equipment has evolved over the years, we need to examine how the sensitivity of break-even days to bitcoin price has evolved with new equipment. We consider four benchmark pieces of mining equipment—Bitmain’s S7, S9, S17 pro, and S19 pro—and analyse the sensitivity around the launch of all four series. Interested readers can see the calculations used for this exercise in the Appendix..

What interests us in this Digital Investor is the relationship between break-even days (BED) and the price of bitcoin for different generations of equipment. Figure 2 presents this sensitivity with an elasticity of BED to price.

Figure 2: Price elasticity of break-even days

Source: SEBA Research

As can be observed in Figure 2, newer equipment’s price elasticity of breakeven days is lower than that of earlier generations, indicating that newer-generation machines are less sensitive to price. This finding is observable for any price. For any given technology, the higher the price is relative to where it is at launch, the more sensitive it becomes meaning the breakeven is achieved quickly. Intuitively, if the price of BTC doubles the day after launch, BED is achieved much more rapidly than before. However, if price declines immediately after launch, it takes more time to achieve break even, but the sensitivity is less. The reason is that the operational break-even price of bitcoin for new-generation machines is lower than that of older-generation machines.

In the last column of Figure 3, we see that in the current environment (hashrate and price as of August 2020), only the newest generations of equipment survive. This result reveals both the competition pressure miners feel and why miners are forced to upgrade technology regularly to optimise their operations. The result also indicates that mining is becoming an industry where only well-organised, large players survive.

Figure 3: Break-even days for different equipment at launch and today

Source: SEBA Research. Hashrateindex

Ways to gain exposure to bitcoin mining

Having sufficiently established how bitcoin mining equipment has changed over the years, we next discuss how investors can gain exposure to bitcoin mining.

  1. Equity route The easiest way for traditional investors to gain exposure to bitcoin mining is to go through stocks of companies involved in the mining business. Some of the listed players include mining companies such as HIVE Blockchain Technologies, Hut 8 Mining, Marathon Patent Group, etc. as well as mining equipment manufacturers such as, Canaan, and NVIDIA, among others.
  2. Hashrate futures A more specific way to gain exposure to hashrate or bitcoin mining activity is to use hashrate futures offered by some of the exchanges. For example, FTX has quarterly FuturesFTX has quarterly Futureslink1 that settle based on average difficulty during the quarter.
  3. Cloud mining Investors can buy hashrate using cloud mining. In this case, the hosting company provides the infrastructure for investors. Investors are paid according to their shares in the mining operations. Though it is a convenient way to gain exposure to hashrate, this route has been used by fraudulent companies to swindle investors in the past and, therefore, is not a recommended way to gain exposure to mining.
  4. Mining bitcoin Mining bitcoin allows investors to remain in control and tweak mining conditions as and when required. It remains the cleanest way to gain exposure to bitcoin mining but requires constant oversight.

Mining as a business

Now that we understand the journey, we can explore the viability of the mining business using an example based on the current environment.

The first question to answer is why anybody should bother mining bitcoin when you can simply buy bitcoin at market price. For investors who are bullish on bitcoin in the long term, mining does allow them to acquire bitcoin at a price that is cheaper than market price. For example, at the time of writing this, bitcoin price is approximately USD 12,000. However, the cost to mine bitcoin as per our assumptions (total hashrate = 130 nm TH/s; 96% utilisation; electricity cost = USD 0.06 per kWH) is approximately USD 6,500. Thus, the mining business currently allows investors to acquire bitcoin at roughly a 45% discount. (See Part A of the Appendix of this article for details about our assumptions.)

Bitcoin mining has three major drivers: electricity cost, capital expenditure (purchase of machines and set-up costs), and bitcoin price. For our example, we performed discounted cash flow (DCF) analysis on a bitcoin mining business for a 36-month time horizon (the expected lifetime of a machine) with initial capital expenditure of USD 1 million.

Performance of the mining business

For the given assumptions (again, detailed in the appendix), net present value (NPV) is highest if the business is terminated at the end of the tenure (in this example, 36 months). This assertion is subject to change if the business environment changes. For example, if BTC price is not as high as assumed, NPV may reach a maximum earlier than anticipated. Figure 4 shows the results of our calculation.

Figure 4: NPV, EBITDA, and Salvage Value

Source: SEBA Research

Opex can be covered either by selling earned BTC or through existing cash. Both strategies are prevalent among miners. However, if the assumption is that BTC price will have an ascending trajectory, using existing cash to pay for running costs make more sense.Figures 5 and 6 compare cash flow and terminal value changes resulting from different opex strategies.

Figure 5: Cash flow and terminal value difference with different Opex strategies

Source: SEBA Research

Figure 6: Differences in total BTC accumulated and in terminal value with different Opex strategies

Source: SEBA Research

At the current-day total network hashrate, monthly operating profit is calculated to be approximately USD 33,600. Figure 7 demonstrates how a business’ monthly operating profit changes when the total network hashrate and the bitcoin price change.

Figure 7: Monthly operating profit sensitivity analysis based on bitcoin price and total network hashrate

Source: SEBA Research

For the given set of assumptions, the mining business example appears to be viable even if the hashrate grows rapidly and the bitcoin price grows moderately.

Business defensibility

As stated earlier, mining simply allows investors to acquire bitcoin at a cost cheaper than the market price. Though the number of break-even days is less sensitive to bitcoin price than earlier, price does have a significant impact on the business.

The share in total network hashrate determines the profitability of a mining business. Thus far in the example, we have assumed that the hashrate of the business remains constant. Two possibilities emerge: the total hashrate increases or the total hashrate decreases. What happens in each case?

The total hashrate increases significantly

The total network hashrate tends to increase exponentially in lockstep with the price. Therefore, it is likely that significant increases in price will drive up the total hashrate. In a case where the business’s share of the total hashrate increases, an increase in bitcoin price makes up for the fallen share of total hashrate. For example, if both bitcoin price and the hashrate double to USD 24,000 and 260 million TH/s, respectively, the monthly operating profit of the business remains at approximately USD 33,000.

The total hashrate decreases significantly

When bitcoin price drops, miners with high operating costs due to higher electricity costs are forced to halt their operations. As a result, the total hashrate drops and the remaining business’s share of total hashrate increases.

For example, if bitcoin price drops by 50% to USD 6,000 and the total hashrate drops by 50% to 65 million TH/s, monthly operating profit remains intact.

Figure 8: Mining business defensibility

Source: SEBA Research

Risks

Bitcoin mining is a full-time business. There are many nuances that investors should be aware of and pay attention to, including selecting a mining pool, negotiating electricity contracts, choosing the geographical location of the facility, and more. If investors are not prepared to allot full-time attention to a bitcoin-mining business, there are other routes to consider, such as hashrate futures or dollar-cost averaging in bitcoin itself.

If bitcoin price does not increase significantly, it can be difficult to recover the capital expenditure.

As has happened in the past, disruption in mining-equipment manufacturing can usher in new-generation mining equipment that has the potential to make the current generation of equipment obsolete5.

Conclusion

Bitcoin mining has become a sophisticated industry over the years. Miners and equipment manufacturers have managed to reduce reliance on price and electricity costs to a certain extent. Given the current environment, our analysis indicates that bitcoin mining could be a lucrative business for the next three years.

Appendix: Part A - Assumptions

The assumptions used in our example analysis are as follows:

  • No machine upgrades for the duration and no new capital expenditures. Therefore, as the total hashrate increases, the mining business’s share in the total hashrate decreases; thus, revenues fall over time.
  • Financial Year (FY) is the same as Calendar Year.
  • Straight line depreciation for 36 months.
  • Calculation of the discount rate: The beta in this example is the average adjusted beta of Canaan, Hut 8, and Riot. The risk-free rate is the average of the United States’ and China’s 10-year bonds, as the majority of bitcoin mining takes place in China and as there has been a gradual shift from China to the United States. Similarly, risk premium is the average of the equity risk premiums of the United States and China. With these assumptions, we arrive at a discount rate of 8.61%.
  • In our hashrate projection, we assume elevated growth at the beginning of the time period and a slowdown as time passes. The rationale for this assumption is that new-generation machines were launched recently by various mining equipment manufacturers and chips are already at the 6-8 nm range. To reduce chip size further will become increasingly difficult. There will need to be a breakthrough for the hashrate growth to sustain the momentum. Bitcoin halving took place recently; miners tend to upgrade equipment after the halving and then wait for significant improvements in machines before upgrading again.
  • Growth rate is conservative so that the total hashrate beats the hashrate estimated by hashrate futures.
  • The decision to choose a mining pool depends on various factors, ranging from a pool’s location to the different pay-out methods used by pools. A miner with sufficiently large operations can choose not to join a pool. However, for a smaller miner, joining a pool offers steady rewards. Different pools and their pay-out methods are listed in figure 9. In our example, we assume that the miner joins a pool with a 2% fee.

Figure 9 - Mining pools and their payout methods

Source: SEBA Research

  • 100-day moving average (since halving) of fee revenue as a percentage of total issuance is approximately 8%. To be conservative, transaction fee revenue is assumed to be 6% of revenue from block rewards.
  • Electricity cost is assumed to be USD 0.06 per KWH.
  • Machine ratings = 3.25 kW; 110 TH/s; 96% utilisation; total number of machines = 286.
  • Cost of one S19 pro chip is assumed to be USD 3,490, which is about 40% premium above the price listed on Bitmain and approximates the average price quoted by variousdistributorsdistributorslink1. The set-up cost is assumed to be approximately USD 50,000 per MW. For 286 machines, the set-up cost is USD 46,475.
  • Average bitcoin price for FY20 = USD 14,000, FY21 = USD 20,000, FY22 = USD 25,000, and FY23 = USD 28,000.
  • Salvage value of the equipment for FY20 = 90%, FY21 = 85%, FY22 = 75%, and FY23 = 70%. These are conservative estimates as the salvage value of mining equipment has been more than 100% on occasion.

Appendix: Part B - Calculation of Price elasticity of Break-even Days (BED)

In general, break-even days (BED) can be defined as follows:

where H = total hashrate, h = miner’s hashrate, R = BTC reward, P = BTC price, M = Capex, and C = Opex. The subscript i denotes time at which new-era mining equipment was launched.

Taking the partial derivative with respect to price:

Price elasticity to break-even days can be calculated as follows:


1GPU stands for Graphical Processing Unit. GPUs are better at performing dedicated tasks repeatedly compared to CPUs.
2FPGA stands for Field Programmable Gate Array. FPGAs have more on-chip cache memory that reduces latency compared to GPUs. FPGAs are more power-efficient compared to GPUs.
3ASIC stands for Application Specific Integrated Circuit. As the name suggests, ASICs are designed for specific purposes. For example, ASICs designed for bitcoin mining are extremely good at bitcoin mining but cannot perform other functions.
4The smaller the chip size, the greater the efficiency.
5Historically, just over two years elapse before the appearance of equipment that demonstrates any material improvement over equipment released after a halving. The most recent halving occurred on 11 May 2020.
Download pdf
Share:
Subscribe to the research newsletter and get weekly updates about the latest articles of SEBAresearch
Subscribe to newsletter

Authors


Yves Longchamp
Head of Research
SEBA Bank AG
in
Saurabh Deshpande
Research Analyst
B&B Analytics Private Limited
in
Ujjwal Mehra
Research Analyst
B&B Analytics Private Limited
in
research@seba.swiss | Disclaimer

Disclaimer

This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is published solely for information purposes; it is not an advertisement nor is it a solicitation or an offer to buy or sell any financial investment or to participate in any particular investment strategy. This document is for distribution only under such circumstances as may be permitted by applicable law. It is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction.

No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained in this document, except with respect to information concerning SEBA. The information is not intended to be a complete statement or summary of the financial investments, markets or developments referred to in the document. SEBA does not undertake to update or keep current the information. Any statements contained in this document attributed to a third party represent SEBA's interpretation of the data, information and/or opinions provided by that third party either publicly or through a subscription service, and such use and interpretation have not been reviewed by the third party.

Any prices stated in this document are for information purposes only and do not represent valuations for individual investments. There is no representation that any transaction can or could have been effected at those prices, and any prices do not necessarily reflect SEBA’s internal books and records or theoretical model-based valuations and may be based on certain assumptions. Different assumptions by SEBA or any other source may yield substantially different results.

Nothing in this document constitutes a representation that any investment strategy or investment is suitable or appropriate to an investor’s individual circumstances or otherwise constitutes a personal recommendation. Investments involve risks, and investors should exercise prudence and their own judgment in making their investment decisions. Financial investments described in the document may not be eligible for sale in all jurisdictions or to certain categories of investors. Certain services and products are subject to legal restrictions and cannot be offered on an unrestricted basis to certain investors. Recipients are therefore asked to consult the restrictions relating to investments, products or services for further information. Furthermore, recipients may consult their legal/tax advisors should they require any clarifications. SEBA and any of its directors or employees may be entitled at any time to hold long or short positions in investments, carry out transactions involving relevant investments in the capacity of principal or agent, or provide any other services or have officers, who serve as directors, either to/for the issuer, the investment itself or to/for any company commercially or financially affiliated to such investment.

At any time, investment decisions (including whether to buy, sell or hold investments) made by SEBA and its employees may differ from or be contrary to the opinions expressed in SEBA research publications.

Some investments may not be readily realizable since the market is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. Investing in digital assets including cryptocurrencies as well as in futures and options is not suitable for every investor as there is a substantial risk of loss, and losses in excess of an initial investment may under certain circumstances occur. The value of any investment or income may go down as well as up, and investors may not get back the full amount invested. Past performance of an investment is no guarantee for its future performance. Additional information will be made available upon request. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. Tax treatment depends on the individual circumstances and may be subject to change in the future.

SEBA does not provide legal or tax advice and makes no representations as to the tax treatment of assets or the investment returns thereon both in general or with reference to specific investor’s circumstances and needs. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of individual investors and we would recommend that you take financial and/or tax advice as to the implications (including tax) prior to investing. Neither SEBA nor any of its directors, employees or agents accepts any liability for any loss (including investment loss) or damage arising out of the use of all or any of the Information provided in the document.

This document may not be reproduced or copies circulated without prior authority of SEBA. Unless otherwise agreed in writing SEBA expressly prohibits the distribution and transfer of this document to third parties for any reason. SEBA accepts no liability whatsoever for any claims or lawsuits from any third parties arising from the use or distribution of this document.

Research will initiate, update and cease coverage solely at the discretion of SEBA. The information contained in this document is based on numerous assumptions. Different assumptions could result in materially different results. SEBA may use research input provided by analysts employed by its affiliate B&B Analytics Private Limited, Mumbai. The analyst(s) responsible for the preparation of this document may interact with trading desk personnel, sales personnel and other parties for the purpose of gathering, applying and interpreting market information The compensation of the analyst who prepared this document is determined exclusively by SEBA.

Austria: SEBA is not licensed to conduct banking and financial activities in Austria nor is SEBA supervised by the Austrian Financial Market Authority (Finanzmarktaufsicht), to which this document has not been submitted for approval. France: SEBA is not licensed to conduct banking and financial activities in France nor is SEBA supervised by French banking and financial authorities. Italy: SEBA is not licensed to conduct banking and financial activities in Italy nor is SEBA supervised by the Bank of Italy (Banca d’Italia) and the Italian Financial Markets Supervisory Authority (CONSOB - Commissione Nazionale per le Società e la Borsa), to which this document has not been submitted for approval. Germany: SEBA is not licensed to conduct banking and financial activities in Germany nor is SEBA supervised by the German Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht), to which this document has not been submitted for approval. Hong-Kong: SEBA is not licensed to conduct banking and financial activities in Hong-Kong nor is SEBA supervised by banking and financial authorities in Hong-Kong, to which this document has not been submitted for approval. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Hong-Kong where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not “professional investors” within the meaning of the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) and any rules made thereunder (the “SFO”). Netherlands: This publication has been produced by SEBA, which is not authorised to provide regulated services in the Netherlands. Portugal: SEBA is not licensed to conduct banking and financial activities in Portugal nor is SEBA supervised by the Portuguese regulators Bank of Portugal “Banco de Portugal” and Portuguese Securities Exchange Commission “Comissao do Mercado de Valores Mobiliarios”. Singapore: SEBA is not licensed to conduct banking and financial activities in SIngapore nor is SEBA supervised by banking and financial authorities in Singapore, to which this document has not been submitted for approval. This document was provided to you as a result of a request received by SEBA from you and/or persons entitled to make the request on your behalf. Should you have received the document erroneously, SEBA asks that you kindly destroy/delete it and inform SEBA immediately. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Singapore where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not accredited investors, expert investors or institutional investors as defined in section 4A of the Securities and Futures Act (Cap. 289 of Singapore) (“SFA”). UK: This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product.

SEBA is not an authorised person for purposes of the Financial Services and Markets Act (FSMA), and accordingly, any information if deemed a financial promotion is provided only to persons in the UK reasonably believed to be of a kind to whom promotions may be communicated by an unauthorised person pursuant to an exemption under the FSMA (Financial Promotion) Order 2005 (the “FPO”). Such persons include: (a) persons having professional experience in matters relating to investments (“Investment Professionals”) and (b) high net worth bodies corporate, partnerships, unincorporated associations, trusts, etc. falling within Article 49 of the FPO (“High Net Worth Businesses”). High Net Worth Businesses include: (i) a corporation which has called-up share capital or net assets of at least £5 million or is a member of a group in which includes a company with called-up share capital or net assets of at least £5 million (but where the corporation has more than 20 shareholders or it is a subsidiary of a company with more than 20 shareholders, the £5 million share capital / net assets requirement is reduced to £500,000); (ii) a partnership or unincorporated association with net assets of at least £5 million and (iii) a trustee of a trust which has had gross assets (i.e. total assets held before deduction of any liabilities) of at least £10 million at any time within the year preceding the promotion. Any financial promotion information is available only to such persons, and persons of any other description in the UK may not rely on the information in it. Most of the protections provided by the UK regulatory system, and compensation under the UK Financial Services Compensation Scheme, will not be available.

© SEBA / Kolinplatz 15, 6300 Zug, Switzerland

Research

more
Research report
Are blockchains that safe? How to attack them and how to prevent these attacks (Part 1)
24 September, 2020
In this edition of The Bridge, we explore some well-known attacks which are commonly used to compromise blockchain networks and discuss how consensus mechanisms such as Proof of Stake and Proof of Work may offer some (if limited) preventative measures to combat attacks.
Read more
Research report
Which crypto-asset regulation for the European Union?
17 September, 2020
In recent years, several European Union (EU) member states have developed their own crypto-asset regulations. The EU is now poised to introduce a single market regulation for crypto-assets.
Read more
Research report
DeFi: What happens when the music stops?
14 September, 2020
In this digital investor, we examine the latest crypto market developments. We compare the 2017-2018 ICOs wave with the current DeFi wave and investigate the sustainability of the liquidity mining trend. Finally, we analyse Yearn Finance by calculating the relative valuation of Yearn Finance based on its price to earnings ratio.
Read more

Join us as we redefine finance.

Contact us
seba

SEBA Bank AG
Kolinplatz 15
6300 Zug
Switzerland

ServicesCompanyNews & InsightsCareersContact
Receive the newest insights, research and news from SEBA directly to your inbox
Newsletter subscription
© 2020 SEBA Bank AG