There are two main approaches to talk about Bitcoin mining: we can talk about the hardware and ‘raw’ inputs or the complex algorithms and the software side. While most of the attention around Bitcoin is devoted to the latter, we stress the importance of talking about the hard inputs. It works like the human body. You need to pay attention to what goes in, before you can expect big results.
How Bitcoin transactions work
To make transactions with Bitcoin, you need a cryptocurrency wallet. A cryptocurrency wallet is a software that functions like a wallet in real life. It keeps track of all your incoming and outgoing transactions and calculates your balance. Let’s look at an example where John wants to transfer some Bitcoins to Laura. He needs to open his wallet and scan Laura’s address. To make sure that the transaction can be made, the system needs to validate that John has enough funds to send.
This is where the network of mining computers come into the picture. These computers, like the ones of Enerhash, mine new Bitcoin blocks and add it to the ledger that store transactions. Once it has been stored, Laura will see the funds in her wallet and the mining computers that provided the hash power for the transaction will receive a block reward and transaction fees . Similarly to real life banks, if John wants to transfer one unit, his balance will be decreased with a little more than one unit because of the transaction fee.
Why electricity is a lot more than just source of power
There are two algorithms that are used to validate transactions: Proof of Stake (PoS) and Proof of Work (PoW). Transactional data is stored in blocks across the network. To verify the transactions in each block, the mining computers need to solve complex computational puzzles called proof of work problems. However, these calculations require a huge amount of electrical power. The amount of power needed for a single transaction would be enough for a US household for days.
PoS has been created as an alternative to PoW to offer a less electricity-intensive substitute. Even though the high costs may deter some miners from opting for PoW, it has many safety benefits. Cyber-attacks such as a distributed denial-of-service attack (DDoS) aim at exhausting the resources of a computer system by sending multiple fake requests. This can be achieved easily with a PoS system where the computational power is limited in order to save on the electricity costs. However, in case of the PoW protocol, given the huge computational power of the system, it is impossible to devote enough resources to carry out a successful attack on the Bitcoin network. Hence, the need for huge amount of electricity guarantees safety. It is important to note that change of Bitcoin from PoW to PoS is not supported by the system.
Key metrics of the system
Hashing is a mathematical function used for converting input of any length into a fixed sized unique string of code. In block chains, every important aspect of a transaction such as amount, address and timestamp are translated into a hash called transaction ID. Since determining the input based on the hash value is extremely difficult – if not impossible -, and the previous hashes are always used to generate the newer ones, hashing guarantees an unbreakable dependency.
Hashrate is a key metric referring to how quick a computer is to convert an input into a hash value. With a higher hashrate, you are more likely to find the next block and receive a reward, therefore, faster computers are more profitable. When we add up the hashrate of all the mining computers around the world, we get the network hashrate. The higher this metric is, the safer the whole network gets.
Network difficulty is a relative measure of how difficult it is to find a hash below a given target. The Bitcoin network applies the same level of block difficulty globally, which is adjusted every 2016 blocks, roughly every 2 weeks to the network hashrate. This is necessary to keep the system in balance and ensure that it takes about 10 minutes on average to add a new block to the blockchain. If the global computing power a.k.a hashrate increases, it gets much faster to create new blocks, this is why the network difficulty needs to be adjusted to the network hashrate.
Target value is a number that a block hash must be below for the block to be added to the blockchain. Based on the computational power of the miner, he receives block reward, which is his actual income. Currently it is 12.5 BTC/block, which is adjusted to the hashing power provided by the miner.
Only the strong survive: energy efficiency as a key factor of competitiveness
As we have mentioned before and will also see later, the price of electricity is a key determinant of profitability since the currently used PoW protocol requires a huge amount of power for safety reasons. However, it is not only the price of electricity that can affect your profitability, but also the market price of BTC. The majority of miners are using older computers that are less energy efficient than the latest models. Consequently, when the market price of Bitcoin drops below a certain level, they lose profitability as it costs them more to keep their computers running than what they can actually earn. This way, they are forced to turn their computers off simply due to the power of the market. This is exactly what we can see on this graph. When the price of Bitcoin dropped below $ 4500, the global network hashrate showed a strong decrease, as well.
Going the extra mile for profitability: the price of electricity around the world
We like to monitor both household and commercial prices of electricity globally to provide an unbeatable offer to our customers. We will be using our price for electricity is 0,0454 EUR/kWh (0,05 USD/kWh) in Russia as a benchmark. When we look at Europe only, we find very few places where it would be profitable to simply plug mining computers into the household power grid. Ukraine is the only country where the price of electrical power is low enough to consider setting up household mines. Just imagine plugging the same computer in in Ukraine versus in Germany. You’d be paying 6 times as much for the same amount of electricity, so you have a huge competitive advantage in Ukraine. The difference is inconceivable. What happens if you opt for a country where you’re doing slightly better than breaking even? Even if you’re doing well in the short run, should circumstances change and you’d be risking long-term profitability.
Looking at the global picture, we find that somewhat flawed countries offer reasonable prices such as Venezuela – where mining is illegal -, Ethiopia – with a questionable legal system – and Iran – with a strong licensing regime. The price for businesses hardly changes at all globally. Some countries, like Germany, offer better rates for commercial users, but the cut is not enough to make the operation profitable. As you can see, you’ll have to go the extra mile to beat our offer.
Why choosing the right location for a server farm is a highly complex decision
There are 5 main elements miners need to weigh before choosing a location for their server park. The first one, as mentioned before, is the price of electricity. Since there are such great differences in price of electricity between two countries and it makes up the biggest chuck of the cost structure, mines are usually located in countries where miners face low costs, assuring high margins and competitiveness. The lower your electricity prices are, the longer your computers will operate with a profit.
The second factor is the weather. Servers generate heat while working, therefore, warmer climates where they would require additional cooling, are suboptimal. Additional cooling not only means extra costs, but also needs regular maintenance. The same applies to climates with high humidity, adding an extra risk factor to the operation of the mining farm. In this respect, Russia, Iceland, Scandinavia are all ideal locations. However, while Bitcoin mining was subsidies before in Norway with low taxes on power, it was suddenly cancelled in 2018 so that mines would not overload the power grid, eliminating the country from the top picks for mining locations.
So let’s say, we’ve got Siberia where the price of electricity is low and the climate is ideal. As a next step, it is also essential to weigh the security of the environment once you’re planning on making a considerable investment. How can you assure the safety of your computers in the middle of nowhere? Not always an easy question.
The legal environment adds to the complexity of the decision matrix. Contractual structures are usually quite complex when setting up mines. It is vital to choose a location where the legal system is transparent and law enforcement is consistent.
Lastly, although Bitcoin mining is not a human labor-intensive business, it is key to have staff available for maintenance and operation such as IT experts and electricians.
How the cost of mining hardware changes overtime
The cost of mining hardware shows an interesting correlation with the market value of Bitcoin over time. If the price of Bitcoin decreases, the price of mining computers drop simultaneously as there is no demand for them. Should the price of Bitcoin increase and the demand grow, the price of mining computers escalate, as well. The movement of these two variables together keeps the ROI in balance. Should these two not move together, you may end up with extremely high costs and low Bitcoin prices, slowing down your return on investment significantly. However, thanks to the power of the invisible hand, the ROI is relatively stable and independent from the cost of mining hardware. This tendency is also reflected perfectly on the market of used devices.
Mining hardware evolution and predictions for the future
Over the last couple of years, we have experienced a huge evolution of chips both in size and computing power. While The Antminer S9, the most frequently used chip around the world today, is 16 nm in size and has a computing power of 14 Th/s, the latest model, the Antminer S19 from 2020 can give you more than 6 times that performance with only 7 nm in size. 16 nm chips are used by 70% of miners around the world that provide very low energy efficiency under current market conditions. However, we can observe an ever-slowing development of chips over time. The manufacturer, Bitmain, has launched its 3rd generation of 7 nm chips that have been the subject of optimization twice already. Moreover, the decrease in size gets smaller and smaller: from 28 to 16 to 10 to stagnating 7 nm. The only technology that could exceed that would be a 5 nm chip which is not even on the horizon yet.
First of all, even if we had the technology to create 5 nm chips, it would first be used in the mobile phone industry, not necessarily in Bitcoin mining. Secondly, the development of technology has slowed down so much that 7 nm chips are likely to stick around for 4 or more years, meaning that our expectations for their life expectancy and profitability are very positive in the long run (in crypto time).
Profitability projections for different scenarios
We have created estimates for the cost structure of Bitcoin mining for three different scenarios: low, moderate and high market value.
The most intuitive takeaway of the figures is that profitability shows a strong, positive correlation with market value: when a Bitcoin is worth more on the market, you make more money mining it. Following the same logic, we can discover that the cost of hardware proves to be inversely proportional to the market value. The ratio of amortization costs of hardware decreases as the market value of Bitcoin increases. What is quite interesting is how the ratio of electricity cost reacts to doubling the market value: it still makes up a huge, significant part of the cost structure. Knowing that the cost of electricity will always play a key role in profitability, no matter what the market value of Bitcoin is, it will always remain a main factor of competitiveness.