Economics of bitcoin mining

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In my last post, I described the properties of a consensus algorithm and how Bitcoin implements Proof of Work. If you're new to Cryptocurrency and want to know more, I'd recommend to check out my last blog post:. In this post, I'd like to write about the economics of Bitcoin mining. I'll do so by explaining the different factors that influence the profitability as well as how these factors depend on each other. All statements are based on actual data retrieved from the Bitcoin blockchain as well as from https: Image by LauraTara - Source: The concept of Bitcoin mining seems rather simple on first sight and lot of its complexity is only revealed by a closer look.

It is a continuous balance of Price, Hash Rate, and Difficulty. Each of which changes under different conditions, influencing the other.

Making mining a very uncertain venture, that is extremely hard to predict. And yet, mining seems to be profitable for a lot of miners.

Leading to some fundamental questions that I'd like to answer in this post:. One thing all these questions have in common is the fact that they define the profitability of any mining operation. Like with many other things, the easiest way to put this is: If the reward is bigger than the effort, mining is considered profitable.

The effort always strives towards the reward. Before talking about the reward, I'd like to start with the effort that needs to be taken.

The effort can be considered to be anything related to the setup and operation of your mining equipment and consists of:. The total of these expenses must not exceed the reward, thus making efficiency crucial. Minimizing costs for Mining Hardware, Housing and Labour Costs maximises the margin and provides a competitive mining setup in the long term.

Let's assume we have a setup of one Antminer S9 from Bitmain. This provides specific numbers and makes the matter more tangible. The first thing that needs to be taken into account is the price of the mining hardware. The price depends on supplier, country and quantity and takes a high influence on the number of days needed to break even.

Besides the hardware itself, it's power efficiency is another aspect to be taken into consideration. The most efficient mining hardware usually has its price. Requiring a tradeoff between the costs of electricity Operational Expenditure and the costs of Mining Hardware Capital Expenditure. In our example, we assume electricity costs of 0. Since "solo-mining" isn't possible anymore, we're required to join a mining pool.

A mining pool is a collective of miners, working together and sharing the block reward relative to the hash power each miner provides. After we had a look at the effort side of the equation, let's have a look at the reward. The reward for processing transactions and securing the network mining consists of two components.

The first component is the so-called Block Reward Created Bitcoins - currently The second component is the transaction fee for all transactions processed in that block. This represents the margin that can be achieved under current conditions. It is a very simple but also rather unreliable way of calculating mining profitability and can be done, using a calculator like to ones listed below:. The reason these calculators are unreliable is that they don't account for the change of Price, Hash Rate and Difficulty over time.

Things tend to become very uncertain if we try to account for the change over time of either Price, Hash Rate or Difficulty. Each is influencing the calculation, pushing inefficient setups out of the competition. If we take our example, Bitcoin's Price is one of three factors. It is highly volatile and has a huge impact on the reward but also on the incentive of new miners to join the playground. Whenever the price of Bitcoin incentivises new miners to join the playground, it increases the Hash Rate and decreases the time between blocks.

Although the increased Hash Rate has a negative impact on the relative amount of hash power our Antminer S9 can provide, it also decreases the block time. This is why the change of the Hash Rate only has marginal effects on the profit.

Unfortunately, effects are only marginal until the difficulty is adjusted to meet a block time of 10 Minutes again. This happens every blocks, approximately every two weeks. Meaning that increased price leads to increased hashing power which will lead to increased difficulty after a maximum of blocks. The increased Difficulty caused by increased Hash Rate the profitability significantly.

Now that we know how Price, Hash Rate and Difficulty can affect the profitability of our mining setup it is time to talk about efficiency and why it is important. Since price is subject to volatility and influences the total Hash Rate which influences the Difficulty, every miner is participating in an ever-changing ecosystem.

If the price either falls or rises, the Hash Rate will follow and so will the Difficulty, which is adjusted every blocks to sustain a block time of 10 Minutes. Since there's no incentive to run an unprofitable mining operation, it will be the inefficient setups that are pushed out of the market first. Although it is almost impossible to determine the reward that only consists of fees, history shows that the numbers always follow and adjust according to their environment.

We can be certain that there will always be a profit for the most efficient setups. Independent of the reward calculated under current conditions, you should always be aware of the fact that only the most efficient setups will remain profitable in the long run. In times of a falling price or increasing hash rate, you're competing against all other miners in the world. Unfortunately, efficiency is mostly dependent on local conditions and size of the setup. Local conditions define the costs of electricity or rent, but also influence the amount of power you need for cooling.

Substantial mining farms are often either located in cold areas or close to cheap sources of electricity. The size of the setup refers to the fact that it will always be cheaper to buy vast quantities of hardware than short ones.

These factors facilitated the creation of significant mining farms in favourable locations, making it very hard for a one-man mining show to remain competitive. At least you can neglect labour costs as well as the costs for cooling and housing when only running a setup with a single Antminer. Leaving some chances to run a small, profitable mining operation. The only thing you shouldn't forget is that these things are pretty noisy, so having one in your living room might not be the best idea.

I hope I was able to give you an overview of how mining profitability can be determined and could provide an insight into the different aspects that influence the equation. Furthermore, I hope you can now decide yourself, whether having your own mining setup would be profitable or not. If you have any questions, feedback or input, please leave a comment below. You can see your post's place along the track here: Find out more about us and join us today. Thank you very much thesteemengine!

Again, it is an honour to be chosen as one of the daily Whistle Stops! Profitability of Bitcoin mining is definitely not an easy topic to cover. The monthly profit when compared to the energy costs and mining pool fees always looks great, but the ROI on the actual hardware, is where things get fuzzy.

Difficulty aside, the volatility of the market, makes it hard to predict when you will break even! Only reason I justified the hardware costs of the ASICs, was because I paid for them using some major cryptocurrency profits made in It was my way of diversifying from day trading, to day trading and mining. Thanks for your reply, I'm happy to hear that you liked my post.

Indeed, ROI is very tricky to predict. Having so many moving parts and variables doesn't help the ROI calculation. I think you chose a very interesting way to diversify. I'd have done the same if I had some place where I can put the miners. I hope your monthly profits keep looking great and that you eventually break even. I wish you success with your mining venture. I admit I don't know as many things about bitcoin as I would like to. I am still hoping that the Proof of Stake will take over as it will be better for the planet overall and the security is still pretty good.

Although, from an economic point of view, the situation stays the same: Effort strives towards the reward. Your post was mentioned in the Steemit Hit Parade for newcomers in the following category:. I also upvoted your post to increase its reward If you like my work to promote newcomers and give them more visibility on Steemit, feel free to vote for my witness! You can do it here or use SteemConnect. Thank you very much for your reply and the mention in the Steemit Hit Parade for newcomers!

I like the idea and appreciate your work and support for newcomers on Steemit, thank you! Thank you for taking the time to research and write about this. Too often, many people look at mining as an extremely lucrative way of making additional income.

Even I was under the impression that you could make a lot money from mining. However there is so much more to understand and look at, though I guess if you are tech person it is a lot easier to understand. Learning more about crypto and blockchain everyday. Thanks for your reply. Indeed, mining is more complex and less profitable than most people think.

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This piece contrasts mining economics between Bitcoin and traditional resource mining. We look at how the difficulty adjustment can impact profitability in the mining industry and some potentially perverse incentives. Mining is the random process by which new Bitcoin blocks are found, such that transactions are confirmed. This is a necessarily competitive and energy intensive process.

In order to ensure a smooth and reliable network, every two weeks, based on how many blocks were mined in the period, the mining difficulty adjusts. There is an average target interval between blocks of 10 minutes. The below chart shows the difficulty adjustments red line and the calculated rolling two week hashrate estimate green line , over the last 2 months.

In theory, the difficulty adjustment keeps the system in check, in an equilibrium position, when external inputs change. For example consider the following scenario of a sudden increase in the Bitcoin price:. The same kind of logic can be applied to an increase in Bitcoin transaction fees or the release of new more efficient mining hardware.

The theory can also be used in reverse, for a sudden Bitcoin price decrease. Contrary to a popular misconception, this short two week period combined with the theoretical ability of anyone to quickly enter the mining industry, does not mean mining industry profit margins tend to zero every few weeks.

What the difficulty adjustment may mean is that the profit margins of the most marginal miner quickly tend to zero. However, not all miners are the same, for example some miners may benefit from structurally lower costs, such as lower electricity costs, more scale or an effective maintenance regime. These more efficient miners may be able to produce stable profits throughout these cycles. In addition to this, it is no longer true that there are limited barriers to enter the Bitcoin mining business, at a particular cost level.

For example perhaps a large capital investment is required, there may be large time lags before the mining farm is active, cheap electricity may be difficult to source and the latest specialist mining chips may be hard to get hold of. Therefore the assumption that there are limited entry barriers may no longer hold anyway. The below chart illustrates total world gold mining production, by mining company. The x-axis displays the proportion of global gold production by company, while the y-axis is a measure of the cost to produce one troy ounce of gold.

The straight red line represents the spot gold price. Gold mining industry cost curve. As the chart illustrates, miners on the left hand side are able to generate profits, despite moderate reductions in the spot gold price.

In contrast miners on the far right hand side, can be classified as the most marginal miners. The profit margins of these most marginal miners does tend to zero over the cycle.

If the gold price increases, over the long term, more gold miners may join the industry on the right hand side of the chart, increasing the supply of gold, eventually causing downward pressure on the price of gold. This type of equilibrium cannot occur in Bitcoin since the supply is fixed, therefore the difficulty adjustment is an alternative equilibrium mechanism. The grey bar on the far right hand side of the chart shows a miner making a loss. However, since the AISC includes depreciation, it may be rational for this loss making miner to remain open, to make a contribution to the capital investment initially made, although the original investment decision turned out to be a bad one.

The same logic could be applied to Bitcoin mining, the fixed costs are items such as acquiring the mining equipment and building a mining farm, while the variable costs are items such as electricity bills and maintenance. One could call this a free cash flow FCF positive miner.

This could help ensure the mining hashrate and Bitcoin network conditions are more stable than they otherwise would be. When the mining difficulty increases, the cost for the miners to produce one Bitcoin should shift upwards.

Incidentally this is a not necessarily a parallel upward shift in costs. Each miner may have a different breakdown between fixed and variable costs.

The fixed costs should remain unaffected by a difficulty adjustment, such that miners with a higher proportion of fixed costs, perhaps due to very low electricity charges, may comparatively benefit from an upwards difficulty adjustment, compared to its peers. This dynamic is different from traditional resource mining e.

If the gold spot price changes, this neither impacts the variable or fixed costs, of producing one troy ounce of gold. Therefore in gold mining, the actions of other miners cannot directly impact the costs in any one mine, whilst in Bitcoin difficulty adjustments, driven by the actions of other miners, can directly impact the cost per unit production.

We have explained how some Bitcoin miners can comparatively benefit from a lower Bitcoin price, however it may also be possible for some miners to get an absolute benefit from a falling Bitcoin price, in the short term. If the spot price of Bitcoin falls, initially all miners take a parallel revenue hit per Bitcoin produced, just like in traditional mining.

However, should miners on the right hand side of the cost curve leave, depending on the shape of the costs curve, some miners could actually see the absolute level of their profits increase. In some ways this could make the Bitcoin mining industry earnings more resilient to price crashes, but in other ways it could produce perverse incentives. The difficulty could then adjust downwards and miners on the left hand side of the curve could, in theory, increase the absolute level of their profits.

A similar analysis could be conducted, but instead of miners leaving, it could apply to the absence of miners entering the market. Contrived mining industry cost curve variable costs. Therefore, perhaps some miners may benefit from falling Bitcoin prices, in some time periods. Who knows, we may already be seeing this phenomenon, to some extent, with larger lower cost miners wanting the price to remain low such that new miners do not enter the market.

Although this is probably somewhat unlikely. Skip to content Abstract: A two week period is split into sections of 10 minutes. If more than blocks were mined in a two week period, mining becomes more difficult, such that if the hashrate remains constant, blocks are expected to be found every 10 minutes in the next two week period. If fewer than blocks were mined in a two week period, mining becomes less difficult, such that if the hashrate remains constant, blocks are expected to be found every 10 minutes in the next two week period.

The maximum adjustment in any one period is a factor of 4 i. Mining Equilibrium and the Misconception This Means Miners Cannot Make Profits In theory, the difficulty adjustment keeps the system in check, in an equilibrium position, when external inputs change. For example consider the following scenario of a sudden increase in the Bitcoin price: The Bitcoin price increases Mining profitability increases, since miners are rewarded in Bitcoin More miners join the network to take advantage of higher profit margins and there are limited mining entry barriers The network hashrate increases and the average block interval falls below 10 minutes After a few weeks, the mining difficulty increases and therefore mining profitability decreases The average block interval increases back up to 10 minutes The same kind of logic can be applied to an increase in Bitcoin transaction fees or the release of new more efficient mining hardware.

The Gold Mining Industry as an Analogy The below chart illustrates total world gold mining production, by mining company. How the Mining Adjustment Impacts Industry Economics When the mining difficulty increases, the cost for the miners to produce one Bitcoin should shift upwards. In theory, Some Bitcoin Miners Could Even Profit in Absolute Terms from Falling Bitcoin Prices We have explained how some Bitcoin miners can comparatively benefit from a lower Bitcoin price, however it may also be possible for some miners to get an absolute benefit from a falling Bitcoin price, in the short term.

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