The rise of major Bitcoin mining institutions is inevitable

Published at: Nov. 15, 2020

There are very few investments that can deliver an infrastructure-style downside case with a venture-capital-style upside. The combination of energy arbitrage with accumulating a balance sheet of Bitcoin (BTC) can deliver this. That is why we are seeing a rush of institutions pouring into the Bitcoin mining space and starting to build out megafacilities.

Securing new-generation hardware

At its peak performance in 2018, Bitmain was able to produce over 95,000 rigs per week. However, since that point, production levels have come down, a partial result of its ongoing legal battle. In the other corner, MicroBT is set to deliver hundreds of thousands machines over the course of the year.

The West only receives a finite allocation of these new machines, and with 17 publicly listed mining companies and ASIC financiers and large co-locations announcing purchases weekly, you can see how that fresh supply of equipment quickly dries up. Building relationships with the manufacturers is now crucial to securing an ample allocation of new machines. How do you get in this queue? Have a big checkbook.

Reducing capital expenditure

Economies of scale stand in contrast to decentralization. Yet, like most other industries, the mining space rewards size. Large mining companies receive discounts on ASIC retail prices. With an average payback period of around 300 days for new-generation equipment, the discount can reduce it by over a month. Large miners also have to put up less down payment, in some cases around 20% compared with over 50% for retail. This allows miners to acquire more machines and build out faster.

On the infrastructure side, in most cases, building out a 30-megawatt farm can be done at a much lower cost per MW than a 3 MW facility.

Maximining operating profits

If you want cheap power, it’s going to cost a great deal of capital for things like buying the land, building out large infrastructure, acquiring generators and other equipment, funding performance bonds, etc. While there are miners taking advantage of small sources of cheap power, in large, the most profitable miners are the big ones. They are able to put up the necessary capital to secure the best locations. And as we know, the cost of electricity is one of the significant determinants of success.

Beyond sourcing cheap electricity, large miners can negotiate lower pool fees, firmware development fees and ASIC management software. They can reduce the amount of labor required per MW, drive efficiencies in their management, and improve their power usage effectiveness.

Access to superior funding mechanisms

Mining is a capital-intensive business. It requires consistent equipment upgrades and new purchases. Filing out a 10 MW farm with new-generation equipment can cost nearly $10 million, depending on the purchase price.

Access to various forms of funding such as debt, equity, equipment financing and ASIC financing is crucial for mining farms to stay large and enjoy the benefits discussed above.

From 2018 to 2019, most of these mining operations were funded through a mixture of traditional company-level debt and equity. In 2020, we have seen an explosion of growth in ASIC financing. Large and reputable mining farms are now able to raise money from financiers while using their purchased ASICs as collateral. There are still a limited number of these financiers, so they prioritize the best, lowest-risk operators to loan money to.

Manufacturers putting on a tie

One of the first questions boards ask when presented with an opportunity to mine is around the equipment: “Where is the equipment from? Who is the manufacturer? Is there a warranty? What’s the pricing? Why is the price changing every day? When do the machines ship?”

Manufacturers like Bitmian are the pioneers of the Wild West mining industry. In 2016, the arms race for who could get the most machines to market began. Left behind were the corporate policies, the details on shipping and pricing, warranties, viable repair centers, and transparency.

When institutions came into the industry, the manufacturers’ mentality of production first and everything else later started to shift. Now, manufacturers must hold weekly calls with big clients, discussing their production visibility and offering more transparency in their operations. Most of the manufacturers now offer machine warranties, they have opened repair centers, and they try to be more transparent on shipping and pricing — although they have a long way to go.

This trend of professionalization will likely continue with MicroBT, Bitmain and whoever else wants to compete in the West.

Mining pools falling in line

“How do we get actually paid?” is another typical question an institution will ask. The answer is by a mining pool. Mining pools are the buyers of hash rate. So, questions arise on who this counterparty is and what the risks associated with dealing with them are.

Pools have historically been a black box in the mining value chain. Institutions have helped bring more transparency to mining pool pricing, reduced the number of pools that steal from the miners, and incentivized pools to build out new feature sets. The mining pool industry is evolving rapidly, and if companies don’t keep up, they will get left behind. All of these trends will benefit institutions that are demanding better, more compliant counterparties to deal with.

Industry consolidation

A wave of consolidation is on the horizon for the mining industry. There are hundreds of great companies and teams fighting for elbow room, primed to be scooped up by institutions.

The main consolidation will happen at the mining farm level. These mergers and acquisitions will most likely be on a project basis rather than a corporate level, similar to the real estate industry.

Other verticals such as mining pools, container manufacturers, ASIC management software, mining media, firmware developers and ASIC resellers may also be consolidated into broader offerings.

Financial services companies will also be natural acquirers as they look to build an ecosystem that spans both the mining and financial value chain.

Financialization of hash rate

In every traditional commodity industry, companies have the ability to leverage financial instruments to hedge their cash flows through futures and options, sell forward some of their production in purchase agreements or forwards, leverage up their bet, and more.

To date, there are very few hash-rate-based financial instruments. The entry of institutions will change this, as they are creating demand for these types of products. The need from miners must be met by other market participants such as traders to form liquid, robust marketplaces.

Five-year mining outlook

In 2015, if you had told the miners where we would be today, they wouldn’t have believed you: millions of ASICs securing the network, gigawatts of power being used and institutions such as Fidelity with their own mining operations.

It’s hard to predict how the industry will evolve over the next five years, but I do think that institutions will continue to drive innovation in the space, creating a more secure network for Bitcoin. But this will bring new challenges such as censorship at the protocol level, more Know Your Customer/Anti-Money Laundering, less decentralization and so forth. Legacy Bitcoin-native mining companies must work hand-in-hand with these new entrants to shape a good future for Bitcoin.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Ethan Vera is the co-founder of Luxor Mining, a North American-based hash rate liquidation platform serving the Bitcoin and altcoin mining communities. In addition, Ethan is co-founder of Hashrate Index, a data website for every mining-related. Prior to joining the mining industry, Ethan was an investment banker at Goldman Sachs.