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Consider Bitcoin (Mining) An OPEC Model

Why is Bitcoin hovering around $4,000 in the past week when “mining breakeven” is supposedly much higher? We consider that Bitcoin pricing is driven strategically by the largest miners, analogously to OPEC’s influence on the oil markets, in an oligopoly structure. The recent price decline possibly reflects choices by China’s largest mining pools to leverage their relatively low costs of production – cheaply priced wholesale energy, and mining hardware at cost – to accomplish broader strategic goals.

Today the price of Bitcoin (BTC) dipped to Nearly $3,600, representing its lowest price in fourteen months since September 2017.

Many investors were caught by surprise, expecting the price of BTC would hold firm near the $6,000 mark, which has widely been considered a key price barrier: the breakeven price of mining Bitcoin itself. While this was true even into mid-2018, data shows this assumption no longer the case for the largest mining pools. Instead a combination of factors resets the “mining breakeven” price for the vast majority of miners (at least 70%, and those in China in particular) to between $3,900 and $4,400.

From mid-2017 into mid-2018, annualized mining costs did in fact approximate $6,000 on a fully loaded basis, with the total cost per unit consisting of:

  1. ASIC component cost of $3,500- $5,000 (Antminer S9 units widely available for significant discounts off the list price of $7,000)
  2. Electricity power costs of $1,350 (typically ranging $0.06 to $0.1 per kWh)
  3. OPEX of $900 per unit
  4. Facilities & CAPEX averaging around $100 per unit.

Today however the Antminer S9 is on its way out (widely available in the market for $300 used), to be soon replaced by more productive (faster processing and more energy efficient) ASIC units. Thus, for reference we run pricing analysis and breakeven estimates using the new Bitmain Antminer S15 and T15, announced in November 2018 and expected to be the dominant ASICs used by miners over the coming 12-18 to months.

BTC Miner Breakeven Price Analysis

Despite seeming bearish, we note that from the analysis above, a $4,000 BTC price is clearly sustainable for the largest Chinese mining pools (in particular groups like Bitmain that build/ sell their own ASIC equipment). In Sichuan and Guizhou provinces, China and inner Mongolia, where most of Bitmain’s mining centers are located, the cost of electricity ranges from an estimated $0.04 to $0.08 cents per kWh at retail. These prices however are healthily discounted up to 50% off for wholesale mining.

Following the data, a calculation of revenues/ costs (chart above) shows “mining breakeven” pricing that is profitable on a daily operating basis, and assumes a required positive ROI in 15 months (typical expectation of 12-18 months for full breakeven and CAPEX repayment).

So now that we understand the new costs of mining, what might be driving the recent price decline? Many discussions point to fear of the Bitcoin Cash (BCH) fork underway, which is certainly newsworthy; however in and of itself, BCH is well insulated from BTC and the broader market to not be responsible for the bearish sentiment across-the-board (witness Ripple’s XRP staying relatively stable during the same period). Others point to the recent SEC actions in the U.S. against ICO issuers, whereby their cryptocurrencies are being reclassified as true securities. However, again this is a longstanding known concern that has likely been priced-in, coupled with the fact that Bitcoin is a truly global currency, whereby the U.S. effect would seem to be an unlikely dominating factor (anecdotally we’ve observed large price movements of the past week regularly occurring during Asia trading time zones/ overnight in U.S.)

Recalling that BTC is a thinly held currency ecosystem, whereby 97% of all Bitcoin is held by 4% of wallet addresses, it seems equally plausible that large holders, in particular the largest Chinese mining pools like Bitmain, are willing to allow the currency’s price level to continue drop. We consider that this price action could be the result of short-term strategic maneuvering for competitive advancement purposes, or even a simple unwillingness/inability to continue to buy in open markets (supporting the prices as large Chinese mining pools are suspected of). This type of action and inaction is reminiscent of OPEC, as it seeks to set and control oil pricing using its production cost advantage as the lever.

One immediate response to the view above might be that it’s in Bitmain’s best interest to see BTC prices increase, as they clearly would make money from selling more equipment. While this notion rings true in the long-term, short-term “pricing pressure” (akin to loss-leading, albeit in a different more strategic manner) could be used as a way to drive competition out of business, both locally (i.e. Asia competition in hardware) and globally (i.e. U.S. competition in mining).

Considering the dynamics of the mining sector, Bitmain for the first time now faces stiff price competition from existing and new Asian groups like BitFury, Ebang, Canaan Creative and others. Bitmain’s S15 retails for $1,475, and the T15 is priced lower at $913. However, Bitfury’s Tardis can mine up to 3.5x faster than the Antminer S15 despite being more expensive on a per unit basis, costing around $6,250 per unit (discounted from $7,000). Alternatively, Ebang offers its eBit 11 for $1,517 (only modestly more expensive than the Antminer S15) with the ability to mine at nearly 2x the speed of the Antminer S15.

We think that driving down, or allowing the price of Bitcoin to decline is akin to a classic price war to consolidate the industry and put competitors out of business. Not allowing competition to sell units effectively starves them of capital and weakens their ability to conduct R&D, and even survive in some cases.

Why now? Bitmain has filed for an IPO in the Hong Kong markets, and recent financial evidence points to the company’s declining strength on relative basis due to a variety of competitive forces. We estimate Bitmain suffered at least $800mm in current year losses from the company’s BCH coin position and inventory/ hardware exposure. According to Bitmain’s IPO Prospectus, the company had losses of $395mm in Q2 2018, combined with inventory impairment costs of $390mm through Q2 2018. Further compounding equipment concerns are Trump Administration tariffs of 27.6% specifically for mining equipment that causes it to be correspondingly more expensive for U.S. miners to compete off-the-bat (recall that ASIC costs represent 30-40% of annualized expenses).

We believe the new key “mining breakeven” price must be viewed as $4,000. Given that BTC has always been highly speculative, the mere fact that BTC is down means it’ll keep going down until there is resistance of some sort. That resistance has been a combination of speculation and miners strategically buying to support the currency. We believe investors must now consider an environment where BTC can no longer be valued as it traditionally has – based upon its role as “crypto gold” (i.e. the base currency for crypto transactions) or as a “store of value” – but as a tool of miners operating in an oligarchic market structure akin to OPEC’s active management of oil prices to their needs. In the worst case scenario, we also cannot ignore the geopolitical realities of the China vs. U.S. trade wars, where currency manipulation has already proven to be not off-limits.

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Written by Ravi Gupat

Ravi grew up in India and graduated in Economics. He is a serial entrepreneur who has founded and exited several companies in tech and media over the past 15 years. He is also an early stage investor and advisor in various blockchain-based companies.

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