If there was an ideal time to start or expand a bitcoin (BTC) mining operation, it’s probably the year when the bitcoin halving event occurs. It is a method to arbitrage electricity prices with the optionality of the bitcoin price rising. We recently witnessed the third halving event in May 2020 where the coinbase transaction decreased to 6.25 BTC from 12.50 BTC. There are several factors to consider for mining, such as the useful life of mining equipment, possibly capturing the early stage of a bull market, and now you can leverage bitcoin futures to obtain extra returns.
“History doesn’t repeat itself, but it often rhymes.” —Mark Twain
About a month before the second halving event in May 2016, Bitmain released the Antminer S9. It has a hashrate of 14 TH/s with a power consumption of 1375 watts. Mining machine manufacturers always warn that any individual machine’s performance is always subject to a slight variance. Bitmain announced the new machine on www.bitcointalk.org which was where most of bitcoin conversations occurred before it migrated to reddit and now Twitter. On this message board, many people discussed the expense of the new machine against bitcoin’s trading price around $500. According to Chart 1, this user calculated that it would take 140 days to breakeven.
Bitmain was the primary bitcoin miner manufacturer during this time. They priced everything in BTC. It cost 4 BTC which was equivalent to about $2,000 per machine. When the price of bitcoin went higher in 2017, they slightly lowered the price in bitcoin. However, the USD value went higher. In Chart 2, we witness a sharp increase in the S9 price (based in USD) during the crypto bull run of 2017.
Some people paid the high price of $6,500 per machine in December 2017. Purchasing the machines in December 2017 produced several headwinds for any bitcoin mining operation compared to buying them in May 2016 such as a shorter useful life and a higher price.
Higher Price for S9’s
Since Bitmain is based in China, the company cannot accept fiat payments. They only accepted crypto where their preference was Bitcoin Cash (BCH). Since crypto prices were increasing dramatically, they did not adjust their BCH or BTC prices quickly enough which resulted in higher fiat prices for the S9’s. Thus, purchasers who bought later had to pay a higher price for a machine that would possess a shorter lifespan.
Newer machines, it is believed, will have longer useful lives than their predecessors. The lifespan of the Bitmain S19 Pro or the Whatsminer M30S+ is expected to last four years till the next halving. It might even be longer this time with Moore’s law seemingly slowing down. Here is a quick comparison of the two current leading mining machines.
Shorter Useful Life. 2 years versus 4 years
Due to a large backlog of orders in 2016, the lead time for the machines to be delivered was 3-6 months. The irrational exuberance in the crypto market led many people to believe they can easily set up bitcoin mining operations. Due to the long lead time, it reduced the useful life of the machines to about 2 years. Currently, mining machines are sold out. However, we are still early in the cycle to start mining and companies such as Compute North have relationships to source new machines. If the crypto bull market repeats, it will be interesting to see what happens to bitcoin mining machine prices. Even though current prices are fixed to USD, it is expected machine manufacturers might increase prices if bitcoin is much higher, like Bitmain did in 2017.
Once again, an additional factor to be aware of is there can be a variance in the performance (or TH/s) of the specific miner as the manufacturer warns.
Fortunately, both companies now accept a crypto USD as payment such as USDT, or Tether. Based on Chart 3, Bitmain appears to be the better bargain. However, there are recent rumors that 20% of Bitmain’s machines have arrived DOA (dead on arrival). If you have your own staff to fix the machines, you possess an edge since you can purchase the more efficient and cheaper machines. However, it is important to note that most manufacturers will not immediately help you with a broken machine unless you are deemed a high value client. And in this industry, time is money – when you are down, you are not producing revenue.
For example, let’s assume you purchase a Bitmain S19 Pro. Assuming a useful life of four years, using straight line depreciation, you can deduct $601.75 annually or $50.15 monthly. Even now, the S9 still has value for mining operations that have contracts for electricity below $0.02 KW/h. Thus, when the S19 Pro is not profitable for you, it might still be valuable to another miner so the machine maintains a salvage value. Based on some fundamental research conducted by Charles Hwang, Managing Member at Lightning Capital, he believes the market will likely witness the bull run of 2017 repeat next year. For the miner who can hold their coinbase transactions versus selling them, they might have a better edge than their competitors. He continues to discuss the bitcoin halving event to the oil crisis in the 1970s where there was a supply shock with an increasing demand. His theory is that we will witness possibly astronomical returns for bitcoin in 2021.
There is a bitcoin mining calculator that has proven to be fairly accurate assuming your inputs are correct. Based on today’s calculations, if your electricity cost is about $0.05 KW/h, you will generate close to $2,000 in profit annually at the current difficulty rate.
One of the options miners have is to hedge their operating costs with bitcoin futures contracts through the Chicago Mercantile Exchange (CME). There are a few advantages executing this strategy: reducing price risk, generating extra yield, and obtaining better tax efficiency. Currently, the futures contracts are in contango. In other words, the futures price is higher than the spot price. Based on Chart 4, the price is currently providing an extra 16% annualized yield.
A bitcoin miner can short a futures contract to hedge the anticipated bitcoin they will receive that month. Miners have several options such as hedging their operating costs with the futures contracts or deciding to completely hedge all their bitcoin as they receive it through their mining operations. There are clearly other combinations a miner can select.
According to IRC (Internal Revenue Code) Section 1256, futures contracts are taxed differently from other assets. Please consult with your own tax professional regarding your tax situation. Regardless of the holding period, futures contracts have a blended rate where 60% is based on the long-term tax rate and 40% is based on the short term tax rate. If you are in the highest tax bracket, this creates a blended rate of 26.8% which is much lower than the short-term tax rate of 37%. A reminder that you are also receiving a slightly higher return hedging with the futures contract while reducing your price risk.
If you believe in the future viability of bitcoin, there is a strong argument that mining bitcoin is capitalizing on electricity arbitrage while accumulating bitcoin through a dollar cost averaging method. The biggest challenge will be knowing when to sell your holdings. If history does repeat itself, bitcoin could experience a parabolic rise with a subsequent crash. The key is to liquidate before the crash.
As mentioned, currently there is a hardware shortage through Bitmain and Whatsminer. The advantage with working with a well-respected company that has vast experience in this space such as Compute North is that they provide a significant edge. They can help source the mining machines sooner and have them set up quickly, minimizing any down time you would experience individually. They also have the experts on hand to deal with any issues you may have. Furthermore, teams like this have the expertise to optimize your hashrate and efficiency, sometimes producing over 20% more bitcoin. If you have considered mining bitcoin or expanding your operation, in Mr. Hwang’s opinion, this is one of the best times to do it.