The rise of large mining companies is inevitable
2020 marked a new era for institutional mining, giving rise to new possibilities and problems.
There are very few investments capable of combining infrastructure and venture capital. Mining, if taken to the highest level, allows arbitrage in the energy markets and simultaneously accumulate Bitcoin (BTC). This is why we are witnessing a boom in the Bitcoin mining industry and start building mega-structures. So let’s analyze some of the main elements to be taken into account for a profitable mining company.
Securing new generation hardware
At its peak performance in 2018, Bitmain was producing over 95,000 machines per week. However, since then, its production levels have dropped, also due to the ongoing legal dispute. On the other hand, MicroBT plans to deliver hundreds of thousands of devices during the year.
Western countries receive only a small proportion of these new machines, and with 17 listed mining companies and large ASIC speculators announcing purchases every week, it is easy to conclude that that limited supply of new equipment is quickly running out. Building direct relationships with manufacturers has become critical to ensuring a wide availability of new machines. But how do you ensure a stable supply of hardware? With a large chequebook, of course.
Reduce capital expenditure
Economies of scale are at odds with decentralisation. Yet, like most other economic sectors, mining rewards large dimensions. More structured mining companies have access to discounts on ASIC retail prices. With an average depreciation period of around 300 days for new generation equipment, the discount can be reduced by more than one month. In addition, large miners pay less down payments, in some cases around 20%, compared to over 50% for retail sales. This allows miners to buy more equipment and build larger structures faster.
From an infrastructure point of view, in most cases the construction of a 30 megawatt mining farm is much cheaper per MW than a 3 MW plant.
Maximising operating profits
If you want low-cost energy, you will need to invest considerable capital for expenses such as the purchase of land, generators and equipment, the construction of large infrastructure, the financing of performance bonds, etc.. Although small miners take advantage of low-cost energy sources, the most profitable companies are the largest: they have the capital needed to secure the best positions and, as we know, the cost of electricity is one of the determining factors for success.
Beyond the supply of cheap electricity, large miners can negotiate lower fees for pools, firmware development and ASIC management software. They can also reduce the amount of manpower required per MW, increase the efficiency of their management and improve the effectiveness of their energy use.
Access to higher financing mechanisms
Mining is a capital-intensive activity as it requires constant equipment upgrades and new purchases. The construction of a 10 MW mining farm with new generation equipment can cost almost $10 million, depending on the purchase price.
Access to various forms of financing is therefore essential to ensure that the facilities remain large and enjoy the benefits discussed above.
From 2018 to 2019, most of these mining operations were financed through a mix of debt and equity. In 2020 we saw a boom in ASIC funding. Large mining companies are now able to raise funds from lenders using their ASIC machines as collateral. The number of these lenders is still limited, so they give priority to the best low-risk operators.
Manufacturers have also changed
Most of the first questions that are asked when the mining opportunity arises relate to the equipment: „Where does the equipment come from? Who is the manufacturer? Is there a guarantee? What is the price? Why does the price change every day? When are the machines shipped?
Manufacturers like Bitmain have been pioneers in the crypto investor review since this industry was a real Wild West. In 2016 the race began to bring as many machines as possible onto the market. Things like company policies, shipping and pricing details, warranties, repair centres and transparency were almost completely ignored.
When big business entered the industry, everything changed, from the mentality of manufacturers downwards. Now mining equipment manufacturers make weekly phone calls to key customers, discussing production visibility and offering greater transparency in operations. In addition, most manufacturers now offer machine warranties, have opened repair centres and try to be more transparent about shipments and prices, although overall the industry still has a long way to go.
This trend towards professionalisation of the sector is likely to continue in the West.
Mining pools offer greater transparency
Another question that a large company could ask itself is: „Where will the money come from?“.
Usually, the answer is: from a mining pool, because they buy hash installments. So it is legitimate to ask who this counterparty is and what risks are associated with managing them.
Pools have historically been a problematic element in the mining value chain. Large companies have helped to increase the price transparency of mining pools, reduced the number of pools they steal from miners, and encouraged them to develop a new set of features. The mining pool industry is evolving rapidly and if companies do not keep pace, they will lag behind. All these trends will benefit large companies who want to deal with serious and compliant counterparts.
Consolidating the industry
A wave of consolidation is probably on the horizon in the mining sector: there are hundreds of large companies and teams fighting for space, ready to be acquired.
The main consolidation will take place at farm level. These mergers and acquisitions will most likely take place at the project level rather than at the company level, similar to what happens in the real estate industry.
Financial services companies will also be natural buyers, as they will seek to build an ecosystem that embraces both the mining and financial value chain.
Financing the hash rate
With each traditional commodity, companies have the ability to leverage financial instruments to hedge their cash flows through futures and options, sell part of their production in purchase or forward contracts, and more.
To date, there are very few financial instruments based on the hash rate. The entry of large companies will change this situation, as they are creating demand for this type of product. The need for miners must be met by other players, such as traders, to create liquid and solid markets.
Five-year prospects for mining
If you had told the miners in 2015 where we are today, they probably wouldn’t have believed you: millions of ASICs securing the grid, gigawatts of energy used and companies like Fidelity opening their own mining company.
It’s hard to predict how the industry will evolve over the next five years, but I believe that large institutions will continue to drive innovation in the industry, creating a safer network for Bitcoin. But this will also lead to new challenges such as protocol censorship, more Know Your Customer/Anti-Money Laundering procedures, less decentralisation and so on. Mining companies will have to work closely with these new players to create a better future for BTC.