The Great Miner Squeeze of 2022

The Vicious Cyclical Nature of Bitcoin Mining

At the end of 2021, CoinDesk published its first-ever year-end survey of Bitcoin miners and asked them for their predictions for 2022. When you read the predictions now, it is clear that the mining industry was caught up in the euphoria of the bull market. Most of the predictions involved a continuation of the good times of 2021, and many mining experts expected the hash rate to eclipse 300 EH/s as miners expanded their operations and increased the efficiency of their machines by upgrading to the latest generation of mining machines.

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It’s not hard to see why these miners were so exuberant in 2021. It was one of the best years ever to be a Bitcoin miner. When the price of Bitcoin was hitting historic heights, some miners’ profit margins were estimated to be as high as ~90%! Amanda Fabiano, the Head of Mining at Galaxy Digital, was cited as describing the mining scene in 2021 as a “gold rush period” due to the high profitability of these mining operations. 

As the price of Bitcoin soared, miners benefited handsomely. As profits rolled in, more and more of these mining companies went public and made plans to expand their operations aggressively. At the start of 2021, there were only two Bitcoin mining companies listed on the Nasdaq. By the end of 2021, sixteen Bitcoin mining companies were listed on the Nasdaq. 

This gave these publicly-traded miners access to capital that they had not been privy to previously. The result was a lot of these miners hoarded their mined Bitcoin and borrowed money to expand their operations and purchase more mining equipment at the height of the bull market. Some of these loans were even financed with the miners’ existing mining machines and infrastructure put up as collateral. But then 2022 came around, and these miners learned how vicious and fast this market could pivot. Capital has completely dried up since the price of Bitcoin has fallen.

Due to a combination of the declining Bitcoin price, continued increases in network difficulty, higher electricity costs, supply chain disruptions, and worsened mining economic conditions, these miners’ profit margins have been compressed from all angles this year. 

Long gone are the days of yesteryear when miners could easily find lenders and raise capital. Nowadays, mining companies are finding it much more difficult to raise cash. This comes at a time when these miners are becoming cash-constrained and find themselves with significant operating expenses and debt payments during a time of reduced cash flow. This puts these mining companies in precarious financial positions.

As such, miners are struggling to keep the lights on in this challenging environment. Many are desperately trying to raise cash to service their debt obligations and cover their operating expenses by selling their Bitcoin, selling their machines, or raising more capital (if they can find it). Signposts of the predicament miners find themselves in today have been popping up in the headlines.

A couple of weeks ago, Compute North, one of the largest operators of mining data centers, filed for bankruptcy and revealed that they owe as much as $500 million to at least 200 creditors. In more evidence of miner stress, Argo Blockchain announced strategic actions to strengthen the company’s balance sheet by selling 3,400 machines and raising $27 million via equity financing. Lastly, Greenidge Generation recently announced the sale of millions of Class A shares to raise approximately $22.8 million in cash. On top of that, the Greenidge Generation CEO resigned, and their expansion in Texas has been halted. 

There is no way to sugarcoat it — Bitcoin miners have been put through the wringer in 2022. There have, without a doubt, been countless smaller or private mining companies that have quietly gone under this year as their operations became unprofitable. But is the worst of it over? Are there reasons to feel optimistic about the future for miners? 

Let’s dig into the various major inputs that impact miner profitability and look at some of the possible headwinds that miners face for the rest of the year. 

High Hash Rate is Making Life Harder for Miners

All of this comes down to the fact that Bitcoin mining is a highly cyclical industry. During bull markets, miners invest in new mining infrastructure that typically takes months before they become fully operational. This dynamic leads the hash rate to lag the price of Bitcoin. Much of the hash rate coming online today is coming from public miners plugging in machines as a result of decisions that were made 8-12 months ago. These miners spent funds and ordered machines but, in part because of supply chain disruptions, this hash rate didn’t start to come online until the summer of 2022.

Another possible contributor to the recent rise in Bitcoin’s hash rate could be a result of Ethereum’s recent merge to Proof of Stake. Some industry analysts have proposed that Ethereum GPU mining farms are selling their now-useless Ethereum GPUs, and using the proceeds to purchase cheap Bitcoin ASIC machines on secondary marketplaces. They already have the mining facilities built, and now these mining farms have newly available rack space, so why not buy some ASICs and mine some Bitcoin?

As the hash rate has soared from these developments, the price of Bitcoin has dropped precipitously. The price of Bitcoin is currently down -59% YTD at the time of writing. This creates a situation where the price of the commodity that miners are producing has fallen off a cliff while, at the same time, the hash rate is increasing, a “double-whammy” for these cash-strapped miners. 

The Bitcoin network hash rate has recently hit a new all-time high of 258 Eh/s.

This means that Bitcoin’s security has never been stronger than it is today.  Today, it requires more hash than ever before for a bad actor to perform a successful 51% attack. More energy than ever before, more specialized ASIC machines than ever before, and it still takes a lot of capital and fixed investment, operating expenses, etc. On the flip side, a higher hash rate means that these miners’ profit margins are being squeezed further.

The big consequence of all this new hash rate coming online is it increases the difficulty for these miners to mine a block. The higher the hash rate, the higher the difficulty, which impacts miners’ profitability because it makes it more difficult to mine a block and collect the block reward. 

The difficulty adjusts roughly every 2 weeks in response to the rise and fall in hash rate and average block times. Today, the difficulty is sitting near an all-time high, and the recent difficulty adjustment on Monday was +13.55%, the largest increase since May 2021 and one of the largest single difficulty adjustments of the last several years.  

This sharp increase in hash rate and difficulty can also be attributed to developments like new high-efficiency machines such as Bitmain’s S19XP finally getting delivered and coming online, cooler temperatures that improve the uptimes of the machines, as well as a recent decline in electricity costs in the U.S allowing less efficient machines to again be economical to plug back in. For the miners though, it doesn’t matter much what the cause is, the only thing that matters is it just got a whole lot harder to mine a block.

The cost of power is one of the most important inputs that impact a mining operation’s profitability, and electricity prices can vary across different geographic regions. The good news for miners is the average price of electricity in the U.S. has started to level off, the bad news is the price is still up massively over the last couple of years. The average price of electricity per kWh in the U.S. currently sits at $0.167 per kWh. This is up 17.6% over the last 12 months.

Energy prices have been steadily rising, and this has been a huge headwind for the mining industry as a whole. 

Another input that fits into the equation for miner profitability, albeit a smaller one, is the average transaction fee per block. The block subsidy is not the only portion of the block reward, transaction fees also play a role. Therefore, transaction fees impact miner profitability, although it only makes up a small percentage of the block reward today. When you look at the average transaction fees per block today, you can see how it has been in decline since Q2 of 2021. The average transaction fee now sits at just $0.80 over the last 2016 blocks. 

All of these factors combined, the rising difficulty, the falling Bitcoin price, the rising electricity price, and the falling average transaction fee per block, have negatively affected miners’ revenues and, thus, their profits. 

Hashprice is a good way to estimate miners’ revenues based on the price of Bitcoin and the difficulty. It is a measurement of a miner’s daily revenue per TH/s of hash rate. Below one can observe how these miners’ revenues have plummeted over the course of the last year. Miner revenue, as measured by hashprice, is now down -79% in the last 12 months and currently sits near all-time lows.

This is especially important when you consider that a lot of these miners have fixed costs that become tricky to afford when their revenues can fluctuate wildly with the volatile price of Bitcoin. If these reduced mining economics sustain themselves much longer, then miners will need to somehow figure out ways to continue to raise cash to survive this bear market.

How Are Miners Raising Cash?

We talked about how many of these miners gorged on debt when life was good in the raging bull market. Fast forward to today, and their revenues are near all-time lows, and they still have debt obligations and CapEx payments to make. Companies that overextended themselves by leveraging their Bitcoin stockpiles or their mining machines to finance new machines and equipment, now find themselves in desperate need of cash.

One way they can raise cash is through equity financing. This is when a company sells shares to raise cash. In other words, they effectively sell ownership of the company in return for cash to service short-term needs. This is what both Argo Blockchain and Greenridge Generation recently did. The problem is that these public miners’ share prices have dropped heavily in 2022.

Without getting into specific companies, below is the stock performance of 16 public mining companies to give you a sense of the general trend of how they have fared over the last 12 months. In short, it’s been a bloodbath. The average performance of these publically-listed Bitcoin mining companies is -86.8% YoY. 

The moral of the story, these companies cannot raise the same amount of cash through equity financing that they once could when their share prices were much higher during the bull market.

Another way for the miners to raise cash is to sell their machines and equipment. This is also what Argo Blockchain recently announced when they sold 3,400 machines. The issue here is that the prices of these ASIC machines have also crashed over the last year.

Below is a chart from Luxor that separates the ASIC prices by efficiency. The three efficiency tiers are 1) those over 68 J/TH which are the older generation models like the popular Antminer S9, 2) those between 38-to-68 J/TH, which includes mid-generation models like the Antminer S17 and MicroBT’s Whatsminer M20, and 3) the most efficient models under 38 J/TH tier, which includes the Antminer S19 and Whatsminer M30s. The prices of the machines that constitute the three efficiency tiers are all down >-65% over the last year.

It’s logical to expect that the machines that make up the less efficient tiers will continue to fall in price as the difficulty continues to rise and new, more efficient machines come online, making less efficient machines no longer profitable to run.

Due to these ASIC prices coming down rapidly this year, mining companies are now taking a loss when they sell them to raise cash on the secondary market. On top of that, some of the loans these miners took out with lenders were ASIC-backed loans. These loans are now at risk of being undercollateralized at the current market price of the ASIC machines. Due to all of these dynamics, there has been a lot of debt restructuring as lenders and miners work together and adjust the details of loans to reflect the changed market environment. 

The miners can also try to borrow more money from lenders to help them get through this bear market. However, from talking with several individuals who work directly in the mining industry, the appetite for loaning money to these overleveraged miners has been minimal at best. 

The last way miners can raise cash is, of course, by selling the Bitcoin in their treasury and the bitcoin they produce through their mining operations. June was the peak in miner treasury sales observed in the financial statements of publicly-traded Bitcoin miners. July and August saw elevated levels of treasury BTC sales, but nowhere near the peak observed in June. 

The following chart shows the amount of Bitcoin being transferred directly from known mining addresses to several of the largest exchanges. You can observe how this peaked in June and then dropped back down, which coincides with the treasury sales from public miners noted in their financial statements. 

It is important to note that there are some limitations to this data. First, there is an assumption being made that a miner sending Bitcoin to an exchange automatically means that they are selling it for fiat, and second, there are other avenues in which miners could be selling their Bitcoin that are not picked up by this metric.

With those limitations in mind, I still find it useful as a broad insight into the on-chain behavior of these miners. One can clearly see a general trend where transfer volume picked up from miners to exchanges at a time when miners were confirmed to be selling BTC, as documented in their SEC filings. This on-chain behavior hints that maybe the worst of the miner selling is behind us.

However, if these poor miner economics sustain themselves, there could be more spikes in BTC sales towards the end of the year. With that being said, it should be noted that a lot of the selling that took place in June from public miners is thought to be from public miners shoring up their balance sheets, covering their costs, and paying down their debts. Compared to Q2 2022, miners are in a slightly better financial position today, all things considered.

While no one can know for sure if the worst of miner capitulation is ahead or behind, one metric that has served as a reliable indicator of miner capitulation in previous bear markets is the Hash Ribbon Indicator. This metric takes the 30-day and 60-day moving averages of Bitcoin’s hash rate. When the 30-day moving average crosses above the 60-day moving average, historically, this has accurately marked the end of periods of miner capitulation. One can think of this metric as a bullish signal that signals a turning point where miners are starting to plug back in after a period when many miners have been unplugging their machines amid the bear market. 

While the hash ribbon indicator is not perfect, it can illustrate points in Bitcoin’s history where selling pressure starts to grind to a halt as miners finish capitulating. If you look closely below, this indicator has flashed (marked in purple) before several major upward price movements in the past. 

One explanation for why this has accurately marked price bottoms in the past is that miners are some of the most bullish Bitcoiners out there. They have invested all their time and money into building physical infrastructure that sometimes takes years to become fully functional and start producing bitcoin. These market players have proof of work and have real conviction in Bitcoin’s future. Typically, these hardcore Bitcoiners are some of the last to capitulate in a bear market after all the speculators and investors have already sold. As a result, this indicator has been a reliable indicator of bear market bottoms historically.

If we zoom in on 2022, On August 19th, the Hash Ribbon Indicator flashed for the third time this year, when the 30-day moving average moved above the 60-day moving average.

Notice the difference between the first two times and the most recent flash. You can observe how in the prior two instances, the 30-day failed to stay above the 60-day for more than a few days, indicating that miners were still capitulating. But since this signal last flashed in mid-August, the 30-day moving average has been able to sustain itself above the 60-day moving average. This hints that Bitcoin’s hash rate is starting to recover, that the inefficient mining operations have given up, and that now efficient miners still online have stopped capitulating for the time being. This has historically been a bullish indicator. 

Conclusion

When you combine all this data together, you start to get the picture. This year has been a very challenging year for miners. It has been one big hangover after the party of 2021. 

Many of these miners aggressively moved to built-out their operations and took on too much debt to finance their expansions. This put them in a precarious position when the price of Bitcoin fell dramatically with the broader markets. On top of that, their power costs broadly increased as the price of energy spiked across the world amidst rising geopolitical tensions. Meanwhile, hash rate and difficulty keep hitting new all-time highs, further squeezing these miners’ profit margins. 

They are now scrambling to raise cash to avoid bankruptcy and are finding it more difficult than when the easy money was flowing in the low-rate environment of 2021. With ASIC prices falling, operating costs to pay, and debt payments to make, many find themselves in quite the pinch. If these mining economics don’t improve soon or continue to deteriorate, then we should expect to see miners continue to sell their Bitcoin, sell their equipment, and raise cash in any way they can to avoid bankruptcy. This would continue to be a headwind to the price of Bitcoin. 

However, the on-chain data is showing some green shoots that perhaps the worst is over. From the miner selling behavior and the Hash Ribbon indicator, it can be inferred that some of the most inefficient miners have closed shop and that selling from miners is exhausted for the time being. A decent portion of the Bitcoin held in publicly-traded miner treasuries has been sold, and some of the debt held by these public miners have been restructured or paid down compared to earlier in the year. All things considered, the public miners that have survived are in a slightly better position financially than they were in the Q2 of this year.  

The one bright side to all this is that only the strongest, most efficient miners will survive. Only the very best operators, with the very best balance sheets, and the most efficient facilities, will live to tell the tale of how they made it through the Great Miner Squeeze of 2022. All the inefficient mining operations with high operating costs and poor balance sheets will either be wiped out, or acquired by other miners. Bitcoin mining is truly a game of survival of the fittest, and right now, the creme is being separated from the crop. By the end of this squeeze, Bitcoin’s security layer will be more efficient than ever before.