Look at those beautiful tasty Bitcoin's. They're just waiting to be mined and pulled out by one of your server farms to reward you for all the time and money you've spent to solve the cryptographic code and get your bitcoins.
When prices are breaking through one record after another mining Bitcoins is kind of a no brainer for some people. It's a no brainer for them because mining relies on a very basic economic equation:
- Miner puts in X + Y = Z
- Selling Price Q is at minimum slightly higher than Z
- If the price of Z goes above the price of Q the Miner stops working
In plain English, X would be the cost of the servers/setup to mine the coins and Y would the ongoing energy and associated costs of running the servers. Q is the current Bitcoin market price (or any cryptocurrency requiring mining.)
But what happens if/when the prices of Bitcoin start to invert and become more expensive to produce than the selling price? Granted in the United States the price would have to fall another 55% before it would hit that first inversion but keep in mind, the United States isn't the most expensive country to mine Bitcoin.
The price for mining one Bitcoin ranges from $531 in Venezuela, to $3,224 in the United States, to upwards of $26,160 in South Korea. Important to note that these figures are based on the energy consumption of running and cooling the servers. You have to add on to these prices the amortized cost of buying the servers, cost of the space, setup etc. which in today's Bitcoin market run into the mid to high 6 figures for a small operation.
For example Salcido Group in the United States runs 1,800+ servers 24 hours a day and is able to produce roughly 5 bitcoins a day. With the average price of $2,000 for most Bitcoin servers you're looking at $3.6 million just in servers. You need to pay for the lease as well.
Irrespective of how cheap your electricity is the fact remains that getting involved with Bitcoin mining is expensive from a hardware perspective. The days of using your laptop or some cheap setup are long gone. Sure you might see some feel good video online about some guy/girl in some super poor country mining bitcoin with some super low level equipment but it's just made for TV. Don't think for a moment they will save/run the Bitcoin system. For example, it is beyond unlikely that anyone in Venezuela with a few million dollars to invest would consider setting up a Bitcoin farm given the political, economic and corruption issues. Foreigners are even less likely to go there and set up shop. I'm not trying to be mean, but if you want to invest you can't use magical thinking hoping that millions of dollars will flow into third world countries with cheap electiricity to save Bitcoin production costs.
So now you might be asking yourself, ok, I get it, Bitcoin mining is expensive and it takes a lot to get involved. How does that impact the technology, price, etc? I'm glad you asked. Follow me for a moment and bear with me till the end. We have to bring a few concepts together so that it's clear but at the end you will get it.
Just like we have the basic economic equation laid out earlier, let me lay out the basic Bitcoin ecosystem relative to miners and price:
- Every time a Bitcoin is traded/used/purchased etc. that change has to be validated by the Bitcoin system i.e. the Miners
- Miners solve the cryptographic problems to validate the transactions and create the block.
- Miners receive Bitcoins as PAYMENT for validating the transactions.
- This is an important concept to remember. Many crypto advocates push the idea that there are not transaction fees like those paid in traditional banking. But there are still fees and they're very expensive. Bitcoin and cryptocurrencies are not free to operate and fees are technically charged in the creation of the initial coins and subsequent validations
- Miners MUST sell/convert their Bitcoins into fiat currencies to pay for the operation of their servers, power, etc. This means the fiat currencies exchange rate is crucial to keeping Bitcoin going. Whatever is leftover after all the expenses are paid is the PROFIT.
- Bitcoin becomes more expensive to mine every year and at every halving of bitcoin/block payouts:
- As more coins are mined the difficulty increase and the required energy to solve each problem increases.
- New/Faster servers will be required (additional cost to the miner) to remain competitive in the market. Otherwise the Miner's old equipment would produce significantly less/no coins and the miner would just be paying high electric bills for nothing.
- When the next halving occurs in 2020, the payout will drop from 12.5 Bitcoins/Block to 6.25 Bitcoins/Block. That means they'll have 50% less for doing more work.
- If the price stays constant the Bitcoin system becomes invalid as no one will pay to mine Bitcoins at a loss.
- The increased difficulty and the corresponding energy/equipment costs means the base price for profitably mining Bitcoin is raised constantly.
Now I want you to take a moment and think about this: what happens when/if the price of Bitcoin falls below the cost of production + amortization combined? Will Miners still validate the transactions?
I'd suggest that they wouldn't lose money to mine/validate transactions at a loss for long. Irrespective of how many coins a miner were to earn they wouldn't be able to cover their costs unless they covered the losses themselves. Also, they would see their wallet balance drop, while their costs would be rising on a regular basis due to the increased difficulty and equipment requirements. If you disagree and believe the Miners would cover financial losses and work for free because they are a part of the crypto revolutionary movement, I'd also assume you'd be willing to pay your boss everyday to go to work without a paycheck, just IOU's. I didn't think so.
So now we're cooking. Once it becomes unprofitable to validate transactions, it's logical and expected:
- Miners to cease work
- As Miners cease work, fewer miners will be in the system to validate transactions, hence longer wait times.
- As fewer Miners are validating, transactions will be slower, utility and trading will be slowed/eroded which will push the price further down.
- It's fairly simple to see how this can easily go into a self-fulfilling downward spiral if the price of Bitcoin drops below the price floor for any period of time.
The main take away from this is to understand the risk associated with Bitcoin at lower price levels. Unlike stocks, when the price falls below a certain point the system stops working all together. You wouldn't be able to sell any of your position at very low prices possibly if there weren't enough/any miners participating in the validation process. You could easily be stuck with a bunch of non-physical Bitcoin Data on your system that you literally can't move.
There is also the issue/question of how the system will work once all the 21 million Bitcoins have been mined. How would Miners who handle the validation process be compensated? No one knows yet and it would be a difficult problem to address. If you have a business idea of how to address this issue let me know. I'd love to hear it. If no one comes up with a viable solution that the majority of Bitcoin users agree on, the Bitcoin system would stop working at that point.
Be prudent in your investing and do your homework to understand the risk of what you're getting involved in.
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