So, the first month of a new year is almost past, and its time to take a look at how market sentiment has changed or, correspondingly, not changed. Last time November overview has let us specify two major criteria of the market. First is “expansion,” as we see this direction as primary one of the coming progress. Blockchain technology and its applicability to cryptocurrencies and finance, in general, show no technological breakthroughs and any new inventions, focusing on tools that already widely used on the market – token, ICO’s, altcoins, forking and halving, etc. As we’ve said last time –
We suggest that this process will be slow. Those who have made big money in the past on classic assets will not dive into new business blindly and will test the “new” market for some time by growing investments. This is the way that we see right now is started.
The second factor that holds explosive growth is “regulation.” It can’t be treated as absolutely negative, because big investors need regulation, while market, in turn, needs big investors’ money. But in the process of legal regulation authorities and central banks could tight bolts too strong. By our view –
The major risk for digital assets is its power that they could give. That’s what scaring governments and supervisory authorities. Regulation cares great risks and could make a serious impact on liquidity and applicability of the currencies…by creating such conditions, sanctions, and barriers that could be not acceptable for big funds and investors.
This could significantly limit the results of the “expansion” driving factor. As both factors are valid and have long-term nature – let’s keep watching how the balance will change between them.
But there is another one topic that stands outside mentioned two factors – Bitcoin halving. It becomes the subject of hot discussion, and interest in this topic is rising day by day. Today’s research, we also would like to dedicate the halving problem.
It is a bit sophisticated topic because to investigate it with all scrutiny, and we need to find a lot of relations between such lines as the hash rate and spending on mining hardware, BTC return per dollar of miner company’s expenses etc. This demands deep economic research. But our task is not to make precise calculation but to answer the question on “what will happen with BTC price after the halving.” In our discussion, we use just common sense, and it should be enough to shed light on this subject.
The Bitcoin Halving…
…approximately should come in Spring 2020, somewhere in May, when reward per block in the chain will drop from 12.5 BTC to 6.25 BTC. In other words, after the halving, the system will issue two times fewer Bitcoins every 10 minutes – the supply of coins will reduce twofold.
In general, we should not search for any magic in the operational activity of any mining company. In fact, they are the same company as any classic one, Exxon, IBM, Walmart etc. They have their own revenues and expenses that directly form their net operational result – earnings and income.
The only difference is the name of major lines in Income report, the name of earnings and expenses. It means that once you understand how mining reward will impact on company’s financial result – you easily understand what will happen with bitcoin price after the halving, or, at least, how the change in reward impacts it by miners’ side. Let’s go through it step by step.
This is simple – it is forming by the number of blocks company is created multiplied on reward per block. We know that the reward will drop two times. Hence, all things remain equal – revenue will drop two times as well. The number of blocks per period depends on miner’s hash rate. To increase it, the miner company has to invest in additional hardware and spend more power on mining. Relatively modern ASIC device costs around $ 3,000 with a Hash rate of around 14-16 TH/s. It consumes around 1.2-1.5 K watts.
The expenses split into a few major categories –
- Power consumption
- Hardware (Long-term investments)
- Sales, General and Administrative expenses (SG&A)
Power consumption –
is a primary expense article that directly depends on the net result of mining. While it the US, it stands around $0.1-0.12 per KW/H; in emerging countries, it significantly cheaper. For example, in Russia, for households, it is around $0.02-0.04, while in China – around $0.08.
So, as the current price of Bitcoin stands around 9.5K, it suggests that miner will get a breakeven result if the cost of power will be around 0.07$ per KW/H
Hardware – here, we talk only on specific hardware which is ASIC devices. Of course, there is a lot of other common hardware (memory, M/B, HD, wires, etc.), but it is common to all companies. Relatively modern ASIC device produces 14-16 TH/s hash rate and consumes around 1.3-1.5 kW per hour. To “extract” just single Bitcoin per year you need 10 ASIC devices.
SG&A – These expenses mostly include personal wages, exchange trading, and other fees to buy/sell or transfer bitcoins, rental payments for building etc. The share of these expenses decreases when the mining power of the company increases. In general, it takes a small part of total expenses, especially power supply.
As a result:
- Miners have to be ready for a double drop in Bitcoin revenues after May 2020;
- Expenses per new block created will stay the same, as they based on electricity cost, hardware cost depreciation, and SG&A expenses. In other words, miners will need the same ~ $4.7K on average to mine a single Bitcoin.
The consequences are as follows:
1. Centralization of mining business.
Reward, BTC price, equipment are mostly of the same cost to any company. So what lines are different? Total hash rate (i.e., mining power), electricity cost, and share of SG&A expenses. It means that companies with better mining margin (higher revenue and lower share of expenses) will get a better position on the market.
It means that we will see the process that we saw in the world economy – big companies will have to reduce margin due to unavoidable halving, but they could compensate this effect by increasing the turnover, i.e., increasing mining power to squeeze out smaller companies. Large companies just have a better breakeven level of bitcoin price when mining makes sense. Also, they probably have a good reserve of coins. You could experiment a bit with the mining calculator and see that for any company result depends on hash rate, electricity consumption and energy price. Thus, the company that has lower constant expenses (wage, rent payments, equipment serving expenses, SG&A, etc.) and lower energy prices will have more advantages to rivals. This is most typical for big companies. The halving mostly hurts small companies, but once they stop to work – their capacity will be replaced and consumed by large companies. Small companies could join pools or become an object for a hostile takeover..
2. Mining acceleration till halving while reward is still 12.5 BTC.
We already see this — last time we mentioned big investments in mining capacity by the largest companies. Hash rate shows a clear tendency, particularly in the recent few months, indicating greater miners’ activity. Thus, miners are accumulating bitcoins:
3. No halving effect on BTC supply.
As 86.6% of Bitcoins are already mined and are in circulation, we do not expect any meaningful effect on BTC supply on the market.
4. No miners’ sell-off at low BTC price.
There were a lot of talks when BTC has dropped to ~3.5K, and many traders appealed to mining breakeven price. Thus they talked that miners will start to sell accumulated BTC to get at least something. We disagree. The cost of mining at 90% depends on power consumption. Decreasing/freezing of mining power and dropping the hash rate could let miners control expenses, and it absolutely doesn’t mean that they will start sell-off rush. Selling the accumulated Bitcoins is quite a different part of their business, and they search for a good price like all the others. The only a small part could be sold from reserves to cover fixed expenses. It means that at the price of 9- 10K where it stands right now, we will not see any panic sentiment.
5. Greater sensitivity to lower price edge.
Theoretically, with BTC price constant but twice drop in reward – companies will have to sell two times more Bitcoins to cover their expenses while other parameters stand constant. As the lower prices of BTC will be as more frustrating miners are. Hence, at low price levels time will work in favor of the bears and the market will be extra sensitive to any occasional drops, which could trigger massive sell-off as miners will be at “standby ” mode to start selling coins to cover expenses. We suggest that this barrier starts around 6K per coin. But, as we’ve said – this is also the function of time. Miners wouldn’t be patient forever. 1-2 weeks below 6K could make now effect, but 3-5 months under 6K level will be the challenge to miners’ psyche which results in dropping the hash rate, selling some BTC or in the combination of both measures.
6. Explosive demand for BTC derivatives.
As miners are coming to strict conditions of doing business, they have to search for tools to protect their profit. Using of BTC futures and options are a great tool for protection as they could fix future BTC price at an acceptable level and deliver coins at delivery day. Miners are the same as Export companies that have revenues in one currency (BTC) but care all expenses in another one (say USD). And they have predefined BTC/USD level which is comfortable for long-term mining. Once they see it on the market – they could fix it by selling futures contracts on BTC with delivery at the current price. Or to Buy a Put option which gives the right to Sell BTC at a fixed price on delivery day.
7. Better opportunities for arbitrage trading.
BTC Derivative market is rather thin and not as efficient as classic markets because of a few amounts of trading volumes and participants. Big demand for derivative from miners will increase divergence with the cash market and should let extract additional risk-free earning by using the classic futures pricing model. We talked about in our December report:
8. Weak relation to BTC performance after two previous halvings.
In the previous two cases of halving, the market was in absolutely different stages of evolution. Although after both halvings, there was a solid rally – this time, we do not suggest that it will be the same reaction. Or, speaking differently, if even we will get some rally, it will be backed not by the halving of the BTC.
As a bottom line:
Today we run through major issues of coming halving process on the Bitcoin market. As you can see – this is not as awful and scaring procedure as it is represented in news agencies, traders’ talks, different rumors. Instead of hazard, it mostly provides new dimensions in trading, although they could be specific to the majority of traders and not suitable for everybody.
As miners could control expenses by just decreasing power consumption and reducing mining activity – the halving will not become a death sentence. At the same time – it will not pass without a trace. We believe that the market will be more sensitive to price levels below $6K. Mining business will turn to the consolidation phase with massive closing, pooling or takeovers of small mining companies. Geographical restructuring is also possible and moving mining activity in locations with lower power costs.
Strong demand for BTC bearish futures and Put options probably will make some impact on the cash BTC market. Arbitrageurs activity could make a bearish impact on BTC, but we suggest that it will be shy and temporal because of the amount of BTC that should be extracted after the halving. They are small amount compares to coins in circulation.
Finally, until the halving – miners activity should rise, and we see the first signs of that as the hash rate is rising stubbornly.
For us, it means that there is nothing to worry about while BTC stands above 6-7K but we have to be aware of sharp downside spikes on lower levels, especially if BTC stands their more than a month.