The 3 Reasons why Bitcoin Miners Have Struggled in 2022
Like most commodity sectors, the bitcoin mining industry is inherently cyclical. In 2021 a spectacular bull market lifted mining stocks to heights few would even have dreamt of. The bear part of the cycle abruptly took over in 2022 and pushed the valuations of mining stocks further down than most anticipated.
The bitcoin mining industry has gone through bull and bear cycles several times before, but the current bear market is unique since it was not only caused by the falling bitcoin price. In a perfect storm fashion, three distinct factors have worked against bitcoin miners, making this bear market the toughest in the history of industrial-scale mining.
At the same time as the bitcoin price fell, the competition among bitcoin miners increased, leading to massive downward pressure on revenues. As if that wasn't enough, miners have also seen their costs increase due to growing electricity prices. In this article, we explain how each of these three factors affected bitcoin miners in 2022. We also discuss whether these factors could improve and allow us to see better times in the bitcoin mining sector in 2023.
The bitcoin price has fallen
Miners' primary job is energy arbitrage - making a spread between their bitcoin production revenue and the energy expense required to produce the bitcoin. A falling bitcoin price puts downward pressure on revenues and narrows miners' gross margins. In addition, many miners have massive bitcoin holdings that will decline in value if the price falls.
Due to the tightening monetary policy, 2022 has been a tough year for most financial assets. Bitcoin has been highly correlated with the Nasdaq since mid-2020, albeit with significantly higher volatility. With Nasdaq down 29% year-to-date, it is no surprise that bitcoin has struggled this year.
The bitcoin price has fallen by 65% in 2022 and is down 75% from its all-time high in November 2021. This price decline had two adverse effects on miners. Firstly, it led to a steep reduction in the dollar value of miners' bitcoin holdings, and secondly, it caused the total industry revenues to decrease substantially.
One of the many unique properties of Bitcoin is that the supply issuance follows a predetermined schedule. Bitcoin miners compete for daily block subsidies of 900 bitcoin plus nominal transaction fees. With fixed bitcoin issuance, the only factor affecting the industry-wide revenue is the bitcoin price.
This year, the bitcoin price's 65% decline has led the mining industry's total revenues to plummet from a daily average of $40 million in January to only $14 million. Such a decline in the industry-wide revenue has naturally led to significant margin compression for all miners.
How could the bitcoin price develop going forward?
In its 13-year history, bitcoin has proved that it thrives in a falling-interest-rate environment and doesn't like tightening monetary conditions. Therefore, it's no surprise that the bitcoin price has fallen this year. The surprise is that it has fallen by 65% while the Nasdaq "only" has declined by 29%. We expect bitcoin to underperform the Nasdaq in a deflationary economic environment, but not by such a massive margin.
In early 2022, bitcoin fell due to the expected tightening of the monetary policy and stabilized at around $30k. It then suddenly plummeted below $20k following the Terra-Luna collapse in May, which started the contagion effects that have swept through the crypto market the recent months. The market chaos culminated with the insolvent crypto exchange FTX collapsing at the beginning of November. Forced selling after this collapse pushed the bitcoin price to a bottom of $16k.
The critical thing to understand is that the only reason bitcoin fell below $25k was forced selling due to the downfall of several overleveraged market participants. Without this forced selling, the bitcoin price would likely trade in the $25k - $30k territory, and miners would still operate with excellent gross margins. When things calm down in the crypto industry as the overleveraged dominoes finish falling, the bitcoin price will likely return to the $25k - $30k area.
In addition, as Arcane Research mentions in its latest report, bitcoin's current bear market has lasted at lengths comparable to the bear markets of 2014-15 and 2018. The current peak-to-through drawdown of 75% is also not far from the previous top-to-bottoms of 85% and 84%. Judging by history, the current bear market might soon come to an end.
The competition in the bitcoin mining industry has increased
In the previous section, we described how the falling bitcoin price led the total revenues in the mining industry to decline. Unfortunately, this development is not the only one that has put pressure on the revenues of bitcoin miners.
The competition in the bitcoin mining industry increased significantly in 2022. The favorable mining economics in 2021 incentivized miners to ramp up capacity, and this capacity has gradually come up and running throughout 2022. It takes time to build mining infrastructure, which creates a lag between the bull markets and new mining capacity coming online.
The global hashrate is the aggregated computing power of all the miners supporting the Bitcoin network. In the long term, a miner's share of the block rewards is proportional to its share of the global hashrate. For example, a miner with a capacity of 2.4 EH/s controls about 1% of the network (238 EH/s) and will earn 1% of the total revenue. At the current total daily revenue of $14 million, this miner will make $140k per day.
The chart above shows how Bitcoin's hashrate has developed in 2022. It started the year at 170 EH/s and now sits at 238 EH/s, corresponding to a growth of 40%. The combination of shrinking industry-wide revenues and higher competition is detrimental to the revenues of each bitcoin miner.
How could the competition in the bitcoin mining industry develop going forward?
As we can see on the chart, the hashrate has fallen considerably lately, most likely due to increasing electricity prices forcing some miners to turn off their machines. Many miners currently operate close to cash flow break-even and will be forced to turn off their machines if market conditions worsen.
Most public miners have low production costs and are not at risk of needing to turn off machines. The miners highest up on the cost curve would be the first to turn off, which would give the public miners' a higher share of the industry-wide revenue.
Still, significant capacity on the sidelines could come online in the next few months, particularly if the bitcoin price increases. Therefore, it's likely that the hashrate will keep increasing for at least until Q2 2023. After this quarter, the hashrate growth will likely slow down as most miners are not awaiting machine deliveries after this time.
Electricity prices have increased
The war in Ukraine has led to a considerable decline in the natural gas supply. Natural gas is a vital component in most electricity systems, leading to rising electricity prices in most markets worldwide.
In the US, where most public miners operate, the average industrial electricity price has increased from $73 per MWh in January to $93 per MWh in September. This 27% growth naturally has created problems for those who did not hedge their electricity prices.
Some public miners, like Riot, had secured long-term fixed-price power purchase agreements before prices started surging, meaning they will keep paying low prices for the foreseeable future. Others, like Bitfarms, operate in hydro-dominated grids that haven't been that exposed to the rising natural gas price.
Unfortunately, not all miners hedged their power prices or operated in hydro-dominated grids. These are now plagued by rising electricity prices at the same time as their revenues have fallen. Some of these miners are currently operating close to cash flow break-even.
How could electricity prices develop going forward?
To project what will happen to the electricity prices, we should look at the natural gas price. This year, the Henry Hub natural gas price is up by 83%, while the Dutch TTF has increased by 69%. What will happen to these prices going forward is entirely determined by the Ukraine war. If the war calms down and Russia resumes gas sales to Europe, the natural gas price will likely decrease, and electricity prices could somewhat normalize.
Still, Russia accounts for nearly 50% of Europe's natural gas supply. With tensions between east and west worsening, it is naïve to believe Russia will not continue to use its energy market power. Therefore, it is highly uncertain what will happen to electricity prices.
Conclusion
Bitcoin mining is a cyclical industry that has been through multiple bear markets, but the current one is unique. A perfect storm of a falling bitcoin price, growing competition among miners, and rising electricity prices have paved the way for potentially the worst bear market in industrial-scale bitcoin mining's history.
The most significant headache for miners is the falling bitcoin price. The mixture of tightening monetary policy and continuously forced selling by overleveraged market participants has turned 2022 into a poor year for bitcoin, with the price falling by 65%. Still, as the chaos calms down in the crypto market, the bitcoin price will likely return to the less undervalued territory between $25k and $30k.
At the same time as the bitcoin price has fallen, the competition among bitcoin miners has increased substantially. Ergo, lower industry revenue must be split between a growing number of players. Induced by the favorable mining economics in late 2021, the most prominent miners made massive machine orders that were delivered in recent months. After the last deliveries in mid-2023, the growing competition in the mining industry will likely come to a halt.
Due to rising electricity prices, many miners have also seen their costs increase in 2022. Luckily, some miners hedged their electricity prices before the energy crisis commenced, while some operate in hydro-dominated grids not reliant on expensive natural gas. The development of electricity prices is hard to predict since it depends on geopolitical circumstances.
The critical takeaway is that it is doubtful that all these three factors will keep going against bitcoin miners. Most likely, at least one of these factors will improve, which would be very positive for the industry. A perfect storm usually doesn't last long.
