Reuters $600 Breakeven for Miners Claim is Wrong

When it comes to mining, the breakeven cost for miners is the most often asked question. In a recent Reuters article, author Edward Hadas states that the “full cost of production is closer to US$600 per token, based on a recent study by Australian researcher Hass McCook.“

Hass McCook who is independent economic researcher and an MBA from Oxford, says that he was misquoted in the article and was not interviewed before it was published. According to McCook, they used a figure which was from June when the bitcoin price was in the 600’s and did not take into account the current economics and price of bitcoin.

Speaking to Cointelegraph, McCook estimates that the most innovative of the chip fabricators can break even at US$160 on the cheaper end in contrast to US$350 on the most expensive end using 30 kilowatt Antminers. But typically the cost would be about US$300 based on the cost of electricity. All other miners generally fall somewhere in between. But as we have seen lately the economics and price of bitcoin have led many mining companies across this spectrum to shut down. 

Equilibrium

McCook’s model is based on the Pareto Principle (80/20 Rule) and the average cost to mine. He has written the Introduction to Bitcoin Mining Economics: A Critical Assessment of the Micro and Macroeconomics of the Bitcoin Mining Industry, using the gold mining industry as a theoretical proxy.

For those who are interested in the formula, variables and calculations, a link to his paper is provided here.  All of his work can be found here.

McCook says that for anyone who is calculating the cost to mine, one should expect the cost to be within 10% of price. If it’s materially different “one should expect some price action or go home and do your homework and get more robust assumptions” because your assumptions are wrong.

The reason for this is that the market is very efficient and equilibrium will be found very quickly between the cost to mine and the price. If the price goes up, the hash rate needs to go higher along with the cost to mine otherwise the upward price is not sustainable and will go back down.

McCook states that after each bubble there was nonstop hash rate growth until equilibrium was found between the price and the cost to mine. As an example of his theory in action, he talked about the run-up in price before the Mt. Gox collapse when the value went from US$200-$1,200 within an 8 week span.

McCook states the hash rate simply doubled as there was no new efficiency or ASICs at that time. Thus, the price skyrocketed 10x and the cost to mine only doubled. The price was way out of sync with the hash rate and the cost to mine and was not followed by an increase in demand so the price corrected back down to a place of equilibrium.

This has happened in every “bubble” in bitcoin’s price as there was an oversupply with not enough demand to match it along with more and more payment processors who have enabled merchants to “accept bitcoin” albeit converting it on the spot.

McCook doesn’t see much demand even at current levels but noted that the current bitcoin price range looks a lot more stable than it had a year ago.

Just like the oil industry

As McCook’s formula shows, the average cost to mine a bitcoin is the average price of a bitcoin based on a perfect economic model of supply and demand. When demand decreases the price plummets as most miners will turn off and only the best and most efficient ones will stay on. According to McCook, this is very similar to the oil industry:

“If the price drops to US$10 big mining will stop mining to bring their cost back up to breakeven based on equilibrium in supply and demand. This is no different from what you are seeing in oil. The Saudis can still afford to drill at cheaper oil because their cost structure is lower while others drop off.”

Innovation leader vs. Cost leader

Innovation leaders grow profits on the back of innovation, have a new value proposition for the market, and are monopolistically competitive economies. An example of this is smartphones. With Apple and Samsung, for example, there is very high differentiation between the companies (closed vs. open systems) but they both are the leaders because of their respective technological advantages.

Cost leaders cannot innovate. They reduce costs in the supply chain. Decrease electricity costs, decrease colocation costs, and decrease labor costs.

Profit = Revenue – Cost. Or, in other words, innovators increase revenues through technological breakthroughs while cost leaders increase profits by driving costs down.

Hass McCook gave a hypothetical example of a cost leader as a retailer (commercial or individual) mining in Iceland for 3 cents per hour based on a huge collocated facility deal with Bitstamp selling at market price.

Where mining is headed

The extreme performance and efficiency improvements seen over the past 7 months are expected to continue over the next few years.

“Our goal is to get to 0.05 W/GHs, 0.03 $/GHs miners by mid-2015 and power more than 30% of the bitcoin network,” said Guy Corem, CEO of Spondoolies Tech, a leading Bitcoin Mining ASIC maker in a December 2014 interview. He also believes that “these figures will help the company match its rival firms in the US and China.”

From McCook’s report, Introduction to Bitcoin Mining Economics:

Due to the laws of perfect competition, it can be assumed that only the most profitable miners are switched on at any given time, and that when a new generation of mining equipment is released, equilibrium is reached very quickly where all miners are operating at a similar cost basis.

 

Retail Best

Chip-Fab Best

Weighted Average

$/GH

$0.2925

$0.22

$0.234

W/GH

0.51

0.38

0.408

$/W

$0.10

$0.07

$0.076

% of Network

20%

80%

 

‘Perfectly competitive market’

As of the date of this report, the total network hashrate is ~295,000,000 GH/s.

As technology improves the cost/GH will get cheaper, watts/GH will decrease and if the total network hash rate is stable, the price will plummet. If the network is not growing in size and efficiency is decreasing, then the price will go down. Meanwhile, if network size increases and efficiency increases, then mining will stabilize.

Price is demand oriented and since the supply is relatively fixed, the cost of mining should equal the price of bitcoin at any moment in time. If demand increases, supply will find a way to meet it.

Profit is maximized where marginal revenue equals marginal cost, essentially where price equals cost.

Right now in this environment McCook guesses that the only miners making money are the chip fabricators who have good control over the supply chain along with those miners who average 3-4 cents per kw/hr. These people are simply more efficient than the average rate, which is ~7 cents per kw/hr.

“Market competition comes in many forms; monopoly, oligopoly and perfectly or monopolistically competitive,” says McCook. “Bitcoin falls into the category of a perfectly competitive market in the long run, while in the short run its near perfect.”

Conclusion

We learned that the cost of production has been severely exaggerated by the mainstream media and is nowhere near the US$600 mark. In fact, the cost of production is dynamic and currently falls within the US$160-$350 range depending on various aforementioned factors. Improvements in mining efficiency will result in more downward pressure on price in the future.

As long as the price stays within the given range, more and more miners will go offline (particularly retail and cloud mining) while only the innovation leaders who are the manufacturers with efficient supply chains and large mining pools will continue to operate in this space.

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