Bitcoin miners play a high-stakes game of chicken

Over the past year, the sector has been hit by a fall in the price of bitcoin, combined with a rise in energy costs and an increase in mining difficulty – a reflection of the amount of computing power directed at the bitcoin network, which dictates the proportion of coins miners are in able to win.

At the height of the 2021 boom, profit margins in the mining business rose as high as 90 percent, says Thiel. But now they have “completely collapsed”. If the price of bitcoin doesn’t rise, he says, there will be “a lot more pain,” and firms that are only marginally profitable today will find themselves “very underwater.”

As they scramble to cut costs, miners are playing a high-stakes game of chicken. In the spring of 2024, the halving, a mechanism baked into the bitcoin system that periodically halves the number of coins allocated, will reduce mining profits. The goal for miners is to ensure that they are in a strong enough financial position to survive the drop in profits longer than anyone else; as miners give in and drop from the network, the proportion of coins won by the rest will increase.

“Any miner struggling now will not be able to survive the halving,” says Jeff Burkey, VP of business development at Foundry, which operates its own mining facilities, a large-scale mining pool and a mining hardware marketplace. The dynamic will create a rush among miners to get their houses in order, he explains.

Miners will look to gain additional profit margins where they can, either by implementing superior hardware and cooling techniques, developing software to closely monitor the performance of machines, moving to territories with cheaper power, or renegotiating the terms of their loans.

Others, such as Geosyn Mining, aim for vertical integration – right down to the energy that powers the plants. The company, says CEO Caleb Ward, wants to build its own solar farm to power its machines, eliminating a major cost. “We need to be more thoughtful as an industry about how we protect against risk,” he says. “It’s not just about shooting for the moon.”

Meanwhile, the miners whose financial difficulties prevent them from fine-tuning their operations are playing a dangerous waiting game, gambling on a rise in the price of bitcoin that may never come.

“The beauty of halving cycles is that the industry [is forced] to become more efficient – many weaker players will have to leave the business, says Jeff Lucas, CFO of mining company Bitfarms, which has been working to restructure its finances during the downturn. “The devil is in the details.”

Already on the back foot, the mining companies are starting to pounce. Compute North, which owned several major mining facilities, filed for bankruptcy in September, and Core Scientific, a publicly traded miner, did the same in December. Others have to maneuver. Argo Blockchain, also a public company, was forced to sell mining equipment and its state-of-the-art mining center, while Stronghold Digital Mining has negotiated a debt repayment holiday. None of the companies responded to interview requests.

A combination of “immaturity, poor planning and greed” has brought miners to the brink of collapse, said Phil Harvey, CEO of Sabre56, a cryptomining consultancy that also operates its own facilities. While the market was hot, companies took on large amounts of debt at high interest rates (10-20 percent) to finance expansion, Harvey says, and now the value of the coins they earn is not sufficient to cover the cost of repayments.

Historically, a steep rise in the price of bitcoin, triggered by a buying frenzy, has been followed by a sharp fall and then a gradual recovery. Although there is no guarantee that this pattern will repeat itself, the process is widely described as the bitcoin cycle. The fatal mistake, says Jaime Leverton, CEO of mining company Hut 8, was imagining that 2021 was different – that the industry was in a “supercycle” that would “break previous cycles” and extend the hot streak. Many people bought into this idea, she explains, and were therefore caught off guard when the market moved.

In an attempt to strengthen its own position, Hut 8 is in the process of merging with US Bitcoin, another mining company. The goal, says Leverton, is to minimize risk associated with the volatility of bitcoin by diversifying both the revenue streams and the regions in which the business operates.

While Hut 8 only has facilities in Canada and mines exclusively for itself, US Bitcoin operates mines across the United States and hosts mining hardware for third-party customers along with other ancillary services. “It’s important to be dynamic,” says Mike Ho, co-founder of US Bitcoin. “It’s an optimal strategy, depending on the price of bitcoin. It’s about knowing how to navigate through the cycle at different stages.”

Recognizing the trajectory of the market, other companies have sought to eliminate outstanding debt as quickly as possible. In the summer of 2021, Bitfarms had 165 million dollars in debt on its books, with interest rates between 16 and 18 percent. Lucas says it may seem “absurd” to put up with these exorbitant rates, but it “made sense” because the cost of debt was dwarfed by the revenue generated by mining activity – at least until it wasn’t.

“When revenues fell dramatically with the price of bitcoin, there was still a high level of debt to pay for,” he says. “And that put a squeeze on a lot of companies.”

In June 2022, Bitfarms began selling off bitcoin in the treasury to eliminate the debt. Earlier this month, the firm also managed to negotiate down a $21 million debt to bankrupt crypto lender BlockFi that was instead paid off in a single cash payment of $7.75 million. The company’s approach to cutting debt, coupled with a focus on maximizing the efficiency of its mining rigs, Lucas says, will put Bitfarms in good stead to make it through the rest of the crypto winter.

The struggle among miners to balance the books has attracted the attention of other market players hoping to increase market share at a reduced price. Investment firm Galaxy Digital has long been eager to expand its bitcoin mining operations. Spotting an opportunity, the company swooped in to take Argo’s flagship Helios mine in December, spending $65 million for a facility that is reported to have cost at least $1.5 billion to build.

Mergers, acquisitions and collapses will continue to be a theme, says Alex Mologoko, an analyst at blockchain intelligence firm Elementus, until “all financially unsustainable mining operations are weeded out.”