BitMEX Research: Capital is flooding into Bitcoin mining, and financial failures are expected to increase significantly in the coming years

Author: BitMEX Research

Original Title: 《Mining Bull Market》

Compiled by: Linqi, Chain Catcher

Abstract

Let’s first understand where we currently stand in the Bitcoin mining cycle. By comparing the current market conditions with the golden age of crypto mining from 2012 to 2014, we find that capital is flooding into the crypto space. We predict that both the network hash rate and financial failures in Bitcoin mining will significantly increase in the coming years. Furthermore, we anticipate that mining companies and products that are more conservative in capital deployment and focus on long cycles may emerge victorious throughout the cycle.

Bull Market

With the booming crypto space, the trading price of Bitcoin has risen from around $5,000 a few years ago to about $40,000 now. Many people are eager to enter this thriving field, planning to establish a company in hopes of making big profits, which is understandable. If your capabilities are not sufficient to launch a DeFi DEX, but you can launch a new Bitcoin mine, what could be easier?

This reminds me of around 2012 when gold trading exceeded $1,600 per troy ounce. In hindsight, this marked the end of a 13-year bull market that began around $250 per ounce in 1999. The gold price multiplied sixfold, and the success of industry veterans led to a frenzy of capital pouring into gold mining. For those who remember the 2012 or 2013 Prospectors & Developers Association of Canada (PDAC) conference, it was an exhilarating time.

Thousands of people hoped to raise funds for their future gold mines, with narratives and promotions that were very similar:

• Two partners with investment banking backgrounds (co-founders of the mining company)
• A very smart geologist serving as a corporate advisor, firmly believing in the project's feasibility
• A high-quality mine located in North America, with a purity of over 5 grams per ton
• The project is only open-pit mining (underground mining is technically too complex)
• The mine is ESG-friendly and has strong local support (the founder has had beers with locals)
• The mine has reserves of about 500,000 troy ounces, with an annual production of 50,000 troy ounces
• Seeking $50 million in initial investment
• Bernanke has only one way he is willing to use, which is to print money. Therefore, gold prices will continue to rise
• In the long run, the company will continuously scale up and become the next Goldcorp

It’s understandable that not all of these potential projects raised the funds they wanted; however, for those that did, most failed to recognize the challenges of development, leading to project failures. Similarly, the rhetoric in Bitcoin mining is as follows:

• Two partners with investment banking backgrounds (co-founders of the mining company)
• A very smart Bitcoin researcher who entered the field early, serving as a company advisor
• Plans to build a 50MW infrastructure in North America, achieving a mining power of 1 exahash per second
• The company plans to partner with Bitmain from the outset and will consider opening up to others as needed
• The company's mining operations will be fully ESG-friendly (carbon-neutral company)
• Requires $200 million in initial funding
• The rise in Bitcoin prices is inevitable
• In the long run, continuously scaling up to become the largest Bitcoin mining company globally

In some cases, we won’t mention specific names, but those who speculated in gold mining in 2012 are now joining the Bitcoin mining ranks. Many of these projects will likely end in failure, just like gold mining projects from a decade ago, although a few may succeed.

Publicly Listed Mining Companies

Below is a list of Bitcoin mining companies that are also publicly traded. The total market capitalization of 21 mining companies is $15.3 billion. These companies are at different stages, with Core Scientific mining power exceeding 8 exahash per second, while Terawulf, for example, has just begun to ramp up production.

Source: Bloomberg

We estimate that the aforementioned mining companies currently generate about 25% of the Bitcoin hash rate. In recent years, as more companies have entered the market, the percentage of network hash rate controlled by publicly listed miners has rapidly expanded, and due to capital acquisition, the expansion rate of publicly listed miners is faster than that of private miners. With Bitcoin prices exceeding $40,000, gross margin performance is expected to be very strong, and a common characteristic among the 21 companies mentioned is that they all have aggressive expansion plans. Large miners (at least the top 15) plan to expand by over 1 exahash each in the next 12 months. Many of these large miners are building independent sites of over 250 megawatts, and almost all operate in North America.

It can be said that many publicly listed mining companies are frantically rushing to deploy capital for scaling. They understand that it is currently easy to obtain investment, but this situation may not last forever. Therefore, if mining companies do not expand significantly now, they may fall behind their peers and never catch up. This is a prime opportunity for CEOs and major shareholders of large Bitcoin mining companies, and they do not want to miss it. It feels like the gold mining era of 2012, but the outcome may not be as favorable.

Based on the current deployed hash power, many of the aforementioned mining machines appear to be quite expensive, especially those that have recently appeared on the public market and are only ramping up production rather than currently mining. Even from relatively simple ratios, such as market capitalization to currently deployed hash rate, there are significant differences in valuation ratios. This may present an interesting opportunity for some investors or traders. Another interesting metric to watch is the comparison of expected mined Bitcoin (based on reported hash rate) to actual Bitcoin mining. This metric is less favorable for some mining companies, while others meet expectations.

Mining Equipment Financing

In addition to equity financing, debt financing is also a popular method, typically secured by mining machines. A new small mining company can use large hosting providers like Core Scientific to host machines, allowing all operational issues to be handled by Core Scientific, while the mining company only needs to raise funds. This makes the debt collateralization method easier, as in the event of liquidation, ownership of the hardware can be transferred to creditors, and the mining machines can continue to operate at Core Scientific.

As credit investors are eager to flood into this field, the average interest rate in Q1 2022 has dropped to around 9%, down from 26% at the beginning of 2021. The interest rate data comes from remarks made by Core Scientific's CEO Mike Levitt at the Bitcoin 2022 conference held in Miami.

Galaxy Digital is the largest single lender to miners. The lending team is led by Amanda Fabiano, who is sometimes referred to as the "Queen of mining lending." Many traditional banks have also entered the mining lending space, adopting traditional equipment financing models to provide attractive terms for mining companies. These banks may lack the expertise of specialized lenders like Amanda in this field.

Mining Rights Royalty Financing and Stream Financing

In the field of Bitcoin miner financing, mining rights royalty financial assets and stream financing models have yet to gain traction. When this model is explained to some people in the field, they often feel confused. However, stream financing is a commonly used tool in gold mining companies, typically used alongside more traditional financing forms such as debt and equity.

From an investor's perspective, stream financing has been the most successful model in gold mining. As shown in the chart below, the largest gold streaming mining company, Franco Nevada (in blue), has outperformed the other two gold mining companies.

Percentage returns since 2021 (in USD)

The stream financing model works as follows: investors provide miners with a lump sum of cash, in return for which investors have the right to receive 5% of any gold produced from the mine permanently. Because there are no debt contracts, there is no risk of default. If ownership of the gold mine is transferred, the stream agreement moves with it. If the mine goes bankrupt, investors do not profit, but they can wait patiently until the next gold bull market and production recovery period. It is important that the stream percentage is low, possibly 5% or lower, otherwise it may significantly impact the economic decisions of the mining company.

Due to the lower expected economic lifespan of ASICs (Application-Specific Integrated Circuits), applying this model to Bitcoin mining is challenging. On the other hand, with Bitcoin soaring to an all-time high of $68,991 in November 2021, many Bitmain S9 miners that had been idle, machines released 4 or 5 years ago, are now being turned back on.

This indicates that the economic lifespan of ASICs may be longer than many expect, and as the incremental improvements in efficiency become smaller, it is not hard to see that applying a specific ASIC stream financing model may work. During bull markets, we would not be surprised to see the current Whatsminer M30S+ machines running for 10 or even 20 years. Therefore, long-term investment products without maturity dates may be favored by some investors.

Since there is no debt, there is no risk of default. If the stream financing model begins to gain some attention in ASIC-type financing processes, it would not be surprising. Even if this model still lags behind debt and equity as the primary financing methods, it may be the most attractive to investors and could provide a convenient opportunity for established or new mining financing companies (such as Blockstream, Galaxy, Maple, Compass).

ASIC Manufacturers

In the U.S., there are two dominant Chinese Bitcoin ASIC manufacturers, Bitmain (Antminer) and MicroBT (Whatsminer). The earliest ASIC manufacturer was a Chinese company called Canaan (Avalon), which produced corresponding machines as early as 2013. It remains active globally. Canaan's global market share is actually very close to that of MicroBT. Canaan leads in market share in Kazakhstan and other Asian countries. Even though Canaan's machines are not as energy-efficient as those from Bitmain or MicroBT, this seems less important in a bull market.

Another new ASIC manufacturer, Intel, has announced its entry into the field. This American chip giant has announced exclusive partnerships with four companies: Hive Blockchain, Argo Blockchain, Griid Infrastructure, and Block (formerly Square). According to a statement from Intel, the efficiency of these chips is expected to be 26 J/TH. The announcement also stated that shipments would begin in the third quarter of 2022. Producing ASICs is a challenging process, and the first generation of machines is unlikely to meet expectations. Additionally, selling only to four companies, rather than adopting a more open sales process chosen by other manufacturers, may not contribute to decentralization as intended.

Given the connections of the other three companies to China, new entrants like this significantly increase the diversity of ASIC supply, which should be welcomed by the Bitcoin community and should be a positive factor for Bitcoin. Furthermore, we have also heard rumors about another large American semiconductor company entering the field soon.

Meanwhile, MicroBT announced the specifications of its next-generation 5nm M50 series hardware in Miami, with this series being produced by Samsung as the foundry. The new WhatsMiner M50S has a hash power of 126 TH/s and an efficiency of 26 J/TH (the same as Intel). This is 15% more efficient than the M30S++.

Conclusion

With the excitement in the market and capital flowing into the mining industry, there is no doubt that we are in a frenzied mining bull market. Investments in ASIC development and deployment will lead to a faster growth rate of hash rate than many model projects. By the end of 2022, even if Bitcoin prices do not change significantly, we may surpass 320 exahash/s (currently at 220 exahash/s).

We may see some publicly listed mining companies go bankrupt, and many securitized ASIC loans being liquidated. Single-digit financing rates may have become a thing of the past. Bitcoin mining is not easy, and we expect many will come to this painful realization in the coming years. Those successful companies will need to remain resilient, think long-term, and not deploy all their capital too quickly.

Ethereum will soon transition to PoS, and almost all new tokens are opting for this consensus mechanism. Meanwhile, tokens using PoW consensus mechanisms, such as Litecoin, Bitcoin Cash, and Ethereum Classic, are losing ground. Litecoin's circulating market cap has dropped to 21st place on coinmarketcap.com. Therefore, all discussions about PoW mining only concern one token: Bitcoin.