Bitcoin Mining Profit Squeezed in Face of Surging Hash Rate and Mining Difficulty

2022-10-18, 01:20

[TL; DR]

🔹 The bitcoin hash rate reached an all-time high in October 2022.

🔹 When the bitcoin hash rate increases its mining difficulty also rises.

🔹 One reason for the increase in bitcoin hash rate is the shifting of Ethereum miners to bitcoin mining.

🔹 The increase in bitcoin hash rate on a backdrop of depressed BTC price has led to a low profit margin.

Introduction

Despite the fact that most blockchains such as bitcoin and Ravencoin are fully decentralized they require the participation of many stakeholders to function well. Apart from the general users and investors, proof-of-work based blockchains require contributions of miners to secure their networks.

The high mining reward increases competition among the miners which leads to a rise in hash rate and mining difficulty. In addition to discussing the current hashing situation and mining difficulty, this article explores the effects of a surge in hash rate.

October daily hash rate hits 10.8%

The bitcoin hash rate has been increasing in October and at one time it hit a daily high of 10.8%. Incidentally, this is an all-time high daily bitcoin hash rate. Such a rise in the hash rate shows an increase in the security of the bitcoin blockchain. This is because the higher the hash rate the more secure a proof-of-work based blockchain like bitcoin becomes.

Source: Coindcx

As we observe on the chart, the hash rate of bitcoin has been increasing since the start of the year, 2022. The highest daily hash rate for the year is in October. In June bitcoin recorded another all-time high hash rate but it decreased over time due to the summer heatwaves in countries such as the United States. In fact, many companies shut down their rigs during the summer to reduce electricity usage.

As a note, the stability of the temperature is a specific factor that contributed to the recent increase in the bitcoin hash rate.

What is the bitcoin hash rate?

Before we discuss further the reasons for the surge in bitcoin hash rate, let’s explain the term hash rate. In simple terms, hash rate is the computing power used in validating transactions on a proof-of-work network. The process of verifying transactions through solving cryptographic problems is called mining.

A vast network of computing machines participates in validating transactions and securing the bitcoin network. When the number of mining machines that verifies transactions increases there is a rise in bitcoin’s hash rate.

Mind that bitcoin mining requires specialized computing machines such as ASICs. The miners who solve the problem and add new blocks to the bitcoin blockchain are paid in BTC.

Therefore, they benefit the most if the price of bitcoin is high as that increases their profit margin. The current reward for mining a bitcoin block is 6.25 BTC. However, the surge in the hash power is accompanied by a rise in bitcoin difficulty.

Understanding bitcoin difficulty

The change in bitcoin difficulty and hash rate affects the level of profit the miners get. The bitcoin difficulty is the level of difficulty the miners face when they strive to solve the cryptographic puzzles in order to get the required hash value of a block. An increase in the bitcoin difficulty means that the miners require more computing power than before to mine a block.

The bitcoin difficulty reached a 17 month all-time high of 35.61T in October. This represents a 13.55% increase from its May 2021 level. The logic for the increase in the bitcoin difficulty is that many miners generate more guesses than before leading to faster mining of the blocks. Thus, the bitcoin system increases the mining difficulty to align with the requirement to mine blocks within 10 minutes. In other words, there is a 10 minute window to add a block to the network.

Causes of the increase in hash rate in October 2022

We have already mentioned that the cooler weather pattern has prompted an increase in the hash rate as many mining companies have increased the number of functional rigs. Nevertheless, there are other reasons for such an increase.

First, the bitcoin miners have been purchasing better mining equipment to improve their hash rates and becoming competitive in the industry. Notably, during 2022 the prices of most graphics processing units have been falling. The decrease in their prices has helped the miners to cover up their operational costs, thereby incentivizing them to increase their mining activities. The table below shows the reduction in prices of specific GPUs.

Source: Coindcx

As you note, there was a decrease in prices of most GPUs.

The shifting of the Ethereum blockchain from the proof-of-work consensus mechanism to the proof-of-stake one has contributed to the increase in the bitcoin hash rate. Therefore, most of the ethereum miners either sold their mining equipment or repurposed them to mine bitcoin.

The CEO of Luxor Technologies, a mining service firm, summarized the key contributors to the increase in the bitcoin hash rate. He said, “A combination of high-efficiency machines such as the S19XP getting delivered, cooler temperatures heading out of summer, lower power costs in the U.S. and old ETH-mining power capacity being reallocated has led to a sharp increase in network hashrate.”

Effects of Margin Squeeze

Mining bitcoin results in several costs the miners need to cover to remain viable. For example, mining companies buy the required machines and equipment. They also need storage facilities for the equipment as well as maintaining certain standards such as the right temperature and humidity.

As the bitcoin difficulty increases the cost of running the mining equipment increases. For instance, when mining difficulty rises the process uses more electricity resulting in higher operational costs. In the end, the higher the cost of mining bitcoin the lower the profit the mining process generates.

In some cases, the mining companies incur losses. When the bitcoin difficulty increases when the price of bitcoin remains constant or decreases the profit margin decreases. That is the reason why Peter Wall, the CEO of Argo Blockchain said, “Our profitability has been squeezed from both sides from higher energy prices to lower bitcoin price, that's resulted in a cash crunch.”

The decrease in profit margins or accrual of losses affects the mining companies in different ways. The miners that have high operational costs or debt load will be forced out of the industry. Also, many companies that had been holding BTC sell it to cover their expenses.
Observers believe that in the future some of these firms will sell the BTC they have been keeping in the cold storage as well.

However, some mining companies that are well-capitalized continue to operate. This is because some of them have been securing better machines during the year. Also, when other companies close down their mining operations, the hash rate decreases and so does the mining difficulty. Thus, in the long run firms may experience better returns again.

Another possible development is that the companies that used to hold BTC will no longer do so. Instead, they sell it as soon as they get it to stay afloat in the business.

Conclusion

The bitcoin hash rate has been increasing during October. As a result of its mining difficulty and the mostly constant or falling price the profit margin has remained very low. In some cases, the mining firms have incurred losses due to the high cost of electricity and other maintenance costs. Thus, some of the bitcoin mining companies have paused their operations. Others have been selling their BTC holdings to cover up their operational expenses.

Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all cases, legal action will be taken due to copyright infringement.

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