Are you still buying bitcoin? Chances are, probably not. Just one year after bitcoin reached the peak of the hype curve, the cryptocurrency has collapsed so dramatically that its dollar value is now rapidly approaching the amount it costs to actually “mine” new bitcoins.
Since peaking at $19,783 (£15,520) last December, bitcoin has lost nearly 80 per cent of its value; this week it was trading as low as of £2,903. Financial analysts have a word for it: the currency has fallen “below its support level” of $6,000, which means it has now reached a value from where recovery is extremely challenging.
The big problem for bitcoin? The cost of mining is now higher than the value of the coin. Think of it as paying £10 for a £5 note. You wouldn’t, would you?
“Bitcoin is no longer profitable to mine, and the rates of interest are way out of a profitable business model,” says Roger Benites, chief executive of BitInka, a crypto exchange based in Lima, Peru, which operates in more than 40 countries.
For him, the bitcoin troubles are really close to home: his company until recently had an office in Caracas, Venezuela. It had to close the office because civil servants and police tried to extract bribes. Venezuela is a special case in the crypto world: facing a collapsing economy and hyperinflation, many Venezuelans are putting their savings into bitcoin – as an escape valve. Cryptocurrencies are regarded as a much more stable store of value than the country’s official currency, the bolivar.
Everywhere else in the world, though, investors are questioning the fundamental value of bitcoin. So what’s gone wrong?
One part of the answer is that bitcoin was rolled out before the blockchain infrastructure that underpins its operations was able to support secure and scalable payments, says Avivah Litan, a Gartner analyst. Much of the current market jitters can be traced back to the latest “fork” in the world of bitcoin, when in November the currency split into two different flavours - Bitcoin Cash ABC and Bitcoin Cash SV, each based on a different “block size” used to process and calculate transactions.
Another reason for the plunge was the tremendous hype surrounding Initial Coin Offerings (ICOs). Many people who missed out on the original bitcoin surge invested billions of dollars in ICOs, but when that bubble burst, it brought down cryptocurrencies with it. The decision by the US regulator for financial services, the Securities and Exchange Commission, to classify ICOs as unlicensed securities played a major role here; offering ICOs in the US effectively breaks the law.
Read more: How much energy does bitcoin mining really use? It's complicated
Bitcoin mining requires a combination of chunky computing power and cheap energy. When the popularity of cryptocurrencies soared, chip and computer manufacturers rushed to flog specialised equipment to make mining efficient. As the value of cryptocurrencies collapsed, so did the demand for all this gear. Nvidia, one of the world’s leading chipmakers, recently discontinued all its lines of bitcoin mining gear and processors.
Still, overall the value of bitcoin amounts to around $70 billion, ten times what it was two years ago. “No other asset class comes close to that level of growth,” says Alex Tapscott, a Canadian business author and co-founder of the Blockchain Research Institute, a think-tank. He says the cryptocurrency storm happened, because the prices reached across the crypto asset ecosystem earlier this year was simply unsustainable and had only one way to go – down.
Well, down they went – with a lot of large-scale miners recently shutting down – especially in China. Worried miners seem to be selling off hardware because they presumably are losing money.
The fundamental problem, though, is the fact that mining bitcoin might soon be more expensive than the actual currency itself. If only we could know how much it truly costs to mine one bitcoin. But the true cost depends on where you mine it; it can be as low as $531 (in Venezuela) to a whopping $26,170 (in South Korea). On average, it currently costs around $5,000 to mine one bitcoin. That’s dangerously close to the currency’s actual market value.
Of course, the cost of mining depends on the quality of your hardware, the cost of electricity, other overheads like rent, salaries, taxes – and the price of bitcoin itself, because mining becomes more difficult when the price goes up.
Then again, bitcoin can be mined for near free, if you use solar and hydropower (as is the case in Iceland) – so it’s difficult to be precise about the true cost of mining.
On average, where electricity prices are cheaper, bitcoin mining is cheaper – think Sweden ($0.10 per kw/h), Canada ($0.06 per kw/h), a number of US states ($0.06 per kw/h), China ($0.04 per kw/h), Russia ($0.02-0.04 per kw/h) and Venezuela – where it’s less than 1¢, but rather risky because of the Petro, the new cryptocurrency sanctioned by Venezuela’s government and designed to boost the bolivar.
If the electricity price exceeds 0.06 kw/h, investing in bitcoin mining won’t ever lead to any return on investment, says Benites. The cost of mining fluctuates – as the price of bitcoin increases, new miners start mining, thus increasing the effort required for mining. But while gold still stays valuable even if no one is mining for it, with bitcoin it’s different. If there are no miners, bitcoin has zero value – it’s just a set of encrypted numbers. So while bitcoin can’t “die” as long as there are nodes around the world that continue to run the software, if no one uses it, its value disappears.
However, bitcoin is able to course-correct itself as prices change, based on the original Satoshi Nakamoto algorithm. On average every two weeks the difficulty of mining is adjusted either up or down, generally following the hash rate of the network. In the past few months that difficulty level has declined. “That makes mining less costly, and thus more profitable,” says Tapscott.
What’s a much more fundamental problem, though, is the fact that bitcoin has a crypto glass ceiling. The maximum number of bitcoin that can be created is 21 million. And the closer we get to this level, the less attractive it gets to mine bitcoins. That in turn will mean fewer miners, making bitcoin more insecure and open to manipulation, says Cathy Mulligan, a cryptocurrency expert at Imperial College London.
And it’s not just bitcoin that’s in trouble – when bitcoin dives, the rest of the cryptoworld follows. Most of bitcoin’s value is based on expectations of future adoption and utility, which are rather volatile assets. Other major cryptocurrencies including Ethereum, bitcoin cash, and litecoin are also experiencing a fall in value. With some, it’s quite clear now that their promises of “decentralised” applications and protocols will take much longer to pan out than originally thought. And others are in an outright existential crisis.
Atulya Sarin, a professor of finance at Santa Clara University, writes that the current bitcoin downfall is different from previous fluctuations, though. One, it’s bigger. Two, the losers now are new investors who will likely stop mining and wait to see what happens. And finally, the futures markets have changed the game, and now miners are able to estimate their mining losses and profits from the start – and are likely to avoid mining if there’s no profit looming.
But not everyone is quite so gloomy. Litan says bitcoin will definitely recover – as it gains mainstream credibility, regulatory clarity, and adoption. Talent continues to leave the tech industry and Wall Street and enter the crypto industry, adds Tapscott, and “developers around the world continue to improve the code, build applications and dream up exciting new projects”. While the price of bitcoin has been diving, bitcoin has been thriving, he argues.
After all, some miners “can mine bitcoin at little to no cost because their energy is free; the difficulty of mining adjusts up or down depending on the hash rate, and recently it has declined significantly, meaning it costs less to mine (the price of mining is NOT fixed); there is a business case for miners to mine uneconomically to gain competitive advantage in the market,” says Alex Tapscott.
It also helps that some big corporate players continue to believe in the cryptocurrency. Take Bringing Trust and Utility to Digital Assets, or BAKKT – a product of Intercontinental Exchange, the company behind the New York Stock Exchange. Large companies such as Fidelity and VanEck are investing now more in crypto projects than ever before, and many big enterprises are harnessing the underlying blockchain to transform their businesses.
Institutional trading in bitcoin may soon become ‘safer’, with companies offering security, custody and regulatory compliance services. “Once this happens, we will see BAKKT start working in retail payments, for example with its partner Starbucks, to enable retail payments in bitcoin that shield merchants from price volatility and security issues, while enabling them to broaden their customer base and lower their electronic payment card merchant fees,” says Litan.
At the end of the day though, even with the biggest slump in mining profits, says Alastair Band of Verum Ventures, “the brave and true believers will carry on”.
This article was originally published by WIRED UK
