Is Now the Time to Start a Bitcoin Mining Business?

Please note that VanEck has exposure to Bitcoin.

Images Generated Using AI Program DALL-E.

Simulations of a Bitcoin mining business suggest that starting a mining business is a better option than simply buying Bitcoin at current prices.

In 2022, Bitcoin miners faced the triple entente of electricity price hikes, substantial hash rate growth and Bitcoin price declines. As a consequence, mining Bitcoin is currently unprofitable for many firms, resulting in a rolling tide of bankruptcies. Industry stalwarts such as Core Scientific and Compute North have declared bankruptcy, while others such as Bitfarms, Argo and Iris Energy have warned of default. Luxor’s HI Crypto Mining Stock Index, based upon publicly traded Bitcoin miner stocks, is down 72% year-on-year. Even more dramatically, the price of mining computers themselves has declined more than 86% from the same period last year. This compares to a 58% decline for BTC. Were Baron Rothschild alive today, he might be on CNBC beaming about the crimson color of opportunity presented by the pain of Bitcoin miners. Given the immense fear, uncertainty and doubt across the industry, we assessed whether it was time to don a hard hat and enter the Bitcoin mining business.

Rolling Week on Week Yearly Returns, BTC vs Mining Rigs

Source: Luxor Technologies, VanEck Research, January 2023. Past performance is no guarantee of future results. The joule is the unit of energy in the International System of Units. 1 joule is equal to the energy that is required to raise the temperature of 0.239 g of water from 0 °C to 1 °C.

To analyze the opportunities presented, we compare the projected returns of simply buying BTC on the market versus investing in BTC mining computers to run a mining business. It is important to recall that miner businesses operate similar to farmers in the sense that both derive revenue by harvesting a commodity to sell at market. Of course, miners markedly differ as they run computers to solve a complex cryptography problem to receive a portion of Bitcoin’s inflationary block rewards. In the Bitcoin mining business, the more computing power one has relative to the network’s computing power, called “hash rate,” the greater share of Bitcoin block rewards they receive.

We built a conceptual business model for a mining operation hosted in a third-party facility based upon quoted all-in hosting rates and the current market prices of Bitcoin mining rigs. In our business plan, we buy the rigs using brokers and ship them to a company who will run, maintain and optimize the machines on our behalf. In turn, this hosting party passes through the costs of personnel, electricity purchase agreements, and infrastructure in its hosting fee. For our purposes, we are assuming an all-in hosting cost of $0.075 per kw/h of electricity usage. The maximum life of our business is three years.

The endeavor’s expenses consist of mining rig acquisition costs, variable costs of hosting the rigs, and asset disposal costs from exiting from the business. The business revenues are based upon projected sales proceeds of the mined Bitcoin and the estimated gain on sale from liquidating the bitcoin miners upon close of the operation. To maximize tax benefits, we double line depreciate over a useful machine life of five years. The greatest factors affecting profitability of our theoretical mining operation are:

• Purchase price of the mining rigs
• Efficiency of the mining rigs
• Hosting cost (electricity cost)
• Price of Bitcoin
• Growth of the hash rate
• Mining rig resale price

The base of our model begins by applying live broker quotes for seven different miner rigs of various efficiencies as well as hosting rates from five separate miner data centers. To estimate the price of Bitcoin, price of mining rigs and growth of hashing rate, we use historical data to project future variation. We feed this variation into Monte Carlo simulations to create thousands of hypothetical outcomes to assess profitability of our business across many scenarios. In each situation, we compare the return profile of the mining entity to the returns of Bitcoin. To simplify our model, our business has three potential exit timings as well as two strategies for selling the mined Bitcoins:

• Exit after 1 Year
  • Sell the mined coins at the end of the year alongside mining rigs.
• Exit after 2 Years
  • Hold the mined coins until end of year 2 and sell them alongside the mining rigs.
  • Sell the mined coins continuously throughout operation and the mining rigs at the end of the second year.
• Exit after 3 Years
  • Hold the mined coins until end of year 3 and sell them alongside the mining rigs.
  • Sell the mined coins continuously throughout operation and the mining rigs at the end of the third year.

These different strategies are compared in our model against the benchmark of just holding Bitcoin. Basically, our business is run through thousands of hypothetical scenarios where we adjust all the previously mentioned key factors affecting profitability against the various types of mining strategies. Because we do not know what the outcomes will be, these permutations provide an understanding of the profitability of our business over many, many outcomes.

The below table reflects the results of different mining strategies when compared against mining rig beta and hash rate growth. The variable inputs in this table is the yearly average price of Bitcoin in 2023, 2024 and 2025. The prices used to generate the below table are $18k for 2023, $33k for 2024 and $45k for 2025. Eight bitcoin mining strategies were compared - which included holding mined bitcoin for a period of time before selling (1-3 years), selling mined bitcoin as soon as they are mined, or buying and holding bitcoin (1-3 years).

Source: VanEck Research, January 2023. Please see important disclosures below regarding hypothetical performance. Hypothetical performance is designed with benefit of hindsight. These simulated results have no financial risk, and they do not represent actual trading, and as such, may not account for various market factors that would have impacted the results. Beta of rig price is a measure of the price volatility of a mining rig compared to Bitcoin’s price. Hash rate is a measure of the computational power on a blockchain network. The chart represents different hypothetical scenarios comparing mining rig beta to hash rate growth.

The orange dotted box denotes the historical ranges of rig beta and hash rate growth. The shading of the box denotes in each scenario whether mining or holding Bitcoin produces higher returns, with green indicating mining and red holding. Likewise, the text denotes the best strategy to pursue within the broader strategies. The takeaway is that based upon past values of hash rate growth and rig beta, and Bitcoin price as noted, a better risk versus reward is to buy machines and mine BTC. Additionally, the best mining strategy, if the past is any predictor, would be to hold the coins until the end of the business in three years.

Other price outcomes, both the absolute values and the trajectories of those values, will change our sensitivity table outcome. For example, if the Bitcoin price exploded 200% the first year and then cratered to decline 50% in each of the next two years, the best mining strategy would obviously be to sell all the coins as well as the rig after the first year of operation. Clearly, we do not have Congresswoman Pelosi’s crystal ball to see future price outcomes, so we employ simulations to inform us which strategy is most profitable, the most number of times, and on average how profitable it is.

The below table reflects the results of a single, hypothetical scenario out of 5,000 using a Monte Carlo simulation. The variable inputs for the simulation included the average price of Bitcoin in future years, the hash rate growth, and the beta of the mining rigs to Bitcoin. From there, the simulation calculates the return of eight different strategies for the miners, which included holding mined bitcoin for a period of time before selling (1-3 years), selling mined bitcoin as soon as they are mined, or buying and holding bitcoin (1-3 years).

Source: VanEck Research, January 2023. Please see important disclosures below regarding hypothetical performance. Hypothetical performance is designed with benefit of hindsight. These simulated results have no financial risk, and they do not represent actual trading, and as such, may not account for various market factors that would have impacted the results. The table represents the result of a single Monte Carlo simulation (out of 5,000) showing the result of different strategies that bitcoin miners can employ (hold for pre-determined time/sell continuously/hold).

The key takeaway from our analysis is that from an expected value standpoint, it is more profitable to run a mining business than it is to buy and hold Bitcoin if our main inputs behave as they have historically. Additionally, of all the mining strategies, the highest expected return (mean return) comes from the strategy where a miner holds its coins to sell them when the business is rolled up at the end of three years. Likewise, it is also clear that the downside risk of running a mining business is greater than buying and holding Bitcoin as an investor can easily loser more of his initial investment supporting an unprofitable mining entity. We attribute these findings to two factors. First, the Bitcoin mining rigs trade at prices that are favorable relative to their potential value for appreciation in bullish Bitcoin scenarios. Second, the historical price trajectory of Bitcoin is skewed positive with high kurtosis (fat tails) and it appears this potential is not reflected in the current price of mining rigs. Therefore, the risk-seeking, adventurous investor may want to consider the mining business. Give us a call if you have a site with cheap power!

DISCLAIMER: The above is not intended as financial advice nor as a recommendation to buy or sell any securities, Bitcoin mining equipment, or to take any other action. These are solely the results of a simulation and are for illustrative purposes only. This simulation projects distributions of BTC based upon the distribution of historical returns as well as the distribution of Bitcoin miner beta and hash rate growth. These historical data points were used as the basis for functions that would output projections based upon the distribution of these historical data points. This is not intended as a projection of what the returns of BTC look will like. Neither we, nor anyone else including Satoshi Nakamoto himself, know what the price of Bitcoin, the hashing rate, the price of miners or the beta of miner to Bitcoin will be in the future. This is simply a mock-up based upon historical inputs. Please conduct your own research.

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