Why We Anticipate A Wave of Crypto Mining Insolvencies!

Crypto Mining - revenues and costs

The crypto hype 2017 produced thousands of crypto mining startups resp. crypto mining projects worldwide. Ever increasing prices of cryptocurrencies have made their  business models attractive. In 2017, miners could speculate that the coin mined today will increase in value again tomorrow (or the day after tomorrow). Many mining startups have onboarded investors with promises of high returns. They sold either hash power via cloud mining models or mining servers operated via hosting models and profit-sharing. The hype has put a veil over the business model and fatally seduced both the operators and their investors. We expect a wave of if not a tsunami of bankruptcies in the crypto-mining sector in early 2019 in the depressive post-hype environment.

The Fatal Assumptions

The hype is definitely over. The post-hype depression brutally exposes the false assumptions in the business model of crypto mining operations. Without the constantly rising prices, crypto mining does simply not produce the high returns that were expected and promised. Moreover, if crypto prices fall, fixed costs cannot be financed any longer. It turns out, crypto mining is a classic fixed-cost business. This means that considerable capital investments  are required upfront:

  • Data centers and infrastructure have to be built,
  • servers have to be bought, and
  • personnel need so be hired and employed.

Even the energy for the operation of the servers is to be considered as part of the fixed costs. As long as the servers are online, electricity expenses accrue. For the time that the prices of Bitcoin, Ether & Co remained at a high level or even rose – as we experienced in 2017 – the mining models delivered unbelievable profits.

FOREX Gains Financed Business

As a matter of fact, crypto miners financed their operations from the sale of cryptocurrencies. The more the prices of the cryptocurrencies rose, the less Bitcoins, Ether & Co had to be sold to cover the costs of operation. The more profit remained for the investors. If, however, the prices fall, then the business model becomes the death trap for operators and investors.

Costs eat the business model

The essence of fixed costs is that they are fixed, isn’t it? Even if cryptocurrencies price starts to go north, the cost level remains unchanged. The economics of fixed cost businesses. In addition, the difficulty level of the blockchains does not react as flexible as the crypto prices. The delay is easily recognizable by looking at the statistics. While, according to Blockchain.info, BTC miners earned almost USD 55 million per day (24 hours) in January 2018, in December 2018 this amounted only to about USD 7 million. The total revenues of BTC miners were crunched by 87%. That’s a fact.

Bitcoin Miner Revenue Bitcoin Difficulty

Here is a simplified calculation for the crypto miner segment:

Description Jan 2018 Dec 2018
Price BTC/USD 15.000 3.500
Price Index 100% 23%
Mined BTC per day 1 BTC 1 BTC
Revenue per day in USD 15.000 3.500
Assumed Cost of Production per day** 7.500 6.900*
Gross profit per day in USD 7.500 -3.400
(*) including efficency and price effects
(**) Rent, depreciation, people, energy, etc.

This very simplified model must, of course, be refined accordingly in each individual case. But it is valid as an industry model. Truth is, current crypto mining models simply do not pay off. Therefore, we forecast a wave of insolvencies in the crypto mining sector in 2019. How this will affect the consensus algorithms of the different blockchains cannot yet be estimated in our opinion. In any case, we fear that psychology will turn negative for entrepreneurs and their investors and this could actually lead to the collapse of some cryptocurrency systems.

Finally, it should be noted that we have not allowed for the upcoming regulatory aspects in this valuation of the crypto mining business model. For example, the Austrian Financial Market Authority (FMA) has already qualified some business models around the sale of crypto-mining packages to investors as an Alternative Investment Fund (AIF). The operation of such an AIF would dramatically increase the cost of operations and thus potentially make the business model even more unattractive for start-up entrepreneurs and their investors.