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The price of Bitcoin (BTC-USD) has been flat in recent months despite a geopolitical situation in Ukraine that was meant to be the time to shine for decentralized money. In this article, I will discuss the rising cost of energy and its effects on Bitcoin mining.
Soaring energy costs eat into miner profits
The soaring cost of energy is putting pressure on countries, businesses and consumer across the world. We can now count Bitcoin miners amongst the casualties.
The price of Bitcoin has been largely rangebound over the last few months and we can discount the coin’s status as an inflation hedge. During those few months, the hash rate and mining difficulty have risen consistently.
The current market is putting strain on miners at the moment, especially those without a fixed rate supply.
The mining sector could struggle in the year ahead due to previously agreed power purchase agreements (PPAs). Many miners that leverage the grid are usually locking in prices with PPAs to better determine their operating expenditures (opex). If energy input prices continue to surge at the same pace that they have over the last year, the utility companies that signed those PPAs are incentivized to get out of the contracts to increase their own profit margins. It will be a nervous proposition for miners who are coming to the end of previous agreements, and also works as a barrier for entry to new players in the mining sector.
Electricity is said to make up 90-95% of Bitcoin mining costs.
Bitcoin cannot plant trees
Bitcoin had its critics for its energy-intensive process long before the inflationary surge. As governments pivot to aggressive green policies, the debate over Bitcoin’s energy usage will likely intensify.
It was reported at the outset of the Russia and Ukraine war that EU policymakers were set to limit the usage of energy-intensive cryptocurrencies in their MiCA regulations. This came on the back of calls for a ban on cryptocurrency mining by Sweden. Lawmakers were worried that renewable energy sources would be used by miners, which was then backed by politicians in Germany, Spain and Norway.
EU Parliament member Stefan Berger, who was drafting the regulatory package, said a potential ban on crypto mining would be a death sentence for bitcoin in the EU. One provision sought to prohibit crypto services that rely on environmentally unsustainable consensus mechanisms starting in January 2025. The provision specifically referred Prof-of-Work, which is used to mint popular cryptocurrencies like Bitcoin and Ethereum (ETH-USD). The difference between those two is that Ethereum is now moving towards a Proof-of-Stake consensus.
This is a major headwind for Bitcoin going forward because the politicians responsible for the Green movement now have a target on the back of Proof-of Work mechanisms. That may provide little threat to some altcoins, but an EU ban on PoW would be followed by a big sucking sound as money charged for the exit in BTC and rushed to the likes of Ether.
The calls for a limit on energy-intensive mining happened before the Western economies were grappling with the highest inflationary costs in forty years, and before the Russian invasion into Ukraine threatened gas supplies to the heartland of the European economy.
The decentralized can also count Greenpeace amongst its detractors with the group joining other campaigners for “Change the Code Not The Climate”. The goal is to force a remake of the code underpinning bitcoin, moving it away from a proof-of-work process or reinventing that method to make it less energy intensive.
“Bitcoin uses an outdated technology called proof-of-work to validate transactions. This proof-of-work method, at least as it currently operates, uses massive amounts of energy, and thus is a huge source of climate pollution,” campaigners said in a statement.
An executive from Ripple has donated $5 million to the campaign but the problem for BTC is that the process is not easy. Ethereum is said to be months away from its own PoS merge but it has been seven years in the making. By the time Bitcoin changed to a greener consensus the market may have moved on.
Bitcoin as a decentralized currency could actually lose ground to centralized projects in the coming months because of this debate. For example, the Polygon network has announced a “Green Manifesto” that will see the project go carbon negative in 2022. The development team pledged $20m to offset its energy usage through carbon credits, community initiatives and donations.
Unfortunately for PoW enthusiasts, Bitcoin cannot plant trees.
Will Russia affect the mining outlook?
In my last article on Bitcoin, I warned that European officials could use Russian sanctions as an excuse to shut down Bitcoin’s presence in the world economy. In the last 24 hours we have a report from the International Monetary Fund that joins the chorus of Bitcoin as a means to evade sanctions.
The report specifically said that Russia could use its vast energy resources to power crypto mining and generate revenue.
“Over time, sanctioned countries could also allocate more resources toward evading sanctions through mining. Mining for energy-intensive blockchains like Bitcoin can allow countries to monetize energy resources, some of which cannot be exported due to sanctions,” the IMF said.
President Vladimir Putin had previously said that Russia has a “competitive advantage” in Bitcoin mining. Russia also benefited from the China ban on Bitcoin mining as it rose to third place in the world for mining, according to a study by Cambridge University.
For Russian miners, the benefits of Bitcoin mining have become strained with the US dollar near six-year highs versus the Ruble. For European governments there is therefore an incentive to keep the price of BTC contained.
There was further news this week that a Russian Bitcoin miner had been included in the latest round of US sanctions. The Swiss-based Bitriver AG had moved its assets to Switzerland last year but found itself on the cross-fires, alongside 10 of its subsidiaries.
Bitriver claims to be the world’s largest hosting provider for climate-friendly crypto mining (using renewable energy), and boasts a 100-megawatt data center in the Siberian city of Bratsk which it outsources to foreign miners from the United States and other Western nations. Bitcoin mining was shut down in China and may start to disappear in Russia. If the US sanctions subsidiary companies it could lead to a company’s demise through cash flow issues.
Will energy prices return to their previous ranges?
We were told by central bankers that the inflationary pressures caused by government lockdowns and fractured supply chains was ‘transitory’. They have been forced to retract the transitory label but assure us that inflation will peak by the end of this year. That is not assured as pressures remain for the oil and gas supply in markets.
Goldman Sachs Head of Energy Research said recently that “the next move was higher for oil”.
“We are at record-low inventories, and all those headwinds (China lockdown/US SPR release/Russia) are transient. So we really haven’t resolved the significant underinvestment, and that’s why prices need to recover. We’ll probably see short-term volatility but I guess, from this level our view is the next move is indeed higher,” he added.
The investment bank has forecast an oil price of $125 for the second half of this year. There is also still no sign of a peace agreement in Russia and the gas supply chain will remain pressured in the months ahead. The effects on real wages are starting to be seen and the pressure on governments will grow from disgruntled consumers. That will put energy price reduction measures in the spotlight and could put Bitcoin in the firing line for its energy usage.
How is energy impacting the US mining sector?
The US mining sector could benefit from the sanctions on Bitriver as third-party clients from Western nations will not be able to use its services.
That will present market share for the US mining firms but they will also have to contend with higher energy prices.
The stock price of Riot Blockchain (RIOT) is testing lows from December 2020. The weakness in Bitcoin has dragged the industry lower and that has been amplified with the energy headwinds.
The company is expanding its operations and holds over 6,000 BTC, with the company stating: “The Company continues to hold a long-term view on its Bitcoin holdings and believes it is in the best interest of shareholders to have strong Bitcoin holdings on its balance sheet.”
Those holdings could be unwound to see it through a period of higher costs. However, an operating margin of -10.50% shows that even with prices of over $40,000 BTC, the company is struggling. It adds in the year-end results:
“Because our miners are designed specifically to mine Bitcoin and may not be readily adaptable to mining other cryptocurrencies, a sustained decline in Bitcoin’s value could adversely affect our business and results of operations.
This is the real threat to the mining firms as the wolves of green energy circle the PoW industry. Riot hosts 200MW of institutional clients in its 370MW operations and some of that could dwindle if the energy debate increases.
HIVE (HIVE) is a Canadian miner which produced 278 BTC in March of 2022. The company also mines Ethereum with 2,549 produced, so that can diversify the company away from BTC. However, the company draws down on its ETH holdings to fund their strategic deal with Intel (INTC). The company sold 10,000 ETH to fund BTC rigs.
Interestingly, the company has an ETH mining operation in Sweden which was the country leading the hostility against PoW miners. “Excess green/renewable energy that allows HIVE to migrate our environmental footprint,” is a selling point on the company’s website. The Swedish policymakers may not agree with that statement.
Hive has access to 50MW of power and has an operating margin of 74% at present.
Marathon (MARA) digital is focused on North American operations, which would shield it from European legislation. Marathon produced a Record 1,259 BTC in Q1 2022, up 556% Year-Over-Year and its total Bitcoin holdings Increased to 9,374 BTC. Cash on hand was around $118.5 million and total liquidity, defined as cash and bitcoin holdings, was approximately $546.2 million.
Marathon had $33 million cost of revenues from $150m in revenues in 2021, so maybe the threat from energy is not existential. However, the company still made a loss of $85m with $164m coming from compensation and taxes. The company’s balance sheet suffered from the drop of BTC into year-end.
The Bitcoin mining sector shares a similar outlook with all miners seeking to aggressively ramp up mining, “Hodling” their BTC production and not diversifying. That could be their downfall if legislation impacts the potential for companies to mine and these companies are at major risk of further downside on BTC. This would be an ideal time for companies to diversify their mining into cleaner energy coins and they may regret not doing so.
Conclusion
Bitcoin miners have been hit by the soaring cost of energy as the cost of electricity can be between 90-95% of operating costs. The price of energy may not cool anytime soon due to geopolitical tensions and supply chain problems, so that will act as a headwind for the mining industry. The other problem for Bitcoin is its energy-intensive mining process and the coin has come under fire from European governments for its effects on the environment and local energy sources. As energy prices soar that could see the debate intensify over Proof-of-Work mechanisms and we cannot rule out a price destructive event in the final MiCA regulations from the EU. The pressure on the balance sheets of miners may also see more and more gravitate to cleaner coins for increased profit margins. There is now a move by Greenpeace to pressure a change in Bitcoin’s code but that could take years. It is because of these and other headwinds that I advised investors that Ethereum was a better option if they wanted crypto exposure. The mining industry for US-listed miners could benefit from the US sanctions on Russia, but they are aggressively long BTC and should be diversifying some of their stock into other coins.
