When I read the incredible stories in ‘The Prize’ about the early wildcatters in America prospecting for oil, the irrepressible frenzies, the heights of elation and the depths of despair were palpable to me because I am participating in the modern day equivalent; the crazy world of Bitcoin mining. What’s it like to be a small wildcatter? The fact you are reading this means you think Bitcoin is a real deal, otherwise you would be reading Barron’s, the WSJ, or the FT, so let me tell you a story.
Let’s get something clear from the start. I am a Warren Buffett disciple, a believer in business ownership, cash flows and competent management with skin in the game going for consistent growth. I never liked gold, or commodity ownership and had no idea how you would start valuing a work of art.
So how did I end up Bitcoin mining?
It started when I heard a lecture on blockchain and Bitcoin and was intrigued about a system outside of the obviously corrupt fiat systems that we currently are forced to accept and use. Not blaming individuals, but our political systems are poorly designed. The best examples I can see are Switzerland (look at the strength of the Swiss Franc and give me another explanation other than its federal canton and referendum system), or maybe the positive non interventionism in Hong Kong, now thoroughly degraded Chinese style.
Once I realised Bitcoin was real, and the security of the network was properly engineered, my conclusion was that the ‘Governments’, of all countries whose politicians want to maintain their power, would ban Bitcoin. It was too good, they would have to ban it. But they didn’t, they dithered, they sniped, they moaned, but they didn’t know how to stop it, and now it’s just too late. The horse has bolted, fast and strong, across open land, never to be caught.
A friendly neighbour of mine mentioned a big Bitcoin mining company in America and I looked at the maths. My base case was Bitcoin would rally after the Covid slump and the numbers were pretty simple. You buy some machines, depreciate them over three years (more of this later), and then pay for power each month. The net result was that with .007 BTC per Peta Hash you could quickly calculate what profit was possible. So I had about 7 Peta Hash and that meant some $1000 per day of revenue in BTC and power costs of some $500. What could possibly go wrong, I thought? Why doesn’t everyone do this? At this point I was Blackadder and Baldrick in one body: Moronic and cunning, a dangerous combination.
It turned out lots could go wrong, including:
- equipment delivered that was in terrible condition
- a fixed power contract that suddenly became very unfixed, with surcharges because of the market hike in power costs
- the company hosting the machines went bust, oops!
- my machines had to be shipped to a new provider
- there were some site issues, so all machines were down for a month or more
- machines broke and needed repairs, hashboards, fans, PSUs
But I am lucky, and my guess about BTC’s price was on the money. I decided to depreciate the machines I purchased over one year, on the basis that it was a ‘conservative’ way to counter the huge BTC price swings and the probable hashrate rise. In doing so I was barely profitable, but it allowed me to buy more to counter the hahsrate rise. I won’t use the word invest because buying a computer doesn’t meet Ben Graham’s definition of investing, however you stretch it.
But, oh my, the hashrate just powered upwards. The hashrate rise is unreal. Remember this is a low, low, barrier to entry business. A fool like me can start mining, anyone with enough ability to open Google sheets and a willingness to limit their risk outlook to just the next six to twelve months can get in the game. The hashrate now means that the same 7 peta hash I started with yields about a third of what it did, resulting in a drop of a half in yield, even though the price of BTC is up about 75% and the energy costs have more than doubled. It’s not pretty.
Put that into some perspective. Imagine starting farming, growing your crop and after a few years receiving half of what you were originally making even though the crops you are producing are getting towards twice as valuable. Oh and did I mention the fixed costs have gone up, not down?
It’s a bit like starting a long motorcycle trip, the weather looks okay, not great, but good enough. You start out, the weather worsens, fingers get cold, then it starts to rain, and you get water dripping into your underwear and your feet are soggy. Then it gets really cold and it properly chucks it down, so you think about sheltering under a bridge, but there aren’t any, so you twist the wrist and concentrate, freezing, it’s deeply unpleasant. Have you been there? You know what I’m talking about if you have.
There is no respite, well except when that lovely Chinese government closed down Bitcoin mining in China and made all of us outside China very happy for a month or two: Thanks Xi Dada, I love you for that alone, everything else.. err not so much.
Now, let’s return to equipment depreciation. I have bought new machines, used machines from China, from Canada, from the USA, and every transaction is scary. Will they arrive, will they work, did I pay too much, is the next generation going to make them worthless? These are the questions that often are unanswered when a miner buys equipment. And the really weird thing about this is that the machines are not priced against their manufacturing cost, but against the current hashrate price. So you are forced to massively overpay in a bull market top, or wait until the market is dead (and might stay dead) to buy at a reasonable price. There is no winning here, there is only fear and doubt.
Of course many American mining companies have gone bust, it’s very easy to do this. Imagine the market is good. Mining is profitable. The only rational course of action is to lever up and mine as much as possible, as fast as possible, to do anything else other than this would be irrational given Bitcoin’s fixed supply and endless competition. But suddenly the market collapses, the energy costs soar and all that money you borrowed to get more machines online cannot be paid back. It’s a quick trip to the poor house. Do not pass GO. It’s like Florida property speculation on steroids.
So far I have seen market ups and downs, the hashrate relentlessly climb, the power costs soar and subside, the equipment prices climb and crash, the equipment efficiencies double, and more and more people and companies climb into the ring to fight for the ever dwindling ten minute block rewards and fees due to the lucky miner able to complete the nonce for that block.
What a crazy business, all built on a software protocol that according to the wonderful Mr Peter Schiff has almost zero value, or is ‘rat poison’ according to the erudite Charlie Munger. My counter to the ‘Bitcoin has no intrinsic value’ cry is usually ‘Hey, if someone can pay $100m plus for some pictures of multi coloured soup cans that cost some $100 to make, then why can’t Bitcoin be worth something’
Like art and gold the value is in the global acceptance, the perception and the rarity. Does it make sense, no, almost certainly not. But for me it doesn’t need to. I can no more explain art and Bitcoin valuations than my dog can calculate the force of gravity, but he knows how to jump and land safely when he needs to. It’s an animal spirit, free market thing and right now it is running free.
If you enjoyed this article, you might also like to read: Bitcoin and Political Improvement