"Understanding the Game Theory of Miners' Behavior During Bitcoin Halving" from the selection of excellent articles

Regardless of how the price of Bitcoin fluctuates, miners survive, and the strong prevail. To survive and thrive, miners must gain a larger competitive advantage than their peers.

Authors: Matt D’Souza, Sam Chwarzynski, Mason Jappa, and George Adams, all employed at the cryptocurrency mining services provider Blockware Solutions
Translated by: Jane Zhan

Many analysts believe that Bitcoin has a price floor because there is a break-even point in the production costs of Bitcoin miners. This assumption is not entirely accurate.

Advertisement - Continue scrolling for more content

In fact, as the price of Bitcoin approaches the production cost of miners, Bitcoin selling often accelerates. Bitcoin prices have always faced selling pressure from miners. The actual factors supporting the price come from miners surrendering and a net decrease in hash power on the Bitcoin network—favorable difficulty adjustments. Understanding how to analyze miner behavior using game theory is crucial.

A miner's cost of producing Bitcoin is determined by their electricity bill, as 95% of operating expenses for miners are electricity costs. Bitcoin needs to reach a certain price for miners to earn more Bitcoin revenue than their electricity costs. Miners with the lowest electricity prices have a significant competitive advantage.

We will analyze in the following steps:

1. Bitcoin Network :
   • Who are the market participants, and how do they influence Bitcoin's price?
   • Analyze the various levels of the mining network
2. Next-Generation Mining Machines leveling the playing field—allowing high electricity cost miners to remain in the game.
3. Debunking the myth that "the break-even point of miners is the price floor of Bitcoin".
4. The impact of the 2020 Halving on the Bitcoin industry—scoring three wins.
5. Mining difficulty: Satoshi Nakamoto's ingenious network stability mechanism—understanding its gravitational pull.
6. How miner surrender speeds up the bottoming process of Bitcoin prices.

There are three main types of participants in the Bitcoin market:

1. Investment Funds: Hedge funds, venture capital funds, family offices, and other institutional investors. They almost entirely adopt a "long-only" strategy, rarely shorting. They typically have a long bias, but if their belief is challenged, they have the ability to exit their positions at any time and leave.
2. Hodlers: Long-term accumulators seeking to maximize their Bitcoin holdings. Hodlers tend to have a long-term bullish bias and are less sensitive to price fluctuations than investment funds. However, like investment funds, Hodlers can exit their entire positions and leave at any time.
3. Miners: The backbone of the Bitcoin network. Compared to investment funds and Hodlers, miners have a higher conviction in Bitcoin. They have long investment horizons. They invest in assets with long lifecycles that cannot be repurposed or quickly liquidated at fair market value. For example, ASIC miners have a lifespan of over 3 years and can only be used to mine coins with the Sha-256 protocol (almost exclusively Bitcoin). Bitcoin mining facilities have a lifespan of over 5 years, usually refurbished warehouses designed specifically for cooling mining machines. On average, after investing in mining machines, facility construction, and electricity expenses, miners need 18 months to break even. Miners are the main driving force of selling pressure on the Bitcoin network. They harvest all newly issued Bitcoins and must sell Bitcoins to fund their capital and operational expenses for their mining business.

Approximately 54,000 new bitcoins are mined every month. Assuming a bitcoin price of $10,000, this translates to about $540 million worth of new bitcoins being released into the hands of miners every month. Miners must sell a significant portion of these 54,000 bitcoins to cover electricity costs. Miners with higher electricity costs must sell a larger proportion of bitcoins to cover expenses. Therefore, a significant amount of capital outflow from the Bitcoin network is driven by miners.
The released new bitcoins represent potential selling pressure

Breaking down the mining network hierarchy, the chart on the right shows the distribution of miners' electricity costs and the percentage of hash power controlled by each level of miners, with the percentage of hash power coming from the percentage of bitcoin mining rewards earned by each level

With the release of next-generation miners, significant changes have occurred in the dynamics over the past 8 months. Bitmain's S17 Pro 50T consumes 50% more energy than the S9 13.5T, but generates 300% more hash power. Deploying one S17 Pro 50T is equivalent to 4 S9 13.5T miners in terms of hash power.

Miners in the first and second layers of the network used to dominate the network hash rate, as their electricity costs were lower, they had little incentive to upgrade to the next generation of miners. The older generation S9 13.5T used 16nm chips, while the S17 Pro 50T uses 7nm chips. Innovations in chip technology have made electricity less important, as the power consumption per terahash has decreased. The next generation of miners alleviates the financial impact of high electricity prices.

Conversely, inefficient older generation miners do not have a significant relative disadvantage in low electricity prices. For miners in the first and second layers, considering the percentage of old miners still in the network, it is not cost-effective to upgrade mining equipment to obtain lower production costs. As long as miners from other layers continue to use old miners, the first and second layers remain competitive even with older equipment.

Mining is about survival and being more competitive than your peers. As miners from layers 3-8 transition to the new generation of miners, when they control close to 100% of the hash rate, the first and second layers will be forced to upgrade. The Bitcoin halving is likely the catalyst for this event.

As electricity prices rise, it becomes immediately cost-effective to deplete bitcoin reserves / balance sheets to fund the purchase of next-generation miners. From an opportunity cost perspective, it becomes cost-effective.

As early as May 2019, forward-thinking miners began predicting that the S9 would face the risk of shutdown due to the halving in 2020. As a result, over the past 8 months, miners from layers 3-8 have actively entered the hardware upgrade cycle, transitioning to the next generation of miners, while miners from the first and second layers are still running their old S9 miners.

The upgrade to the next generation of miners has increased the network hash rate by 80%, and has increased the percentage of the network hash rate represented by layers 3-8, diluting the share held by layers 1 and 2 in the overall network hash rate.

As a result, environmental concerns about the Bitcoin network have been refuted. Many predicted that exceeding a certain hash rate on the Bitcoin network would lead to excessive energy consumption. However, as miners become more efficient, the energy consumption rate of the network hash has actually significantly decreased.

The following analysis will explain how miners operating under different electricity prices create selling pressure in the market when profits are squeezed, and how the shutdown of unprofitable miners (impacted by difficulty) leads to a relief in selling pressure.

We simulated the behavior and decisions of miners in different scenarios based on game theory. These scenarios do not propose a target price for Bitcoin but aim to illustrate the impact on the mining network before and after the halving, and how the network reacts at different Bitcoin price levels.

For simplicity in the simulation, a single average kWh rate was used for all miners in the same "mining layer". This simplification helps identify the number of machines that would shut down at each break-even price threshold and creates a cascading effect when miners shut down, amplifying subsequent network difficulty adjustments and enhancing the profits of remaining miners.

Confidence in these settings is derived from the following:

• Blockware Solutions, LLC is one of the largest Bitcoin mining distribution companies in North America. Our clients and partners mine in the following countries and regions: the United States, Canada, Mexico, Venezuela, Paraguay, South Africa, Iceland, Sweden, Norway, British Columbia, Germany, Eastern Europe, Kazakhstan, Russia, the United Arab Emirates, Iran, Mongolia, China, Japan, and Australia. Our business is extensive: our client base, strategic partnerships, business associates, and network account for over 20% of the network hash rate.
• We collaborate with top mining pools and major ASIC manufacturers to gain insights into hash rate distribution, electricity prices, and miner model distribution in each region.
• We have visited a 30+ megawatt mining facility in Chengdu, China, as well as operations in hydroelectric-rich regions in northern New York and the Pacific Northwest.
• Customers and partners in Sichuan Province, China, Venezuela, Kazakhstan, West Texas, northern New York, and the Pacific Northwest pay less than 3 cents per kWh, but most still use older generation miners. They have little incentive to upgrade to the next generation of miners because their electricity costs are low, and the benefits of using more efficient miners are not significant, making it financially impractical to upgrade to the next generation of miners due to the high cost involved.

When Bitcoin trades at $10,000, each mining layer has a healthy profit space, especially for S17 mining equipment. However, for miners in the eighth layer, S9 miners are nearing the shutdown price point. Even at a high price of $10,000, S9 miners in the eighth layer need to sell 96.3% of their mined bitcoins to cover electricity expenses.

Based on the above scenario, all miners must sell at least 39.12% of the mined bitcoins per month (equivalent to $211,225,815) to cover electricity expenses. This means that new funds deployed by investment funds and hodlers must reach $211,225,815 per month to keep up with the fiat expenses required by miners to operate. The selling pressure from miners is ongoing, while the new funds raised by investment funds and hodlers are market sentiment-driven and vary depending on the market cycle stage.

As Bitcoin's price drops, miners' profit space is squeezed. Consequently, they are forced to sell a larger proportion of mining rewards to cover electricity costs (income decreases while costs remain constant).

Let's look at miners operating S9s in layers 6, 7, and 8: as Bitcoin's price approaches and breaches the miners' breakeven price, miners are now operating at a loss. They must sell all the mined bitcoins and even sell previous bitcoin reserves to cover electricity costs. This introduces additional selling pressure to the market—counteracting price support.

Many believe that when Bitcoin's price reaches the breakeven point for miners, they can simply shut down and will not operate at a loss. This is a widely misunderstood concept. Contractual obligations and failed financial management often lead miners to continue operating at a loss. This also forces miners to sell more bitcoins than they mine; depleting their bitcoin reserves and adding additional selling pressure to the market:

1. Miners have negotiated lower electricity rates with power companies, but the prerequisite for these lower rates is to meet a minimum electricity usage threshold. Therefore, some miners may find that even though mining is unprofitable at a certain period, they must continue mining to meet the minimum usage requirement to enjoy the expected long-term electricity rates. (In unprofitable times) they cannot simply shut down for a week or a month to wait for a Bitcoin rebound.
2. Many miners send their machines to hosting facilities. These hosting contracts lock miners into a fixed rate for 1 to 2 years, charging a fixed fee per month per machine (determined by electricity prices). If a miner fails to pay the monthly fee, the hosting facility can confiscate the miner. As a result, many miners continue to mine at a loss for several months to avoid default and the risk of losing expensive machines.
3. Miners turn into speculators. Miners are human too and are subject to emotional fluctuations. Many miners may attempt to implement a plan to sell a certain amount of bitcoins at a specific time. Some miners may sell as soon as they receive block rewards, while others may choose to sell weekly, monthly, or only enough to cover electricity costs. Unfortunately, when Bitcoin rises, miners often become speculators, hoping to catch the next bull market. We have shared some thoughts with one of the largest OTC trading platforms in the cryptocurrency space. In September 2019, we discussed why some mining clients of the OTC trading platform deviated from their cash-out plans and chose to hold instead of selling the mined bitcoins in July and August—because they believed Bitcoin would continue to rise. However, Bitcoin peaked in late June, and these miners had to sell bitcoins at much lower prices in September and October. This situation accelerated the selling of bitcoins, as cashing out bitcoin reserves outside of newly mined bitcoins added extra selling pressure.

In summary: when Bitcoin is at $10,000, only 39.12% of the total mined bitcoins need to be sold to cover electricity costs. Once Bitcoin drops to $7,500, the profit margins for all miners decrease, leading to layers 6, 7, and 8 operating S9 miners at a loss. Consequently, miners must sell 53.18% of the total mined bitcoins each month to cover electricity costs.

Explanation of the above image:

1. Bitcoin approaches a miner's breakeven price. The miner's profit space is compressed, forcing them to sell most of the mined bitcoins, creating more selling pressure in the market.
2. Bitcoin drops below a miner's breakeven price, forcing them to operate at a loss. They must sell all the mined bitcoins and even sell previous bitcoin reserves to cover electricity costs, adding additional selling pressure in the market.
3. The miner must sell all mined bitcoins and deplete their bitcoin reserves to cover electricity costs, introducing additional selling pressure beyond newly mined coins, acting in opposition to price support.
4. This additional selling pressure accelerates the selling of bitcoins and
   Related

   • AI replacing human reviewers, TikTok begins massive layoffs starting from Malaysia
   • Crypto.com receives Wells notice, files lawsuit against SEC
   • Eigen's locked EIGEN tokens sold off for 5.5 million EUR, EigenLayer releases investigation results