When you hear the term ‘mining company’ you probably think of some huge corporation that digs holes in the ground, and although some of these organizations actually started out in that business (long story), I’m actually referring to Bitcoin mining.
Mining is a term used to describe the work done to secure the Bitcoin blockchain. This work occurs through the consumption of electricity by huge farms of computers specifically designed for this work. Believe it or not, this is actually a profitable enterprise. In fact, it’s designed to be. The reason why a decentralized network like Bitcoin can survive is that the participants securing the blockchain from attack are rewarded economically for their participation in the form of new Bitcoins.
This is now a HUGE business
Back in the day, you could mine Bitcoin on a home PC but now it takes millions of CPU. Not only that but there is a lot more money at stake — every 10 minutes, $150,000 is up for grabs for the winning miner!
Currently, Bitmain ($3–4B operating profit in 2017) hardware runs 70% of the Bitcoin network but there are many companies launching products this year that will compete with them including consortiums from Russia, the EU and Korea with Samsung announcing their foray into the market in early 2018.
This massive amount of hardware is run by various public and private enterprises, including several public companies trading in Canada:
How do these businesses create value for shareholders?
Simply put, when the cost of operating the business is less than the value of bitcoin being mined, they generate a profit. This varies wildly depending on the price of bitcoin and many external factors that we’ll discuss below.
So what’s the issue with this business model?
Public businesses such as the above are risky because, unless they evolve with this rapidly changing market, the will run out of ways to create value with the capital they have accumulated.
- Electricity and hardware costs are significant. It costs a lot of money to build/scale these businesses and economies of scale are paramount.
- No diversification. If bitcoin falls out of favour or underperforms the rapidly expanding crypto market then this is a bad long-term bet from an investors perspective
- Mining bitcoin is a race to zero. Because there is no theoretical limit to how much mining hardware can be used to secure the network the possible reward will continue to trend to zero ( infinite competitors fighting for a fixed reward).
- Hardware mining is actually falling out favour due to the aforementioned issues. The most significant competitor for securing decentralized networks is an alternative protocol called Proof of Stake, which provides the same value as Bitcoin’s Proof of Work but with none of the hardware or other costs.
- To remain competitive, Bitcoin mining firms need to expand their business to other consensus protocols
The two largest opportunities to diversify will be to adopt proof-of-stake nodes and masternodes as assets within their portfolios.
Proof of Stake
PoS is a consensus algorithm used by many decentralized networks that serves the same purpose as Bitcoins Proof of Work, but without the high energy costs. As a result, it is more attractive economically and allows greater network efficiency which manifests as cheaper transaction costs and higher throughput for the network.
Rather than mining, participants managing consensus must stake a large value of coins in order to participate. Any attempt to subvert the majority results in a loss of this stake, thus incenting all to vote with the majority.
Proof-of-stake is widely adopted in different permutations due to its performance improvements over PoW, especially with dApp platforms which demand high transaction rates and low cost.
Total PoS projects operating: >100
Total PoS value: >$100B
Average Yield: 2–5% per annum
Masternodes (MNs) are a special class of network node that provide advanced utility and governance functions to decentralized systems. They are consensus-protocol agnostic and serve to provide additional trustless value to various types of projects that require it (transaction encryption, computational resources, governance). The operation of a MN involves ownership in a specific (large) amount of network tokens and a high-availability internet-connected computer that can keep the node actively participating on the network.
The operation of a MN is incentivized economically with a combination of transaction fees and block rewards, which is analogous to the incentive models for managing consensus (including PoW and PoS models).
Projects that utilize MNs span most industry segments to-date, since the utility provided can be applicable to any project type — it comes down to a design decision by the architects of the network. The vast majority are used by privacy coins for transaction processing and governance, however there are many more uses coming online this year.
Total MN coins operating: 240
Total MN in operation: 116,800
Total MN value: $2.5B
From a business perspective, investing in nascent blockchain infrastructure is an excellent long-term position because the incentive scales with the value of the network. Owning a node enables the operator to capitalize on the growth of the network while receiving a reward for doing so.
Enter “Node AI”, where I will be joined by Erik Lagerway (COO and Co-founder), to create our cryptoasset management — PaaS (Platform as a Service), currently focused on enabling institutions to own and operate proof-of-stake and masternodes.
Upcoming events we are attending:
May 11–17 — NYC
- Ethereal: https://etherealsummit.com/
- Consensus: https://www.coindesk.com/events/consensus-2018/
- Token Summit: http://tokensummit.com/
Reach out if you are interested in hearing more!