How mining affects the value of cryptocurrencies

At the moment this mining process, known as ‘proof of work,’ takes up a significant amount of computational power and time, and by extension, electricity. As we all know, electricity isn’t free, so there is an associated cost with this process. There is also a continued need to upgrade computer hardware, chips, cooling mechanisms, and support infrastructure to make sure you have the fastest equipment out there. If you’re not the first to validate a block, then there is no reward. 

When we’re trying to value a cryptocurrency, there is an argument to suggest that the base cost of how much it costs to mine an individual coin is going to be the ‘fair value’ of what that coin is worth. In the same way as a drilling rig wouldn’t extract oil at a cost of $120 /barrel if you could only sell that oil at $60 /barrel, crypto miners are unlikely to continue to mine (or at least sell) their coins if the free market value is less than the cost to mine. 

How much does cryptocurrency mining cost?

A big factor affecting how much a cryptocurrency costs to mine lies in the cost of electricity and the relevant tax implications based on geographical location. The cost to mine can even change based on where you live in a single country. For example a recent blog post published by CESCO from January 2018 showed that the cost to mine a single bitcoin in Hawaii was almost $9500 while in Louisiana, which came as the cheapest state in America, just over $3200. This was when the price of bitcoin was about $15,000 on the open market.

Alternatively, you can look at the average cost to mine bitcoin. If you take the average cost of electricity in the United States to be $0.12/kWh, and assume the entire bitcoin network was mined at a requirement of 27.6/tWh, then the cost of producing one bitcoin is roughly $5041.

China, as you may expect, has a significant concentration of miners due to their low electrical costs, relatively cheap technology, affordable rent, and efficient labourers. Areas like Alaska and Iceland are being investigated more and more as miners look to reduce the cost of cooling their computers with the ambient temperatures, and therefore increasing efficiency. If you know the cost of electricity, then you at least have a start.

However, even if you know the cost of electricity in each region, you will still have trouble figuring out how expensive it is to mine a cryptocurrency, as it’s unlikely there will be a fixed energy requirement. Most blockchain systems have a variable mining difficulty which adjusts the hash power needed to mine a single block. In the case of bitcoin, a new block is mined roughly every ten minutes, but the ability to mine in this time is dependant on how much power you have on the network as a whole. 

If the network suddenly receives a boost to the computational power it’s receiving (which should in theory cause each block to be mined quicker) the bitcoin algorithm will increase the hash difficulty (which should reduce each blocks mine time back to a consistent ten minutes). These changes will use more/less energy in a non-linear scale depending on the adjustment. Essentially, it’s not only difficult to calculate, but it’s difficult to predict.

How does cryptocurrency mining profitability affect valuations?

As with everything, the price of an asset is based on supply and demand, and the utility (or perceived future utility) it may have. Mining itself is going to have a knock-on effect on the price of that asset, simply because it doesn’t make sense for an individual miner to sell their cryptocurrencies reward if the market price doesn’t match or beat the equipment and electrical cost it took to generate that coin. 

To put it another way, if it cost you $1000 to set up the hardware and $4000 to pay for the electricity to mine a single bitcoin, you’re unlikely to sell if the current market price doesn’t match at least $5000. If you take this basic principle, factor in different energy and hardware costs, project it globally, and then take the weighted average of how much it costs to mine a single crypto (for example bitcoin), you’re going to have a good base of where miners are unlikely to sell below. This, in theory, creates a soft floor or level of support for the price of a crypto asset. Calculating it is the hard part.