William John Market Report 25-08-21
William John Market Report 25-08-21Category: Reports
The process of ‘global warming’ and climate change is the ecological paradigm of the early 21st century. In the press, it tends to be recycled in summer seasons as the world observes devastating forest fires, volatile weather patterns and heatwaves. In the financial press, however, headlines have been dominated by cryptocurrency mining.
Cryptocurrency mining is the process by which new cryptocurrency enters into circulation. But, it has a much more important role to play in the crypto economy. All cryptocurrencies rely on the underlying technology of a blockchain ledger system, which allows peer to peer transactions to be verified, anonymously, using computers. The process of verifying these transactions by computers is the crucial role that cryptocurrency mining plays. In return for people contributing their processing power and sophisticated computers for verifying “blocks” of crypto transactions, their operators are rewarded with new currency. This has two major implications, one economic and one environmental.
Addressing the economics of this, the rewards for mining cryptocurrency vary for each cryptocurrency. Taking Bitcoin as the most popular example, the reward for mining Bitcoin approximately halves every four years, from 50 bitcoins per block in 2009 to 6.25 in 2020:
Source: William John Analytics, Investopedia.com
As the rewards for Bitcoin mining have lowered over the past decade or so, so has the number of coins mined in return:
|2009||21,000,000 (Total coins to be mined, ever)|
|2012||10,500,000 (New coins mined)|
|2016||5,250,000 (New coins mined since last halving)|
|2020||2,625,000 (New coins mined since last halving)|
Source: William John Analytics, Investopedia.com
If the number of bitcoins rewarded for mining is falling every four years, you would expect miners to mine more cryptocurrency, not less, in order to maintain the value they are gaining from mining in the first place. This would be assuming the price of Bitcoin, amongst most other cryptocurrencies, has not changed since 2009. Of course, the opposite is true. Prices for cryptocurrencies since their inception have risen dramatically:
Source: William John Analytics, Yahoo Finance. Prices taken in September of each year.
And the rest of the cryptocurrency asset class has followed suit. Finding reliable and accurate Cryptocurrency indices that have large amounts of historical data was difficult given the emerging nature of the asset class. A benchmark to analyse going forward would be the NASDAQ Crypto Index, which tracks the performance of: Bitcoin, Ethereum, Litecoin, Chainlink, Bitcoin Cash, Uniswap, Stellar Lumens and Filecoin. However, the Crypto Currencies Index 30 (CCI30) which includes all the constituents aforementioned as well as other notable currencies such as Dogecoin and XRP, was chosen as it has historical data running back to 2016:
Source: William John Analytics, cci30.com
From this data, the economics of crypto mining becomes clearer. Reverting to the Bitcoin example where most data is available, in 2012 you would be rewarded with 25 Bitcoins for each block of ledger transactions your computers verified. 25 Bitcoins multiplied by an average price of $12.50 would give the average Bitcoin miner a value of $312.50 per block of transactions mined. In 2020, you receive 6.25 Bitcoins. The price of Bitcoin in September 2020 was $48,600. This means you would earn $315,900 per block of transactions mined.
Clearly, miners need to mine significantly less amounts of the blockchain ledger to amass small fortunes, and whilst less bitcoins being issued reduces the amount of the currency being injected into circulation per year, there is huge economic incentives to involve yourself in the mining process (if you have the tech expertise) and these incentives become stronger and stronger the higher the price of these currencies rise.
So, what are the implications of this? This is where the environmental impact of mining comes into play. According to the Cambridge Bitcoin Electricity Consumption Index, Bitcoin mining alone accounts for 0.4% of the world’s energy consumption, using more electricity annually than Finland or Belgium. The energy consumption of Bitcoin mining computer networks is so severe that popular executive of Tesla, Elon Musk, reversed his stance on Bitcoin in May 2021 stating his company would no longer accept Bitcoin as a form a payment for their cars given the environmental concerns about generating or “minting” the currency.
The environmental impact of Bitcoin is particularly damaging if it is mined in countries that rely on the combustion of fossil fuels to generate energy. China, which until recently accounted for 40 to 50% of global bitcoin production (according to the Financial Times) has a strong reliance on coal-powered energy meaning that almost half of the world’s issuance of Bitcoin in recent years has been directly sourced from coal power.
In June, Beijing ordered a clampdown on Bitcoin mining operations in Sichuan to shut down the 26 largest mines in the province whilst other local governments implemented similar measures in Xinjiang, Yunnan, and Qinghai. These local government are under pressure to reduce energy intensity.
Moreover, cryptocurrencies represent an essential challenge to government and particularly authoritarian rule. For example, China is currently developing its own digital currency to increase its awareness and control of cryptocurrency whilst restricting the use of other cryptocurrencies.
A common question raised by Treasuries and Central Bankers is how to control these ledger transactions and what they are used for. The anonymity of cryptocurrencies is appealing for its users, but this appeal could be based on a need for financing terrorism, narcotics trafficking or other criminal enterprise and whilst security agencies can “follow the money” with fiat currency, they cannot follow cryptocurrency.
This, combined with the environmental impacts of mining cryptocurrency, represent an existential challenge to the future of these coins. China’s crackdown alone in June has approximately halved global Bitcoin mining operations (see next page).
So, what does all this mean? The economic conclusion to draw is that even though Bitcoin issuance is halving approximately every four years with the last Bitcoins set to enter circulation around the year 2140, as long as the price of Bitcoin remains as high as it is (or higher), Bitcoin mining remains a lucrative emerging industry with industry profits globally soaring – an industry to watch this decade certainly.
The environmental conclusion to draw is that the mining companies that operate on clean energy are likely to dominate the market for the foreseeable future. Government clashes with cryptocurrencies and its surrounding infrastructure are already widespread and if miners do not adapt to the many eco-friendly policies in their country of operation, crackdowns that have been observed in China could become commonplace leaving the eco-competition to soak up the mining market.
Source: William John Analytics, Blockchain.com
Any opinions expressed in these documents are those of William John and are provided for information only. E&OE.