Cryptocurrency mining for power suppliers
By Matthew Mazzucchi, Xander Hector and Spencer Anderson, with Houlihan Lokey in Dallas and Minneapolis
Outsized profits from cryptocurrency mining are an enormous current opportunity for electric power suppliers. However, the length of time this opportunity will remain available is uncertain.
The profitability of bitcoin mining has increased rapidly along with the price of bitcoin, which has increased more than 75% year-to-date. Profit margins for bitcoin miners using state-of-the-art mining machines have climbed more than 80%.
In power market terms, bitcoin “mined” at a price of $50,000 per bitcoin is equivalent to selling power at a price of more than $400 per megawatt hour. This compares to wholesale electric prices that typically range from $20 to $60 per megawatt hour and that rarely exceed $100 per megawatt hour absent super peak pricing.
Electricity demand from cryptocurrency miners has reached a scale that increasingly commands notice by all electric industry participants and is likely to become an increasingly integrated part of the United States electric grid.
If all bitcoin mining load was aggregated, it would represent the 32nd largest country in terms of total demand, and this is expected to increase meaningfully in the coming years. Regulated utilities report being inundated with inbounds for grid interconnection requests at a scale consistent with massive industrial complexes.
Power plant owners should view cryptocurrency not as something to be dealt with, but rather as a differentiated load source for their existing asset base that creates new avenues to sell electricity.
Depending on market dynamics, cryptocurrency mining has the potential to allow electric power producers to capture far more value for their electricity than otherwise available through traditional offtake agreements or by selling into wholesale markets.
High profits are attracting significant investment to cryptocurrency mining operations. As more miners are added to the cryptocurrency network, the share of revenues and profits for individual miners will decline all else equal.
In simple terms, cryptocurrency mining revenues are distributed based on an individual miner’s pro-rata share of the total computing power of all miners on the cryptocurrency network—known as the network hash rate.
Electric power is the largest operating cost for cryptocurrency miners. Therefore, miners with the lowest power costs will have the highest margins and be in the best position to capture profits whether network hash rates rise or fall.
Considerations for Power Suppliers
There are several important considerations for electric power suppliers while evaluating opportunities with cryptocurrency miners.
First, cryptocurrency mining operations have large, upfront capital costs for mining machines and infrastructure. Typical large-scale cryptocurrency mining facilities have capital costs of approximately $2,500 to $3,500 per kilowatt.
Second, power suppliers will need to secure, or partner with someone who has, access to mining machines and the expertise to run a cryptocurrency mining facility. While state-of-the-art mining machines are currently available for order, that has not always been the case historically.
Third, setting up a cryptocurrency mining facility from scratch can take nine to 12 months or longer. Long-lead-time items can include the delivery of mining machines, transformer installation, electrical grid upgrades and interconnection approval.
Fourth, cryptocurrency miners can earn additional revenues from non-mining activities, such as providing demand response and ancillary services to the electric grid. Some cryptocurrency miners have indicated they are earning upward of 30% of their revenues from non-mining activities.
Demand from industrial-scale cryptocurrency miners can range from 25 megawatts to hundreds of megawatts of around-the-clock load. Unlike traditional data centers, cryptocurrency miners offer flexibility to shut off load, whether for forced outages or to sell power to the electric grid when it is more economic to do so during peak pricing periods. Furthermore, compared to traditional data centers, which must be located near backbone fiber networks, cryptocurrency mining facilities can be located any- where there is sufficient power and internet connectivity.
Increasing electricity demand from cryptocurrency miners is driven by the rapid expansion of cryptocurrency mining operations in the United States in response to China’s ban on most cryptocurrency activities, including mining. The United States is now the leading location for cryptocurrency mining worldwide with a 35% share of global cryptocurrency mining activity.
Cryptocurrency mining in the United States is expected to continue expanding and attract more miners due to an attractive mix of low-cost generation, increasing renewable penetration, a favorable regulatory environment and a reliable legal system.
Expansion of cryptocurrency mining in the United States has created a shortage of power infrastructure suitable for cryptocurrency miners to procure power or access the electricity grid.
Historically, securing access to mining machines has been the primary restriction limiting expansion of cryptocurrency mining operations.
However, cryptocurrency miners generally report there is a sufficient supply of state-of-the-art mining machines and instead indicate that access to electric power infrastructure, whether behind-the-fence or to the electricity grid, has become the most difficult aspect for developing new cryptocurrency mining sites.
The primary decision for electric power producers is whether or not they want direct exposure to the upside potential and downside risks of cryptocurrency mining.
Under a traditional power purchase agreement with a cryptocurrency miner, power is sold at a set price and the electric power producer does not capture excess profits generated from mining bitcoin. However, depending on the strike price traditional power purchase agreements still provide value to certain electric power producers as a hedge against merchant power prices. Several power purchase agreements have been announced among merchant generators and cryptocurrency miners this year, with many more in discussions.
As an alternative to traditional power purchase agreements, certain electric power producers have entered into joint venture partnerships with cryptocurrency miners or have become vertically integrated cryptocurrency mining operations.
Joint venture partnerships have typically been structured such that the electric power producer contributes land and a favorable power supply agreement, which is further enhanced by potentially siting the mining assets behind-the-meter. Both the electric power producer and cryptocurrency miner contribute capital to fund development of the cryptocurrency mining facility and, as such, share in the mining proceeds and associated ancillary revenue streams.
The market for joint venture partnerships is still in the early stages, with nearly all options for structures and economic terms open for consideration and negotiation.
Additionally, cryptocurrency miners are increasingly interested in acquiring power-generating assets directly. With low-cost power purchase agreements difficult to find and joint venture partnerships complex to negotiate, cryptocurrency miners are actively looking at acquiring generation in order to secure power and expand operations as quickly as possible.
How Bitcoin Is Mined
Bitcoin mining is the process through which the bitcoin blockchain is secured and transactions are completed.
Bitcoin miners perform this service by processing calculations to verify a batch of new transactions—called a block—and add the new block to the bitcoin blockchain, thereby maintaining a record of all verified transactions.
Miners are compensated for performing blockchain calculations through rewards distributed by the blockchain program—called block rewards—and transaction fees.
Block rewards are distributed to the miner that successfully solves the blockchain calculation verifying the new block of transactions. The successful miner receives a block reward of 6.25 newly created bitcoins. Only one miner can successfully solve the calculations and receive the block reward.
Per the bitcoin program, a new block can be mined—and a block reward distributed—every 10 minutes, equal to 144 blocks per day or 52,560 blocks per year. The difficulty of the calculations required to mine a new block is automatically adjusted every 2,106 blocks, or approximately every two weeks, to maintain the average time between blocks at 10 minutes. Therefore, the total number of bitcoins distributed through block rewards is limited to 328,500 per year.
Since only one miner can receive the block reward, there is a high chance an individual miner could receive nothing for long periods of time. To get around this problem, miners join together in “mining pools” to split block rewards and increase the predictability of their revenue streams. Joining a mining pool typically incurs a cost of 1% to 2% of a miner’s block rewards.
Furthermore, the number of bitcoins distributed as block rewards will decline over time. Block rewards are programmed to cut in half every 210,000 blocks, or approximately every four years, in what is commonly referred to as a “halving.”
When bitcoin was first introduced in 2009, the block reward was 50 bitcoins per new block. The last halving occurred in May 2020 when block rewards were reduced from 12.5 bitcoins per block to the current reward rate of 6.25 bitcoins per block. The next halving is expected in 2024. Halving events will continue until the last bitcoin is mined, which is expected to occur in 2140.
In addition to block rewards, miners receive transaction fees paid by spenders of bitcoin when they submit new transactions. There is not enough data space in each new block to accommodate all transaction requests immediately. In order to incentivize miners to include their transaction in the newest block, and thereby complete the transaction faster, spenders can elect to pay zero or more bitcoins to the successful miner when submitting a transaction. Miners select the transactions included in each new block and, absent an error, will select the combination of transactions with the highest total transaction fees first.
Transaction fees vary with the number of transactions and elections by spenders. Historically, transaction fees have made up 1% to 15% of revenue and recently have been observed at around 1.5% of block reward revenues. Transaction fees are expected to rise in the future to offset lost revenue from halving events, and transaction fees are expected over time to become the primary revenue source for mining.
The statements and opinions expressed in this article are solely those of the authors and may not be shared by Houlihan Lokey.