Bitcoin Mining Is A 374+ Million Dollar Per Year Industry, And Growing

BitcoinWith the recent run up in the price of Bitcoin I decided to go back and check on the profitability of Bitcoin mining. Lo and behold Bitcoin mining is still not individually profitable with current difficulties, prices, and hardware costs. However, this doesn’t mean that there isn’t someone somewhere turning a profit on Bitcoin mining. Chip designers, manufacturers, resellers, and pool operators have all staked a claim in the Bitcoin mines and look set for growth.

If you’re new to Bitcoin and don’t quite understand what mining is I suggest you read through our guide to Getting Started With Bitcoin or watch the video over at WeUseCoins.com. If you don’t have time for that here is a very brief explanation. Bitcoin mining is the network of computers that secures and transmits Bitcoin transactions. Users that add computational power to the network are rewarded with some Bitcoin. The amount of Bitcoin that is rewarded declines over time. Currently Bitcoin mining is done through specialized computers known as ASICs, though it was previously done with personal computers.

Bitcoin Mining Is Not Individually Profitable

It is important to note that there are few, if any, Bitcoin mining rigs that are likely to yield a significant return on investment. A common fallacy lies in the argument that if the price in Bitcoin rises, then investing in mining hardware will yield a significant return. However, in almost all cases investing directly into Bitcoin will yield a higher return than the hardware would. A better metric is to calculate your return on investment in Bitcoin. If investing in mining hardware will return you more Bitcoin than it originally cost you, then it may be worth doing. If you lose Bitcoin (but possibly gain dollars/euros/etc due to an exchange rate increase), you lose.

This lack of profitability is due to a shift in the type of hardware used to mine Bitcoin. This time last year Bitcoin mining was done using either personal computers with high end graphics cards, or using slightly more efficient hardware known as FPGAs. Earlier this year several chip designers began producing specialized chips specifically for Bitcoin known as ASICs. These are much more efficient and powerful than the previous methods of mining. The demand for ASICs has allowed manufacturers to keep a relatively high price for the hardware. The relationship that has emerged has been one that keeps hardware prices at a level that either causes investors to break even, or mine at a loss. Still a number of enthusiasts, including myself, have invested in the hardware both hoping to earn Bitcoin and help secure the network.

USB_Miners

For example, last November I made two separate investments into Bitcoin. One investment was to directly purchase $200 worth of Bitcoin off of MtGox at around $12. Those same Bitcoin today (16.6) are valued at around $3,400. At the same time I placed a preorder for a Butterfly Labs Jalapeno for $149. The Jalapeno arrived in August of this year and has mined just shy of 2.0 Bitcoin to date, or around $770. The direct investment yielded a much better return than the investment in mining hardware. Similar scenarios have played out with other manufacturers of Bitcoin mining hardware.

There Is Money In Bitcoin Mining

The fact that Bitcoin mining is not individually profitable is an important point. The Bitcoin protocol calls for the production of approximately 1,314,000 Bitcoin over the next year. At current prices that amounts to roughly $374,490,000 USD over the next year. With many miners mining at a loss the size of the mining industry is likely to be much larger. For instance, if each miner is only making 50% of their original investment back, then the size could be double that. What’s more is if the valuation of Bitcoin continues to increase then so does the size and profitability of the industry.

So where does this money go? One of the most pivotal centers of Bitcoin mining lies in the mining pools. Mining pools are groups of miners that pool their power together in order to have a more consistent payout. Pool operators typically charge 1%-2% of the total Bitcoin produced by the pool as a pool fee. While some of this fee goes to server costs and maintenance fees, a good bit is likely to be pure profit for the pool operator.

Perhaps the largest beneficiaries in Bitcoin mining are the newly formed Bitcoin hardware companies. Companies such as Cointerra have assembled teams of engineers to design and produce hardware specifically for the SHA-256 algorithm that the coin is dependent on. These companies along with the manufacturers for their products could be in a very good position going forward, assuming Bitcoin continues to thrive. Hardware resellers have also emerged on sites like Bitcointalk.org, who purchase mining hardware in bulk and then sell it to individual miners.

By The Numbers

At the moment Bitcoin is trading at around $285 USD/BTC on the exchange Bitstamp (higher on others).  Lets work through the numbers real quick to get a valuation for the current Bitcoin market capitalization, and for the market capitalization for new Bitcoins produced over the next year (assuming a constant price).

Over the first four years of Bitcoin’s life (210,000 blocks) there was a block reward of 50 Bitcoins per block.

50 Bitcoin/Block * 210,000 Blocks = 10,500,000 Bitcoin

The block reward halved in late 2012 resulting in a new block reward of 25 Bitcoins per block. There have been 58,411 blocks added since the block reward halved.

25 Bitcoin/Block * 58,411 Blocks = 1,460,275 Bitcoin

Adding those two totals together provides the total number of Bitcoin produced to date.

10,500,000 Bitcoin + 1,460,275 Bitcoin = 11,960,275 Bitcoin (total)

Next we’ll multiply that by the current exchange rate, $285 USD/Bitcoin to provide us with a current market capitalization.

11,960,275 Bitcoin * 285 USD/Bitcoin = 3,408,678,375

Similarly we can find a simplified expected value for Bitcoin produced over the next year. There will be approximately 1,314,000 Bitcoin produced over the course of the next year (likely somewhat higher due to the speed at which hardware is being added to the network).

1,314,000 BTC * $285 = 374,490,000

Where Is Bitcoin Mining Headed

So while individual mining may not be the path to easy money that it once was, there is still considerable profit to be had in the Bitcoin mining market.┬áLike many I’d expect Bitcoin mining hardware to eventually reach a sort of equilibrium, where mining hardware yields a roughly equivalent return to the initial investment. Thus investing 1.0 Bitcoin into equipment would return 1.0 Bitcoin. Either way, if you’re bullish on Bitcoin in the long term, then you could also expect this newly emergent hardware industry to grow. Opportunities abound for everyone from the pool operator, to the chip designer, to the manufacturer and even the middleman reseller.