Mining has never been a low-risk business. Due to various factors it could either be a success or it could suck all the money out of a miner without giving him any substantial profit. Of course there were some moments in mining history when mining rigs had a payback period shorter than 7 days (e.g. back in 2016, when very few miners had proper Zcash mining utilities, those who had them, could mine up to 1 Zcash per day, which was more expensive than BTC in that time). However now those times are long gone.

What risks do miners take on today? Why are they doing it? Do they have any alternative? That’s what we will think about today.

Hardware maintenance and depreciation

Production of miners requires more technological advances than it used to just 2-3 years ago. While GPU rigs are less and less popular among miners due to Bitcoin dominance, more sophisticated sha-256 ASICs are produced with 5nm process, and there are even plans to produce 3nm chips.
We will get in depth of microchips’ lithography in the near post to sort what it is all about. Now all you need to know is that the more precise the technological process is, the more energy-effective and powerful (and obviously dense) the chip is.

Manufacturers usually plan to release new hardware by the monsoon season in China’s Sichuan province in May to maximize the demand from miners. Most often, new items are sold out instantly. A small percentage goes to retail. Most of the devices are shipped to large miners and distributors on pre-orders. The new generation of ASIC miners is usually available about six months after the announcement.

Buying new devices from manufacturers is like buying pre-1980s oil supply contracts. The seller under the contract agreed to deliver the agreed amount of oil on schedule, but the price was unilaterally determined by the oil company.

After 2018, miner manufacturers have become more careful in managing their inventory. They only collect devices after orders are confirmed and aggregated. Buyers usually expect 2-3 months of delivery.

Many are forced to purchase new equipment at a premium from distributors. The price for it can vary significantly depending on the location of the distributor and the availability of the product.

The market of mining hardware is not consumer-centric, rather producer-centric due to its speculative nature. You may even call it some ugly derivative from Bitcoin price which shows strong positive correlation.

It is common knowledge that the mining equipment market is illiquid. Some of the devices are easier to buy used because they have been in production for longer and in larger quantities. That’s why, despite the fact that Bitmain has been ousted by MicroBT and Canaan over the past two years, Bitmain’s devices still dominate the secondary market.

Electricity bills and hashrate wars

Mining hardware market may seem the apogee of thoughtless consumerism if I put this way:

• You buy a gadget for a fairly high price (more than 1-2 of your salaries) in hope it pays you back faster than it depreciates.
• Your neighbor buys the same piece of hardware, now you need more miners to out-mine him or your whole neighborhood.
• You produce nothing but CO2 (unless you run it on green energy).
• You hope to speculate on the price of a virtual asset with no clear intrinsic value.
• You must repeat this algorithm every 1-2 years and buy new hardware because your old miners are not powerful enough.

The worst part about it all: so many people fell for this, their overall consumption exceeded 100 TW*h per annum, which is almost equal to electricity consumption of UAE (96 TW*h per annum), and the Netherlands (108 TW*h per annum).

Miners are so dependent on (cheap) electricity that they tend to operate in isolated regions with dirt cheap electricity. A while ago heavy downpours in the Chinese province of Sichuan have led to a decrease in the hash rate of the leading Bitcoin mining pools. Companies are forced to shut down their hardware and evacuate employees.

Sichuan-based farms control over 50% of the computing power of the Bitcoin network. The largest pools are Poolin, F2Pool, BTC.com and Antpool, whose hashrate has dropped by up to 20%, according to BTC.com. For Binance Pool and OKEx Pool, this figure exceeded 26%.

Poolin CEO Kevin Ban said that some regions are experiencing connectivity and internet problems, which forced farms to temporarily shut down operations. A number of pools partially suspended work and moved employees to safe areas.

Ponzi schemes in synthetic mining products

In addition to the complexity of financial appraisal, the purchase and operation of mining devices comes with many operational risks. For retail buyers, the process can be challenging. An easier way to invest in cryptocurrency mining is with hash-based synthetic assets.

One of them is cloud mining contracts. It is a primitive form of a financial derivative that separates the hash rate from the physical location of the equipment.

Over the years, countless cloud mining projects have emerged and disappeared unnoticed. The dilemma of such proposals is that they are clearly aimed at retail investors, as large players prefer to work with the hardware.

Evaluating such contracts requires knowledge of the mining industry and experience with financial derivatives. This is the main reason why, while the concept of cloud mining is theoretically the next natural step in the development of capital markets in the industry, most of these projects are considered scams. This is often the case.

Since most traditional investors and venture capitalists do not have the skills and experience to manage equipment or structure complex portfolios of assets based on hash rates, they often invest in mining through specialized companies (SPVs). SPV managers buy and operate machines for the capital of investors, and in exchange take a share of the proceeds.

How SPV managers manage cash flow is critical. Developing a smart sales strategy to counter market changes is critical to financial success.

Mining companies with experienced traders can also sell rewards and redeem coins when the price falls below the cost of production, use financial instruments (secured lending, BTC futures, etc.) to protect against price risks.

There have been many well-capitalized mining projects that have failed due to mismanagement of trading positions. A notorious example is Gigawatt in 2018: according to court documents, the company’s assets were valued at less than $50,000 with liabilities of $10 – $50 million at the time of the bankruptcy declaration.

Hence, at the time of writing synthetic mining products are no alternative to good old mining as they pose even more risks to your capital.

Blockchain evolution from PoW to PoS and DPoS

The first consensus algorithm used in a blockchain system was Proof-of-Work (PoW). Bitcoin blockchain is based on PoW. The idea of such an algorithm was first described in 1993 in a scientific paper by Cynthia Duard and Moni Naor on methods of fighting email spam.

Proof-of-Work is a difficult function to calculate, but the results of the calculations are easy to verify. In the case of spam, the computer can send hundreds of thousands of messages every day. According to Duard and Naor’s assumption, if each message needs to spend 10 seconds of computation, it will not be possible to send more than 8640.

The PoW algorithm gained widespread popularity after the publication of the Bitcoin whitepaper in 2008. There PoW serves as an obstacle to double spending of coins. To create a new block of transactions, the participant needs to find a number by selection, which, together with information about this block, will give the value of the SHA256 hash function suitable for the network rules. That is, the speed of new bitcoin mining – mining – depends entirely on computing power and luck.

Whereas PoW was pioneering algorithm for cryptocurrencies, the sheer amount of wasted energy is frightening enough to look for alternatives. One of the most popular algorithms now is PoS (Proof of Stake) and its variation DPoS (Delegated Proof of Stake).

In PoS, network participants freeze a certain number of tokens in wallets. After that, the algorithm selects the next block producer among the participants, depending on the size of the stake. This way participants reinforce integrity not with computational costs, but directly with assets within the network.

Nevertheless, for PoS, there is a problem of ‘Nothing at Stake’. In case of a fork, participants can act as validators on both chains at no additional cost. Because of this, the likelihood of frequent forks in the system increases, which devalues the cryptocurrency and discredits the system.

PoW and PoS algorithms left room for monopolies. Participants with more computing power in PoW and participants with a larger supply of tokens in PoS receive more profit and power over systems.

In 2013, Daniel Larimer developed Delegated-proof-of-stake (DPoS) – a type of PoS, similar in principle to the representative democracy of modern countries. In DPoS systems, participants use their tokens to select validators who validate and add blocks for reward. The algorithm was used by Larimer in his blockchain projects: BitShares, then in Steem and EOS.

Today top 2 blockchains by the volume of operations performed per day operate on the basis of the Delegated-Proof-of-Stake algorithm (EOS – $2 bn/day, Tron – $650 mil/day).

However the real doomsday for a lot of GPU-miners will come as soon as Ethereum will update to PoS or DPoS in a few years. There is still a lot in store for ETH in terms of mining, but the second cryptocurrency should abandon PoW sooner or later. While the proof of stake Ethereum date was originally set for January 2020, this deadline has been missed and it isn’t clear when Ethereum’s PoS will launch now. Guesses vary from sometime in 2021 to 2022 or later.

Is there really an alternative?

Yes, and we have been developing Megamind so GPU miners can join our service and solve practical computational tasks in the way they are accustomed to. One of our early-days motto was “We create mining of reality”, which is exactly that and more.

We want to mimic cryptocurrency mining pools, but in our case every pool will solve some particular task: e.g. computer vision training, 3D render, or other intensive computations with a lot of tensor math.

We plan to release our beta in Q4 2020 and to become operational in 2021 to save a lot of GPU miners who in other case will liquidate their businesses and sell their hardware at very low prices (because nobody wants to game on GPU used in mining, and who else would want so many 1080Ti’s ?).