Cloud Mining Bitcoin – An Economic Profit or Dead on Arrival Investment? – Example with Excel
Hello! Before I proceed with wrapping up the Part 1a of my tax, I wanted to share my recent decision this past month to proceed with a small cloud mining investment. I recently purchased a cloud Bitcoin mining contract. I am not here to sell the service to you or spam referral, so I am not disclosing which service I used; I am just sharing the thought process when I decided to purchase the contract, through the lens of economics and finance. For me, this “investment” is a fun experiment just to see how it plays out. I held Facebook stock since the day of the IPO, holding stock can be so boring, so I wanted to make things interesting with the investment opportunity in BTC.
What I Spent
I find the prospect of a mining contract very risky, so I only purchased a small amount. In late July, I spent approximately $220 (saved 3% using referral) for an open ended contract with a 1500 GH/s rate. In addition to the up-front fee, this contract has a daily management fee of $0.00028 USD per GH/S, or $0.42 USD per day. This means, however many Bitcoin is mined by the cloud company allocable to my GH/s, a variable amount of BTC is deducted equivalent to $0.42 cents USD, and I receive a net payout in BTC.
There are two key risks (other than obvious risk of being scammed). The first risk is the difficulty of mining increases with time, yielding less BTC to the net payout. The second key risk is if the BTC price deteriorates, or does not rise to outpace the difficulty increase, it will take more BTC to cover the management fee with each difficulty increase. If the BTC mined does not cover the management fee, no payout will be made; after 60 days of this unprofitable state, the contract will be terminated and payouts will discontinue. More informed minds than I will tell us with great technical details, the difficulty rate is increasing rapidly, and therefore, the BTC cloud mining investment is really as risky (in my opinion bullish) bet, as the price needs to increase higher than the difficulty increases so that the management fee does not turn the contract to a loss. My understanding is the average rate increase between August 15, 2016 and August 2017 is 5-6% - per post picture above from coinwisdom.com
Before Investing – Define Profit The following two concepts I considered in determining whether to proceed: (1) Opportunity cost and (2) Economic profit “In microeconomic theory, the opportunity cost of a choice is the value of the best alternative forgone where, given limited resources, a choice needs to be made between several mutually exclusive alternatives.” Quote Source: https://en.wikipedia.org/wiki/Opportunity_cost
“An economic profit or loss is the difference between the revenue received from the sale of an output and the opportunity cost of the inputs used. In calculating economic profit, opportunity costs are deducted from revenues earned.” Quote Source: http://www.investopedia.com/terms/e/economicprofit.asp.
Evaluating the Alternative
When I evaluated whether to purchase a cloud mining contract, I looked at the trading price range of the Bitcoin to see how much I could have paid for with the same dollars; and compared that to the expected yield at the difficulty and considered the risk in making a decision. I used bitcoinwisdom.com for a BTC projection based on the contract execution-date difficulty, with scaling difficulty over time. I am going to analyze the economic alternative based on today’s price and difficulty level, as if I made a “buy-or-mine” decision today, as I don’t have available the data I ran during the day of my actual purchase. I will still use the $220 figure which I spent as I don’t believe everyone is willing/able to purchase a multi-thousand dollar cloud mining contract.
The Economic Profit
Today, the estimated trading price of BTC around the day when I executed the contract is $4,050 to 1 BTC, therefore with my purchasing dollars, through Coinbase, I would have received 0.054 BTC for a $220 USD purchase – ($220 /($4,050). A 4% “haircut” isn’t used, but should apply as there is a fee for using a credit card on Coinbase. Under the concept of opportunity cost, I am giving up purchasing 0.054 BTC in order to mine BTC with the same dollars. Thus, I will need a yield of 0.054 BTC before the cloud mining contract terminates to be on even footing, an economic break-even; with any excess yield representing an economic profit. Scenario #1 The amount I could mine daily under my contract as of the purchase date with a scaling 6% difficulty over time is below (this assumes price fixes at $4,050 USD per BTC and thus the daily fee). The left set of columns was computed by bitcoinwisdom.com calculator (with no hardware/electricity or pool posts), the right hand columns are myself.
Chart – Scenario #1
The chart above shows that, 316 days into a cloud mining contract I the last profitable date. In other words, from 316 days to 330 days the amount of yield decreases (meaning the contract is in the negative). In this case the mining company wouldn’t pay me and after 60 days they would terminate the contract. Thus, after net management fees assuming a constant price of $4,050, I would have yielded approximately .037 BTC (316 day amount) versus. the 0.054 BTC I could have purchased today. This scenario reflects an economic loss of .017 BTC due to the compounding effect of difficulty increases.
Remove BTC-USD Exchange Rate Constant
Therefore, the only way this project could be profitable is if the BTC price rises over time versus USD. Note: the increase in the price of BTC over time, other than the impact it has on the management fee, is neutral between the decision to buy or mine BTC, as the same appreciation could be shared in either case as a constant, rather it is only the amount of BTC received in each transaction that is uncertain. (With price increases, I would collect my $220 back in USD before reaching 0.054 BTC in the wallet, but I would have even more money at that same point if I had invested in the .054 BTC and let it appreciate passively). Let’s assume in a year span, BTC appreciates against the USD evenly with the difficulty increase at a 6% rate per point of increase;, which means the amount of BTC it takes to cover the management fee also decreases to approximately 94% of the previous fee (in BTC). Below are the formulas used in columns J and I, respectively below, to re-figure the management fee at each difficulty change:
Here is the results of a Bitcoin-USD increase of 6% at each 6% difficulty increase:
Chart - Scenario #2
From above, the break-even is at 343 days where more than 0.054 BTC is mined under the cloud contract; with the profitability turning negative by 534 days when the net yield in BTC descends. However, at the 534 day point when the contract turns unprofitable, the amount of mined BTC would be 0.064, exceeding the amount of BTC I could have purchased today (0.054) for an economic profit of 0.01 BTC. This is a very rosy scenario in terms of the price increase of 6% approximately every two weeks but in line with some of the recent bullish calls in the news. This analysis was enough for me to take the risk of mining, for the risk being I receive less than the amount of BTC I could have purchased the same day, in order to potentially receive more BTC from mining with the same dollars.
Scenario 3 – price decrease A price decrease would quickly result in an unprofitable contract, so I have not ran the scenario.
Counterarguments One possible counterargument I could see, or issues with this analysis (other than bad inputs of difficulty/yield), is holding the BTC for the hardfork & receiving the bitcoin cash as a result, made buying/holding a win each time.
Takeaway I hope to hear others’ thoughts and experiences with the decision to make direct investment in crypto, or to open up to other investment types such as cloud mining. If you have your own way of viewing it please let me know!
Disclaimer: This is not a personal recommendation to you to make an investment.