Energy accounts for between 90% to 95% of bitcoin mining costs and plays an extremely critical role in determining profitability for the cryptocurrency’s miners. In turn, profitability is important to attract more miners and grow the bitcoin mining ecosystem as demand for bitcoin spirals.
The Relationship Between Mining Energy Costs And Bitcoin Price
Energy usage for miners is contingent upon several factors, from availability of cheap and plentiful power to energy-efficient hardware to the difficulty of problems being solved by machines to earn bitcoin rewards.
For example, a difficult problem is computation-intensive (versus an easy problem) and, subsequently, will need additional energy resources for solving.
A Forbes post last year suggested that bitcoin’s seigniorage (or the difference in its cost of production and overall value) will become unviable, unless the mining process becomes more energy-efficient. Over the years, bitcoin miners have cut back on energy costs by moving production to China, a country which reportedly accounts for 60% of bitcoin production operations.
A majority of Chinese bitcoin mines are situated in its Sichuan province, where hydropower dominates. Iceland, which provides naturally cooling Arctic air for overheated systems and uses geothermal energy, is also a prominent venue for bitcoin mining operations.
Chinese miners have not provided estimates for bitcoin production costs. But Genesis mining, which shifted its mines from China to Iceland, estimated that it cost $60 for the company to produce a single bitcoin.
In a 2015 paper, Investopedia writer Adam Hayes estimated a cost production model for bitcoin (of which energy was the main cost) and concluded that technological progress, in the form of faster and more energy-efficient hardware, would bring down the market price of bitcoin.
“As real-world mining efficiency increases, which is a likely result of competition, the break-even price for bitcoin producers will tend to decrease. Low-cost producers will compete in the marketplace by offering their product at lower and lower prices,” Hayes wrote.
But that hasn’t happened. An increase in bitcoin numbers has paralleled a jump in bitcoin’s price.
Why? The answer to that question is complicated.
Why An Increase In Bitcoin Production Hasn’t Declined Its Price
To be sure, there have been significant improvements in hardware processing power and costs. Even as energy costs have declined, however, the difficulty levels for bitcoin mining have increased on an overall basis.
With the exception of two instances, the difficulty levels rose consistently over the last year. This increases the cryptocurrency’s hash rate and is necessary to ensure bitcoin’s security. Even though it costs more energy, a significantly difficult problem set translates to a more secure bitcoin network. Halving of rewards for bitcoin mining from 25 to 12.5 has also ensured that mines have to work harder to earn the same number of bitcoins as earlier. Then there is speculation, which has played a prominent role in driving up prices for the cryptocurrency.
Recent forks within the cryptocurrency have introduced new algorithms that require less processing power. For example, the recent Bitcoin Cash fork adjusts problem difficulty depending on hash rate, thereby enabling lower power consumption.
The net effect is that energy costs still comprise the majority component of bitcoin mining costs but exert minimal influence on its price. The energy costs associated with bitcoin mining operations ensure that it remains a significant barrier to enter the industry.