Bitcoin mining: Rising production costs are reducing crypto margins

Crypto enthusiasts have long touted their currencies over fiat currencies in part as a hedge against inflation. A rise in the latter due to energy costs has not only benefited the dollar this year but also pushed up the cost of producing crypto staples like Bitcoin.

Meanwhile, crypto prices have moved in the other direction. As major central banks seek to combat price inflation by raising interest rates, speculative assets have lost value. Bitcoin has more than halved this year to nearly $21,000.

That, in turn, encourages Bitcoin “miners” — owners of the computers used to crack complex calculations that create new coins — to use all available computing power to earn more and maximize cash flow.

The catch is that the more computing power is spent on mining, the more difficult and costly it becomes to create each new coin. The total computing power used, called the hash rate, is currently 220 million terahash per second, close to its all-time high.

This may sound counterintuitive as prices fall, but Bitcoin miners have bills to pay. Although modern mining rigs (essentially computers) are about 30,000 times more efficient than they were a decade ago, this energy-intensive process remains the most expensive input.

A high hash rate signals that many miners have begun to capitulate, says JPMorgan's Nikolaos Panigirtzoglou. He calculates that the average marginal cost of mining each Bitcoin coin has climbed to $15,760, about double last year and a record high. Almost everything relates to the electricity needed to run computers.

If Bitcoin prices continue to fall, they could fall below the estimated marginal production costs. This has already happened in 2018 and 2020, and the result was swarms of miners going out of business. A sustained decline in hash rate followed.

As with raw materials, a market price below production costs can be a buy signal. But this price floor could give way if crypto miners give up, causing marginal costs to fall. Unlike commodities, there is no real demand for Bitcoins. Be careful not to catch falling knives.