There’s a lot of pressure on Bitcoin miners right now:
- Bitcoin’s price is down some 75% from all-time highs
- Hashprice–a proxy for mining revenue per hash created by a miner–has hit a record low
- Difficulty is at an all-time high over 32 trilllion
Typically, energy contracts are the saving grace for cyclical-conscious miners. Energy-hungry miners set up power deals with the cheapest generators or owners in order to keep machines humming during the doldrums.
Yet today’s market has hardly given miners reprieve. Energy prices are up double digits for many end-consumers, as spurred on by the well-trod conversations on inflation, the Russo-Ukrainian conflict and flailing green energy policies.
There’s irony in the fact that Bitcoin, the asset miners produce, failed to be the inflation hedge they now need. Perhaps that’s why so many public mining firms hodl’d when the prudent move was to sell. Regardless, miners find themselves in a pickle. What are miners to do when the cost of operating is closing in on revenue?
In this piece, we will take a look at how energy contracts are constructed, how third parties structure hosting and strategies for gaming hostile markets.
A power purchase agreement is an agreement between two or more bodies to allocate a rolling amount of energy from a producer to a user.
Agreements have a few components, including the amount of energy to be consumed, the price of the power and the rights of both parties under certain conditions.
First, the energy load to be consumed is agreed upon based on the amount of energy available to be sold by the producer and the amount the buyer can use. It’s important to note the buyer is locking in the use of this energy. For example, an aluminum smelter who fails to use a 5 megawatt (MW) load can cause issues for the generator.
Second, contracts for purchasing energy can take on a few forms. A variable model purchases energy at a market-clearing price based on local demand and supply of available fuels, in addition to larger market conditions. A fixed model would purchase a certain load from the generator at a set rate, usually with a higher markup to protect the generator's downside. And finally, a cost-plus model would see a fixed rate with a variable component depending on additional factors, such as average market price for energy or additional load brought to the grid.
Lastly, the rights and conditions of the producer and buyer are swayed in favor of the generator, who must manage not only their own bottom line, but all other energy buyers on the grid. Contractual clauses enable the generator to turn off power (load shedding, curtailment, etc) based on local grid demand to any end user. Rates are also subject to change, as are the operating relationships between the generator and any buyer.
The phrase no operator wants to hear is force majeure, meaning both parties are freed from the arrangement due to extraordinary circumstances. Here, the generator makes all contracts null and void based on their claim to the energy’s production. While unfortunate, the red-pill clause can protect a community resource from one stakeholder’s interest.
Hosting and mining
Bitcoin miners don’t buy energy from the grid. Well, the majority don’t.
Only large miners can typically purchase enough energy from a given grid to have a seat at the table. For example, Riot Blockchain’s 750 MW site in Rockdale, Texas, is the poster boy for large-scale mining with energy contracts from the Energy Reliability Council of Texas (ERCOT). The reason being that Riot’s data center pulls roughly half the amount of energy used by the city of Houston. Volume puts you in a class of your own.
A small miner–we’ll roughly say anything less than 10 MW–is typically not purchasing energy right from the grid. Rather, it's normally purchasing from a hosting provider: someone sub-contracted with the local generator who further breaks energy contracts down into nibbleable sizes for others.
Dedicated hosting providers popped up bigly during the last bull cycle, flipping low energy costs and high demand for rack space into a plug-and-play business. Well-known Bitcoin firms like Compute North, Blockstream, Core Scientific and Riot Blockchain offered hosting space for third-party clients–some wanting only a few rack spots and others wanting dozens of MWs. Thousands of other private parties jumped on the bandwagon as well, learning mining as they went.
These hosting providers become the second pancake in the stack, with generators on the bottom and hosted clients on top. Needless to say, it can be a precarious position for third-party hosted clients given the legal rights of everyone below. Generators can be turned off to meet local demand. Hosting providers can favor their own units, turning off other clients. And third parties themselves often lack insight or the right to maintain their own units at hosted sites. What’s more, the third party has no PPA–as they are not directly buying energy from the generator–but only negotiated terms and services. Clients pressing hard on a hosting service can see degraded services, or be entirely booted from the hosting site. It’s an unkind world!
What to do?
Luckily, there are a few tricks to the trade for those using hosted services: screen hosting partners heavily, know your terms and services and remain flexible.
The first two points bear little explanation. Work with people you trust or people with good reputations. Read their documentation. Ask for insights into their financials and the PPAs they signed. Set good standards on the front end. Align hosting incentives for better service.
Contingency plans become the most important part of a hosting model. Cash on hand, backup hosting locations and mobile-friendly mining containers are key to making a bad situation amendable. In fact, these three points can be a large advantage over mega-miners, who are glued to whatever geography they pick for the long haul. Flexible hosting strategies can decrease operational costs over the long term, if played correctly.
Watch: The Folly Of The Mega Mines