Crypto mining stealing the spotlight during chip shortage
Senior Quantitative Analyst, Saxo Bank
Summary: The crypto mining industry is riding on the crypto bull run. Can it continue to unearth profits?
The global supply of semiconductors is struggling to keep pace with the increase in demand, and the resulting semiconductor chip shortage has implications across multiple industries. Cryptocurrency mining relies heavily on semiconductor supply and it is currently running at record-high levels, despite the chip shortage. The question is whether cryptocurrencies which are employing mining for transaction validation are short lived, as multiple initiatives attempt to limit the mining profitability and the heavy power consumption related to crypto mining.
Semiconductor chips are used in the core logic and memory parts in a variety of computational hardware. The Covid-19 pandemic has caused a distortion of the semiconductor chip markets, impacting the industrial production lines which rely heavily on the chips. The limited supply of semiconductor devices is struggling to keep up with the increase in demand and has led to a global chip shortage. The car industry has been hit especially hard, with General Motors cutting production in several plants, and the chip shortage is in general estimated to have caused a reduction in automobile sales of more than $60bn. The shortage has spread to a variety of other sectors such as gaming consoles, smartphones and other advanced electronic devices. Many chip suppliers are now booked beyond capacity and the timeline for acquiring equipment to ramp up the production seems long.
Mining becoming increasingly profitable
One significant consumer of semiconductor chips is the crypto mining sector. The crypto bull run which started in autumn last year has made the cryptocurrency mining industry significantly more profitable due to increased activity in the crypto space—see figure 1. The hike in activity has caused an increased interest for acquiring hardware for mining crypto currencies. As an example, an unknown miner in Russia recently imported the largest Bitcoin mining batch ever seen for the country. And more alternative ways of setting up crypto mining farms have also been proposed, with Chinese crypto miners buying laptops for Ethereum mining, as the current laptop and energy prices in China are making this profitable. This of course limits the supply for those who need the basic laptop functionalities.
The global chip shortage has caused significant price increases in mining equipment which could be forcing some of the smaller players out of the game. When the number of active miners decrease, the network becomes less decentralised with fewer players to verify the transactions. Looking at the current mining situation, we do not yet see any signs of this, as existing miners may not have short-term needs for replacing their current mining setup. If the chip shortage persists in the longer term, it may in the end cause an increased security risk for the network.
The total computational power which is being used to mine and process transactions is measured by the so-called hash rate, when considering proof-on-work blockchain—in other words, where mining is used to validate transactions. The current hash rate for Bitcoin is at elevated levels, and for Ethereum it is hitting record highs—see figure 2. Ethereum mining currently has the largest yield for any GPU mineable coins, making it popular amongst miners.
Less favourable mining conditions in sight
Ethereum is in an ongoing process of upgrading to Ethereum 2.0, The verification of transactions will be moving away from power-intensive mining to a proof-of-stake framework, where holders of Ethereum can stake a part of their holdings, and through this validate transactions. When fully implemented, the Ethereum 2.0 upgrade will completely erase the concept of mining, so one may wonder why crypto miners are rushing into the Ethereum space. The full transition is expected to take place in 2022, and it is affected by the decisions of the Ethereum development team. This long time horizon may incentivise miners to go for the short-term profits anyway, notably those miners who are able to build up a significant amount of ETH from mining, which they can use for earning rewards in the new Ethereum 2.0 staking framework.
Before the full Ethereum 2.0 upgrade is implemented, another update is in the pipeline. EIP 1559 will change the way users are paying miners for validating transactions. The rollout is expected in July this year, with the purpose of making fees more predictable and less expensive, as well as keeping the inflation in Ethereum at a minimum by burning some of the fees which go to the miners. The upgrade seems to be good for Ethereum as a whole, but miners are not pleased with the initiative. Furthermore, environmental issues of crypto mining are gaining more focus than ever before. One example is a proposal for a shutdown in one of the China’s largest crypto mining centres—Inner Mongolia—due to energy-saving rules.
Looking into a 2021 hangover?
In the semiconductor chip industry, the fear of a crypto hangover is still present. The last hangover was observed after the crypto bull run in 2017 which caused a drastic increase in demand for GPUs for crypto mining. It was followed by a period where graphic card providers had difficulties in delivering hardware to their long-time core client base, and at the same time the declining crypto interest made mining less profitable, leaving miners with no interest to restock on hardware. Companies like Nvidia are now taking new initiatives towards avoiding the overlapping interests in their hardware functionalities. They have launched specialised hardware for crypto mining, as well as having a gaming-specific card in the pipeline which will slow down the system if used for crypto mining, although the latter seems a challenge to implement in a way which cannot be bypassed by skilled miners.
Looking forward, the energy-intense verification of crypto transactions through mining seems to belong to a past generation of crypto currencies. They are not viable for large-scale implementation of a scalable transactions infrastructure, and they do not fulfil the increasing global requirements for power consumption. Although Bitcoin is using mining for validations, it seems to have a special status due to its long legacy. And as Bitcoin is considered more as a store-of-value in the crypto space (despite the large volatility), it may still be present at the top of the next generation of cryptos, where the vast majority of cryptos will be using a proof-of-stake or a similar approach for validating transactions—crypto mining will be a thing of the past. Turning to a shorter timeframe, a continuing crypto rally will likely make miners even more profitable, giving them a lot of bargaining power when competing against other industries for a limited amount of semiconductor chips. This could pose a threat to other chip-heavy industries if they do not take the proper precautions.