State of the Network’s Q4 2023 Mining Data Special

Repost from Parker Merritt Kyle Waters Coin Metrics’ State of the Network: Issue 236: “State of the Network’s Q4 2023 Mining Data Special” The full report and all related findings are available on the official website of Coin Metrics.

Introduction

In this week's State of the Network, we continue our focused series on Bitcoin mining, spotlighting data across the mining ecosystem. Mining stands as one of the most intriguing parts of the digital assets industry, often capturing the interest of the public and enthusiasts. As the industry matures, mining is moving well beyond its hobbyist days. With over a dozen publicly-traded mining companies listed on American and Canadian stock exchanges, mining has now become a sector commanding the attention of equity analysts on Wall Street.

This past year has been an eventful one for Bitcoin miners, marked by a major expansion in hashrate across North America and the globe, accompanied with a surge in miner revenues—a welcomed departure from the challenges of 2022. This all occurs as each block brings us closer to the next halving event in spring 2024. The race to mine fresh BTC before the predictable cut in block rewards is intensifying. Changes to core mining infrastructure, regulatory discussions, new debates within the Bitcoin community, and advancements in miner efficiency all create a complex scenario for operators and analysts alike.

480 Quintillion Hashes per Second

Bitcoin's hashrate—a measure of the computational resources being allocated to mining—surged in 2023. Hashrate has leaped to 480 EH/s from 250 EH/s at the start of the year, boosted by publicly traded mining companies who took no rest in expanding operations throughout the bear market.

Source: Coin Metrics Network Data

Improving market conditions have helped miners regain the narrative, with total quarterly mining revenue exceeding $2B in Q2, Q3, and Q4 of this year, on the back of bitcoin's 150%+ YTD climb over $40K. The string of good news was extended by an unexpected revival in the long-subdued Bitcoin fee market, with over $180M in transaction fees dished out to miners in Q2 and over $200M paid out so far this quarter. The cost side of the equation has also improved, with industrial electricity rates coming down in the US. Even though average rates in the US have risen to $0.085/kWh from $0.075/kWh in April, they are still lower than the peak rates paid in 2022.

Publicly traded mining companies (or simply the "pubcos" in industry parlance) continue to aggressively switch on a selection of the most efficient and modern machines like the Bitmain Antminer S19 XP. With competitiveness rising (see analysis further along in this report) sustaining a modern fleet of ASICs has become essential for survival.

The chart below plots the daily profit (in $) for the most common ASICs mining on the Bitcoin network today. Our profitability estimates assume the average US industrial electricity rate from the EIA, and reveal that the most efficient machines have comfortably weathered the crypto winter. Moreover, this is a conservative estimate considering that large miners often negotiate more favorable rates with utility providers due to mining's unique ability to be location agnostic and consume excess energy in less populated areas.

Sources: Coin Metrics Network Data Pro , EIA.gov ,

But even as the good times roll, miners must avoid complacency: in just about four months time Bitcoin's next halving event will cut block rewards from 6.25 BTC to 3.125 BTC—as well as mining companies’ top lines. Miners are currently racing to collect the final Sats from blocks minting out 6.25 fresh BTC. Though the halving is a predictable element of Bitcoin's monetary design, it still presents a complicated calculation for operators managing substantial capital investments in physical infrastructure and computing resources.

At the macro level, conditions vastly improved in 2023 for Bitcoin miners. Even the fee market, which was frenzied in Q2, has returned in Q4. But along with it, a new debate is now gripping the Bitcoin community.

OP_RETURN to Tradition

Thus far, every quarter in 2023 has brought in a new wave of mempool congestion, and Q4 is no exception. By early December, the total size of the mempool swelled to all-time-highs, bringing with it a fresh spike in transaction fees (and therefore, mining rewards). At one point, the daily mean block reward tipped 9.37 BTC, reaching near-yearly highs topped only by the BRC-20 boom in May 2023.

Source: Coin Metrics FARUM

In past periods of congestion, the culprit for the fee frenzy has been Ordinals/Inscriptions, with users employing novel Taproot-powered methods to embed various forms of metadata into the blockchain, from JPEGs to JSON. This latest iteration of on-chain imprints, however, came with a historical return to form, leveraging an age-old Bitcoin script opcode called OP_RETURN.

OP_RETURN allows users to store small amounts of data on the blockchain, most famously used by the Counterparty protocol in 2014. Counterparty ushered in one of the earliest waves of token minting, including early NFT precursors like Rare Pepes . Even then, Bitcoin Core developers met the trend with hostility , introducing an 80 byte limit on the amount of allowable OP_RETURN data. While this slowed the pace of meta-protocol development in the Bitcoin ecosystem, OP_RETURN transactions are once again flooding the mempool. On Dec. 6, the number of OP_RETURN outputs hit 115.4K, the highest level since June 2019.

Source: txstats.com

While Ordinals-based BRC-20s have gained immense popularity (ORDI currently trades at a $1.1B market cap), recognition of the standard’s inefficiency has led to experimentation with new forms of OP_RETURN-enabled token types. Atomicals (identified by the word “atom” in the OP_RETURN data) attempt to improve on numerous BRC-20 indexing issues with the creation of ARC-20, offering users “self-evident digital object histories.” Runes— a fungible token standard proposed by Ordinals inventor Casey Rodarmor— enables the issuance of on-chain assets by simply including “R” in an OP_RETURN output.

Though the initial waves of Ordinals interest seemed like a flash in the pan to some, persistent cycles of iteration improvement on Bitcoin-based token standards indicate that miners can expect to earn extra fees from meta-protocol mints for many quarters to come.

Be Cool, Mining Pool

Historically, mining pools have fashioned themselves as neutral intermediaries, selecting transactions strictly based on economic factors (i.e. fees). However, on November 21, Bitcoin analyst 0xB10C alleged that several pools were excluding transactions from OFAC-sanctioned addresses. The OFAC list is a collection of “Specially Designated Nationals (SDNs)” labeled by the U.S. Department of Treasury, from terrorist groups to drug traffickers. These sanctions legally bar U.S. persons from transacting with blacklisted individuals companies, as well as any cryptocurrency wallet addresses linked to these entities.

According to 0xB10C, the bulk of the missing transactions appeared to be intentionally filtered out of blocks mined by the 3rd-largest pool, F2Pool. As discussed in our Q3 Mining Special , F2Pool is notorious for unconventional block-building antics, from transaction acceleration services to sidechain MEV exploits. These exclusions, however, may be the first observable instance of pool censorship based on OFAC sanctions.

Source: Coin Metrics ATLAS and FARUM

Despite the OFAC transactions spending plenty of time in the mempool and offering a competitive fee rate, F2Pool purposefully excluded them from its block templates, imposing an opportunity cost of 0.015 BTC in fee revenue. In response to 0xB10C’s allegations, F2Pool founder Chun Wang justified the censorship , asserting his right to refuse transactions from “criminals, dictators and terrorists.” Wang later backtracked, claiming to have disabled the ‘filtering patch’ until the community reached a more “comprehensive consensus.”

Widespread frustrations with the current mining pool landscape have inspired a number of new entrants to join the fray. OCEAN pool— founded by controversial Bitcoin Core developer Luke Dashjr— hopes to “radically decentralize” mining, making claims of improved transparency censorship-resistance.

Key to OCEAN’s value prop is a “non-custodial” payout model. Most pools hard-code a ‘0-hop’ payout address into the coinbase (a.k.a. issuance) transaction, taking direct custody of the mining reward. Then, after consolidating funds (and deducting a small fee), the pool distributes rewards to its constituent miners. In place of this “custodial” model of pool management, OCEAN has opted for a different approach, distributing rewards directly from the issuance transaction. OCEAN claims non-custodial payouts allow them to dodge KYC requirements, providing miners with better privacy guarantees.

Source: Coin Metrics ATLAS

While OCEAN’s commitment to miner privacy is admirable, its views on censorship-resistance are a little less cut-and-dry. In the weeks since its launch, the pool has sparked a cultural civil war in the Bitcoin community, censoring a host of transaction types their team deems “spam.” From intentionally filtering out Ordinals transactions to stubbornly excluding privacy-preserving CoinJoins, OCEAN’s stated principles of censorship-resistance seem at odds with their actual behavior, underscoring the challenge of building consensus around mining pool policy.

Public Performance

With Bitcoin price and transaction fees up in tandem, publicly-traded mining firms are enjoying the fruits of their bear market labor. BTC is up 150%+ year-to-date, but mining stocks are outperforming this benchmark by a large margin, with a mean return of 352% across a basket of 10 top mining stocks. After a Chapter 11 filing late last year, Core Scientific (CORZQ) announced plans to emerge from the bankruptcy process by the end of 2023, leading to an especially outsized return of 860%.

Source: Coin Metrics Reference Rates and FactSet

Ahead of the halving in April 2024, miners are taking care to upgrade and optimize their ASIC fleets. One of the most important industry-standard metrics is hardware efficiency, as measured in Joules per TH (J/TH). This metric measures the ratio of energy input-to-hashrate output, with the most efficient ASIC models currently operating in the 18-22 J/TH range.

Using hardware dominance estimates derived from Coin Metrics’ MINE-MATCH methodology, we can approximate the average network efficiency at around 32.2 J/TH by November’s end. This is an especially important benchmark for publicly-traded miners, with firms like Riot Platforms (RIOT) citing the figure in corporate presentations to highlight their competitive advantage at 27.7 J/TH. While not all mining operations regularly disclose their average J/TH rating, the metric has become an increasingly common means for flexing operational efficiency.

Source: Coin Metrics MINE-MATCH and SEC Filings

Stacking up public disclosures side-by-side, a handful of firms outperform their peers in efficiency terms. Marathon leads the pack at 24.4 J/TH, while TeraWulf and Riot are neck and neck in the mid-27 J/TH range. CleanSpark— the analyst darling boasting ‘Buy’ ratings across the board— has accelerated their efficiency gains, dropping from 28.4 J/TH to 26.4 J/TH in just under 2 months.

It's important to note that ASIC efficiency shouldn’t be evaluated in isolation. Miners with dirt-cheap power rates (i.e. Bitfarms locking in 2.1 cents per kWh in Argentina) often manage to operate profitably with older hardware. Many firms have waited patiently for the perfect moment to upgrade their fleets, with premiums on S19s receding as Bitmain prepares to ship the S21. Still, as we hurdle towards the halving, investors are demanding that operators modernize their mines, with J/TH efficiency ratings serving as a crucial indicator of hashrate health.

Conclusion

Bitcoin miners' wishes for better hashing days were granted in 2023. But as the calendar turns over to 2024, the new year promises to be an important one for the industry. The 4th Bitcoin halving event will undoubtedly test even the most savvy of operators, and may even spark consolidation among miners and push more vertical integration. But miners can't get bogged down studying operational variables, as they will also need to keep abreast of political discussions.

Domestically, they've encountered increased scrutiny, exemplified by New York's two-year moratorium on new mining operations which began last year. Even as the White House's proposed "DAME" tax was dismissed earlier this year during the debt ceiling negotiations, the industry remains under close watch by some policymakers. However, new research is breathing fresh air into long-debated issues, while also highlighting Bitcoin mining's potential benefits to the grid. For example, a recent study led by Cornell University researchers suggests that Bitcoin mining could support clean energy development by providing renewables projects a source of revenue during the "pre-commercial" phase of a project, when the wind or solar farm is generating electricity, but is not yet serving it to the grid.

While 2023 was all about North American miners, it's important to remember that Bitcoin mining's landscape is global and geographically fluid. The 2021 mining ban in China demonstrated how quickly hashrate can shift in response to government action. New projects in other regions, like South America and the Middle East continue to shape the global Bitcoin mining narrative, while some countries in Africa are quietly emerging as new hubs.

As we look to 2024, there are plenty of angles to study the industry and bring new analytics into the conversation. Even as block rewards split in half, the strongest miners are poised to double down as the industry matures and grows.

　　Disclaimer: Includes third-party opinions. No financial advice. See Risk Warning.