Warren Rogers
The crypto mining space is approaching a key inflection point. There are currently two dominant proof of work-based coins, Bitcoin and Ethereum. Bitcoin’s consensus rules are immutable and historically have not been able to be altered by some of the largest exchanges and miners in the space.
Ethereum is constantly changing, and the biggest change could come as soon as Q2 2022.
What does ETH 2.0 mean for crypto miners?
Ethereum is expected to transition from a proof of work-based consensus protocol to proof of stake (PoS), which means that graphics card miners will no longer be useful for adding blocks to the Ethereum blockchain.
However, the Ethereum community has been discussing this transition since 2016, and it continuously gets pushed back. During the Ethereum Core Devs Meeting #124 on October 15, a proposal to push the December 2021 “difficulty bomb” was discussed.
The difficulty bomb exponentially increases mining difficulty at a certain block height, and it essentially freezes the chain and forces a hard fork. The difficulty bomb is now estimated to occur around June 2022, and many in the community expect the transition to proof of stake to finally occur.
When this transition occurs, it will be very destructive for miners who are currently mining Ethereum. These miners will have to transition their graphics cards to mine other coins that are profitable with their equipment, and those coins are significantly smaller than Ethereum, in addition to likely being less profitable to mine. It is very possible that if this transition to PoS does occur as recently announced, the graphics card market will be flooded with cheap used chips from miners.
What this means for crypto miners is that Ethereum miners have a very high risk that their machines become obsolete overnight. Their cash flows would immediately dry up, and the resale value of their GPUs will drop significantly. Knowing this risk, a large majority of capital being deployed into crypto mining is going into Bitcoin mining, specifically.
Marathon Digital and Riot Blockchain, the two largest publicly traded crypto mining companies in the U.S., focus solely on mining Bitcoin. Both companies have a market capitalization north of $2 billion, and they have deployed thousands of Bitcoin ASICs (Application Specific Integrated Circuits), which are the machines used to mine the cryptocurrency. After Ethereum’s transition to PoS, Bitcoin will be the only significant proof of work blockchain.
Some investors staking Ethereum proclaim that this shift to proof of stake could theoretically decrease the future issuance and make the token scarcer. While it is possible that this could be true in the short term, in the long run, this transition sets the precedent for being able to materially change the underlying protocol.
If the protocol can completely change its consensus algorithm, what else can they change? Practically anything.
This is in stark contrast to Bitcoin. With Bitcoin, its algorithmic supply schedule has not and cannot be changed. The 2015-2017 Blocksize War revealed just how immutable the Bitcoin protocol really is.
With a large amount of corporate interest supporting a Bitcoin hard fork that would have changed key consensus rules (block size), Bitcoin users (node operators) were able to resist consensus-altering changes and upgrade the network in a backward-compatible way.
Regulatory challenges to mining
In the summer of 2021, China banned Bitcoin mining. At the time, roughly 50% of the total network hash rate was located in the country, but after the ban, virtually all of that hash power migrated to different parts of the world.
China hasn’t been the only jurisdiction putting serious regulatory pressure on Bitcoin miners. Miners in Kazakhstan were placed under extreme pressure recently, as the country’s electricity grid was heavily strained. Bitcoin miners were forced to temporarily turn off, and they faced the threat of a potential permanent ban.
Miners in Russia and Ukraine are also at high risk due to the war in the region. Lastly, even the European Union proposed regulation to ban Bitcoin proof of work mining, though this failed to pass on March 14.
In contrast to certain parts of the world threatening Bitcoin, jurisdictions like the United States have been more welcoming. States like Kentucky, Wyoming and Texas are offering businesses incentives to mine Bitcoin, including special tax breaks.
Crypto mining transition
The looming shift in Ethereum from proof of work to proof of stake will have a noticeable impact on the broader crypto market in addition to the overall mining landscape. Ethereum could become scarcer, leading to higher prices.
The effects on the overall mining universe will be lower consumption of energy for a time while miners repurpose their rigs and shift to new coins — or completely leave the market.
Given the specialized nature of Ethereum mining, it would be our bet that those miners will leave the market completely. Bitcoin will remain the dominant crypto treasury asset, as it is one of the only assets that has the monetary property of immutable scarcity.
Investors looking to deploy capital into crypto mining should focus on Bitcoin, as it has no impending protocol transition and significant potential upside.
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