Mining difficulty is a key parameter in Bitcoin’s proof-of-work (PoW) consensus mechanism. It is designed to regulate the creation of new blocks on the blockchain and maintain the network’s security and stability. By automatically adjusting every 2016 blocks (approximately every two weeks), mining difficulty ensures that Bitcoin blocks are mined at a consistent rate of one block every 10 minutes, despite changes in the total computational power, or “hash rate,” of the network.  

What is Mining Difficulty?

Mining difficulty refers to how hard it is for miners to solve the cryptographic puzzles that allow them to validate transactions and add new blocks to the Bitcoin blockchain. The difficulty is adjusted based on the total computational power of the network. When more miners join the network and contribute their processing power, the difficulty increases. Conversely, if miners leave the network and the hash rate decreases, the difficulty will adjust downward.

The adjustment is essential to ensure that blocks are produced at a steady rate, regardless of how much mining power is directed at the network. Without difficulty adjustment, an influx of miners could result in blocks being mined too quickly, disrupting Bitcoin’s fixed issuance schedule and potentially destabilizing the network.

Impact on Bitcoin Miners

Mining difficulty directly affects the profitability and viability of Bitcoin mining. As difficulty increases, the amount of computational power required to solve the cryptographic puzzles and mine new blocks also rises. This has several key impacts on miners:

Increased Competition and Costs:

As mining difficulty rises, miners need more powerful hardware and greater electricity consumption to remain competitive. This leads to higher operational costs. Miners often invest in advanced Application-Specific Integrated Circuits (ASICs), which are designed specifically for Bitcoin mining. However, as difficulty increases, even cutting-edge hardware can struggle to maintain profitability. Miners must continually upgrade their equipment or face declining returns.

Reduced Profit Margins:

With higher difficulty, the probability of any individual miner successfully solving the puzzle and adding a block to the chain decreases. As a result, the time between successful blocks mined by any one miner grows longer, reducing the frequency of rewards. Since mining rewards are fixed—currently 3.125 Bitcoin per block, with the amount halving roughly every four years—the rising difficulty means that miners earn less Bitcoin per unit of computational power invested, leading to thinner profit margins.

Market Dynamics:

Difficulty fluctuations also shape broader market dynamics in the mining industry. When difficulty spikes, smaller and less efficient miners may be pushed out of the market, unable to compete with larger, industrial-scale mining operations that can afford the latest technology and lower-cost electricity. This can lead to a more concentrated mining industry, with fewer but more powerful players controlling the majority of the network’s hash rate.

Impact on Decentralization:

While Bitcoin was designed to be decentralized, rising difficulty levels can lead to centralization concerns. Large mining pools and corporations with vast resources could dominate the space, potentially reducing the network’s decentralized nature. This concentration of mining power could pose risks to network security if a few entities control significant portions of the hash rate.

The Impact of Mining Difficulty on the North American Bitcoin Miners

The table below examines the impact of mining difficulty over the first six months of 2024, on production and profitability for three major Bitcoin mining companies: IREN (IREN), SATO Technologies (SATO), and TeraWulf (WULF). These companies were selected for comparison because they consistently report their average revenue and energy cost per Bitcoin on a monthly basis, providing a clear illustration of how mining difficulty influences their operations.

Bitcoin mining is influenced by a variety of key factors, with one major uncontrollable variable being the price of Bitcoin. However, miners can manage two critical cost-related variables that directly impact profitability: energy costs and fleet efficiency.

Energy Costs

Energy represents a substantial portion of Bitcoin miners’ operational expenses. Effectively managing these costs is crucial to sustaining profitability. Companies like Cipher Mining (CIFR), TeraWulf, and Soluna Holdings (SLNH) have actively worked to reduce energy expenses by securing favorable rates and tapping into lower-cost energy sources.

Some miners have implemented advanced energy strategies to further mitigate costs. For example, Riot Platforms (RIOT) and IREN have leveraged power purchase agreements and demand response programs, which allow them to curtail energy usage and even sell excess power back to the grid when electricity prices spike, particularly during periods of high demand. These strategies provide miners with a way to offset future energy costs, thus improving their financial resilience in volatile markets.

Fleet Efficiency

Fleet efficiency is another major controllable cost for miners. To remain competitive, large-scale Bitcoin mining operations are continuously investing in more advanced and efficient mining hardware. By upgrading to newer technology, miners can increase their hash rate while reducing the cost per Bitcoin mined. For instance, the recently released Bitmain S21 miner is more than twice as energy-efficient as the older S19 models introduced in May 2020. Upgrading fleets with such efficient models enables miners to boost their hash rate and overall fleet efficiency without expanding their physical footprint, reducing costs and improving profitability.

Bitcoin Price

While miners cannot control Bitcoin’s price or the rising mining difficulty, they can strategically manage energy costs and improve fleet efficiency to maintain profitability. These factors are particularly critical in the context of Bitcoin halving events, which reduce mining rewards by 50%. In previous cycles, Bitcoin’s price generally rallied post-halving, allowing miners to remain profitable and secure the network.

In the first half of 2024, Bitcoin’s price increased by 47%. However, since the halving on April 19, 2024, Bitcoin’s price has fallen by 2%, closing at $62,678 on June 30, 2024. This drop has squeezed miners’ margins significantly. For example, SATO’s mining margins fell from 57% in January 2024 to 28% in June 2024, despite fleet efficiency remaining relatively constant.

To counteract these challenges, companies like IREN and TeraWulf have invested in more efficient machines, growing their hash rates and lowering costs. Nevertheless, their margins remain below January 2024 levels, and Bitcoin’s price would need to increase by 34% for IREN and 25% for TeraWulf to regain the same profitability. SATO would need Bitcoin to reach nearly $112,000, a 69% increase from its June 30, 2024 price, to achieve the same margin as January.

As of August 31, 2024, Bitcoin’s price has further declined towards $59,000, which will undoubtedly impact the mining margins of even the most efficient Bitcoin mining companies in North America.

Summary

Mining difficulty is a crucial element that ensures the stability, security, and predictable issuance of new Bitcoin. For miners, rising difficulty presents both a challenge and a competitive factor, as it requires continuous investment in powerful equipment and operational optimization. Although higher difficulty reduces individual profitability, it strengthens the Bitcoin network overall, enhancing security and resilience against attacks.