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How To Earn Passive Income With Cryptocurrency Mining

When and why cryptocurrency mining makes financial sense


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Graham Sahagian

3 years ago | 4 min read

Photo by Hans Eiskonen on Unsplash

My cousin called me yesterday for advice on how to get into cryptocurrency (specifically Ethereum) mining. I could tell he was excited but didn’t really know where to start.

With the recent surge in price, tons of people have started to look at crypto mining as an appealing avenue for generating passive income.

I’ve had some experience mining on a hobbyist scale and am well acquainted with the benefits and drawbacks of crypto mining as an investment vehicle. Here is the spiel I gave him and now give to you:

It’s An Investment; Don’t Overthink It

Purchasing, building, and operating a cryptocurrency mining computer is an investment activity and as such should be analyzed through a financial lens.

Putting aside mining algorithms, GPU efficiency, blockchain protocols, and a milieu of other complexities associated with mining, we can understand the benefit of crypto mining through a simple cost and profit analysis.

Mining cryptocurrency, compared with owning the underlying cryptocurrency, will reduce your losses in a bear market.

In a bear market, you must be ready to absorb potential losses and hold out for future bull markets. If you aren’t ready to do that, you shouldn’t get into mining.

This is of course assuming the market recovers to an upward trend, which I think any crypto-enthusiast would agree is a fair assumption. Stagnant markets are exactly where you want to be as a hobbyist miner. This will make more sense when you see the example below.

Investing into a cryptocurrency mining is a market hedge.

What’s a hedge? A hedge, in essence, is a method of reducing your overall investment risk exposure.

In this context, mining alters your return characteristics in a somewhat unique manner:

(1) Upside profit potential is reduced as you won’t have the market exposure inherent in owning the underlying asset. Instead, you’ll receive payouts on a relatively constant basis dependent on your rig's computational power (how much you spent on your GPUs), whereas investment into the underlying asset offers unlimited upside with no such constraint.

(2) Downside risk is reduced moderately. By purchasing this hardware you trade one asset for another asset-producing asset. You’re also inheriting a slew of other liabilities like depreciation expense and operational risks, however, because mining rewards are independent of the financial value of the underlying asset, you’re better off mining during a bear market, rather than owning the underlying asset.

(3) Mining creates an upside in a stagnant market where there previously was none.

Miners flourish in a mean-reverting market as they’re able to generate block rewards, aren’t paying the opportunity cost associated with mining during a bull market, and aren’t losing money as they would in a bear market.

Examples

Let’s assume we have $4000 to invest in cryptocurrency and we want to make as much money as possible. We have two options:

Option 1:

Purchase parts and build a cryptocurrency mining rig with our $4000. Assume we buy a stock power supply, processor, monitor, case (rack) for about $500 and purchase a GeForce RTX 3080 and a GeForce RTX 3070 for $3500.

Option 2:

Buy $4000 of the underlying asset.

Comparing Two Investment Options under 3 Market Conditions:

Figure 1: Brownian Motion Simulation
Figure 1: Brownian Motion Simulation

Red = Bull Market, Green = Stagnant Market, Orange = Bear Market

I used a Brownian motion function to mimic the movement of high volatility cryptocurrencies to create an unbiased simulation of market movements. Figure 1 above shows 4 such simulations, that illustrate possible outcomes of investing $4000 (Price) for 12 months (Time).

1a) Mining (Stagnant)

Profit = ~$975

Our daily profit would be roughly $16 dollars, assuming the same price in 12 months, giving us $6000 in mining revenue. Depreciation on our GPUs would be around $525, our electricity cost $500 (assuming a high electricity cost of 20 cents per kWh). Our initial investment was $4000, leaving us with $975 in profit.

1b) Own Underlying (Stagnant)

Profit = $0

By definition, we wouldn’t make any money in this market.

2a) Mining (Bear Market)

Profit = $480

To simplify the payout calculation, I decreased the daily profit in proportion to the value of the underlying at the final time. Our average daily profit would be approximately $12.27 and our revenue $4480.

2b) Own Underlying (Bear Market)

Profit (Loss) = -$1000

3a) Mining (Bull Market)

Profit = $2539

Assuming our average daily revenue from mining is $20. A rough average of our initial daily payout at t(0) and final daily payout at t(12). By the end of the year, our revenue would be $7465, the depreciation on our GPUs would amount to $525, and our electricity cost $500, conservatively.

3b) Own Underlying (Bull Market)

Profit = $2500

Easy as taking our end value ($6500) and subtracting our original investment ($4000).

Expected Returns (TLDR;)

Expected Return = (Probability Bear * Return Bear) + (Probability Bull * Return Bull) + (Probability Stagnant * Return Stagnant)

**Assuming equal probability of outcome

Expected Return (Own Underlying) = $500
Expected Return (Mining) = ~$1331

Conclusion

The benefit of mining is in its ability to protect you from potential losses due to market downturns and create unique opportunities to generate wealth in stagnant markets.

While cryptocurrency mining isn’t quite akin to printing money, it comes pretty darn close when done right and can tender a pretty solid ROI if done under the circumstances described in this article.

Depreciation expense will be greatest in the first year and your GPUs all but obsolete by the end of year five.

Electricity costs will vary of course. This article didn’t factor in the amount of time it will take to source, build and operate the mining rigs. It can be a lot of work to get set up but shouldn’t be a heavy burden to maintain.

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