Santiago Osella made a spectacular interview with Ben Gagnon, Bitfarms’ Chief Mining Officer, taking advantage of his presence at the Bitcoin Conference in Amsterdam.
Interviewer: Consolidation: How do you feel about the mining business in relation to the inevitable concentration needed to adjust to increasing difficulty level? How does this trend affects decentralization in the future?
Ben Gagnon: That’s a good question. You know I think there’s a really powerful economic incentive when it comes to mining Bitcoin and I think a lot of the ways people have been mining Bitcoin since inception until now are not going to be the ways that we mine Bitcoin in the next 15, 20 or 30 years from now. There’s a transition happening now because the block reward is getting smaller, because it’s getting much more competitive and because Bitcoin has already had a lot more time to prove itself as a stable asset and an asset class that is worthy of investment.
We are seeing compressing margins and with compressing margins you are going to have to reduce your costs. We as Bitcoin miners cannot control our revenue but we can control our costs and it becomes crucial to do so. So right now, the transition is going from higher cost sources of energy to more marginal cost sources of energy. And in order to achieve lower electricity inputs, you have to pay in other ways. Generally speaking for most people this means incurring greater amounts of downtime. If you want to have 100% up-time, you are going to have to pay for every single peak. If you are willing to be more flexible in your up-time, you can achieve much lower costs.
What you need to understand is that this is the move forward, everybody is going to be moving towards some marginal costs sources of energy. And when the industry moves to marginal costs sources of energy, two really interesting things come in to place: 1) you end up with this incentive where energy producers are now able to monetize access to electricity basically on spot market, this is a new ability they never had before. Electricity storage is very expensive. The most cost effective form of energy storage is pumped hydro, but you are really restrained geographically where you can do that sort of thing. Bitcoin mining is as a unique asset, it will get to the point where, if you are mining Bitcoin with a unit of electricity that has no other customers, that’s already been costs incurred in its generation and is right there on the line, you either use or you lose it. You end up in a situation where it doesn’t even matter the efficiency level of the miner because you are now getting some monetary value out of the electricity that you otherwise would never be able to get anything out of. This is where the industry is going and you are going to see because of this incentive, Bitcoin mining will not make sense as much at large GW size facilities to best monetize these tail scenarios but smaller sites more dispersed and integrated throughout grid infrastructure.
So I say all the time: look at a normal distribution curve: Bitcoin mining makes the most sense at the ends furthest from the center. It doesn’t make sense here (marking the tip of the curve) where most electricity is bought and sold. Just a bad idea. It’s a really weird scenario but this is true for very, very low price energy but it’s also true in scenarios with high price energy, where Bitcoin mining, at least in some capacity, can make a lot of sense. And so through that incentive I think we are going to see an attempt to actually scale down operations, to distribute them all over the world. I think it’s also going to drastically reduce the capital expenses required to set up a new facility because again, that marginal cost of energy, I can buy an older machine, I don’t need the energy efficiency of the newest machine, I actually want cheaper machines because my goal is to monetize the most units of energy, not to get the most monetary value out of any unit of energy. There is a really big difference in those two objectives.
I: That’s a very interesting view, it’s a kind of decentralized mining...
BG: And it’s purely driven by that marginal economic incentive.
I: Energy consumption: As energy costs keep increasing worldwide, new power sources become more relevant. Which ones do you think will succeed in the mid term? (nuclear, solar, wind, carbon, hydrogen, methane, etc).
BG: Another good question, I think that I’ll start off with this: when we look at energy and we look at human civilization and human prosperity, there is an abundance of energy and I don’t think anybody can argue against this: that the more energy consumed by the human population, the greater the success, the productivity and the greater the wealth created by human society. So over time, more energy, more wealth, more prosperity, undeniable. Over time humans have constantly been searching for more efficient forms of energy. We used to have things like fire, that was dense energy, and then they found whales’ fat, and that was even more dense energy, more powerful, and then they got to coal and “Oh! This is even better than that!”, and then we got from coal to crude and from crude to nuclear and the strangest thing now is that now we are traveling back in time, a millennia, to go back to the technology of wind. Wind is not a more dense or reliable form of energy and completely conflicts trends and objectives that have steering humans for millennia. Wind and solar are not even a more cost effective forms of energy when you take into account all the costs often hidden from these technologies like subsidies, and costs of standby power/energy storage. So I don’t think wind and solar are cost competitive and they cannot last in the long term because they are just not reliable enough. These technologies are not cost effective enough and if they are not reliable you have to supplement them with an additional source of energy, so you really double the price. Wind and solar make sense in very rare scenarios, off-grid scenarios mostly…like if you have a boat! If you have a boat, solar makes a ton of sense, you are sailing, you are already using the wind to power your boat you might want to use or capture some of that wind and power your fridge. It makes sense in those scenarios but not in anything that has more traditional access to energy.
And so, when you look at the sources of energy which are going to be successful, I think there are three renewables: hydro power, geothermal and nuclear. I think those are the three technologies that, if you want to push for a carbon free energy market, those are your three that you should push. And notably, economic incentives do not push those, actually they restrain those, they restrict those, they increase the cost of those. I don’t think that can last long term. I also don’t think that fossil fuels are going away. Natural gas is a very efficient technology, like I have said, every energy technology until recently has been more efficient that the last. Natural gas is more efficient than coal, and cleaner, and everything else…Natural gas is not going anywhere, I don’t think coal is going anywhere either, and if you look around the world, China and India are building coal plants at an incredible fast pace. I think, long term, you are going to see a lot more geothermal. Geothermal is an older technology.
The geothermal power plants you see around the world (were) mostly build in the 40’s, the 50’s, the 60’s, similar to nuclear: this is old technology that hasn’t seen a lot of R&D investment and disruption and now there are new companies saying “Hey let’s supply modern technologies, let’s supply modern engineering, new materials…how can we do this better, faster, cheaper more efficiently”. I think that you are going to see, especially on the geothermal and the nuclear side a lot of disruption. On hydro you are also seeing this on a smaller scale but it is hard to disrupt that. Those three would be the biggest and coal and natural gas are not going anywhere.
I: Environment: Considering the latest failure of ESG (Environmental, Social, and Governance) philosophy, do you foresee lighter regulations for the sector? Do you / would you voluntarily work for carbon footprint reduction?
BG: You know, at least at Bitfarms, we are a company that operates almost entirely on hydro power, and we have done that since our founding in 2017. We have mined well over 21,000 BTC just with hydro power. Out of 11 sites only one is not powered with hydro, and is powered with natural gas in Argentina. We have a very long history of being renewable or green friendly, and it is not something that we really wanted to promote because things change, economics change, political situations change.
The reality is that the hydro is environmentally friendly in terms of the carbon emissions and everything else but it’s real attractiveness is it’s economical sustainability. When you have something like natural gas where you have a fuel input that can be very volatile on price, you have unpredictability in the cost of energy. When it comes to hydro you have no variability in your price of the fuel. Your only costs that can drive up price are human labor, parts for maintenance which are very minimal and then, political pressures. Most of the political pressure is usually towards driving the price down because cheaper energy facilitates industrial investment and job creation. So, there is a big incentive to push those different things and for hydro power to stay cost competitive. We really like the economic sustainability of hydro. We haven’t pushed ESG very heavily despite the fact that we have one of the better ESG profiles for public Bitcoin miners in existence. Of the public companies, we have some of the better policies, some of the better history, and a lot of better data on it.
What I find is rather funny about ESG, is the people who talk about it the most are often the least compliant. There are companies who put out ESG reports talking about changing light bulbs, while continuing to rely heavily on fossil fuels. It is a really strange position in the end. I don’t think ESG drives decisions or value creation for investors. I think is a box that people like to tick. When we are on calls with investors, they do ask about ESG but not in depth, I think they just want to say “Hey, can we tick the box? Yes or no?” If they can tick the box, fantastic, but if they can’t tick the box, that is not the ultimate deciding fact on whether or not it is a good or bad investment. We will see what happens on the ESG front, in principle it is a nice idea, (but) I think in practice like most things, it is very different than it’s stated purpose.
I: Volatility: How does Bitfarms deal with BTC volatility? Does this challenge require further financial tools beyond plain mining? Do you think mining companies’ valuations might be overvalued, as many companies are, weighing the fiat money constant debasement?
BG: I think there are two separate questions. I will try to take it one after the other. At least when it comes to Bitcoin volatility in addressing that question first, from my miner’s perspective, Bitcoin has this self-healing mechanism built directly into it. As long as we are primarily motivated by profit, we are going to be seeking lower cost operations and the reality is that if you can imagine a normal distribution curve of miners, if we can position ourselves in the lower quartile, or the lower third of low cost producers, we have so much of our hedge built in to a lower price because all those miners with higher costs have to start under-clocking, curtailing, turning off, and liquidating. All the way down that process they are ceding market share and profitability which helps to compensate for a lower Bitcoin price. So the way that any Bitcoin miner should deal with the risk of Bitcoin price volatility is: you need to invest in an asset that doesn’t make sense just today but an asset (that) you know is going to make sense visibly for the next 5, 7, 8, 10 years at least, on the cost side of it. You do that, you should be fine.
On the public valuation side of things, that is a completely different ball game. I think the reality is it that in 2021 there was certainly a lot of capital flowing into this space. The industry attracted a lot of investment from a lot of new players and people were able to raise a lot of money on very little. That time has now come and gone. What we are left with now is some 30 public mining companies that control roughly a third of the hash rate. Valuations across public mining companies are widely different and the market doesn’t seemingly know how to price them. There are a lot of different things that I think that they are looking at when they are trying to determine the valuation of a miner but strangely profit is not one. The market has a forward-looking view and they are saying – What is the future hash rate going to be like? What is the future efficiency? – all different expectations on future value. I don’t think the market is looking at current valuations rationally. There is a distortion here, in how people are viewing miners and the valuations that eventually miners have as public companies.
From an investment point of view if you are trying to value Apple or Colgate it’s more tangible, they have customers, they have sales, they have products, they have costs produced, they have marketing…it is much more predictable and clearer. When it comes to Bitcoin mining it is more ambiguous: we have no customers, we have no real products that we sell. As an operator the only thing that really should matter is profit, utilization of assets and ROI. but I think what people largely do is treat miners like an inefficient options market. They say “Hey, let’s assume Bitcoin price goes to 50k, 75k, 100k, 250k by such a date, what is the probability of that and then what would this company be worth, what would their future cash flows would look like, what would the Bitcoin that they have on balance sheet be worth at those times. And so, they are treating the public miners like a very inefficient options market, they are saying – what is the probability of Bitcoin at 50k and what is the value of Marathon or Bitfarms are high at 50k at this date. What is the probability of that occurring? And so there, we are all over the map, even from my perspective which has been all day and night looking at this stuff for years, I have been a full time miner for years, the valuation of companies makes no sense to me.
I: I am glad you share that point of view because I am absolutely confused about that. It makes no sense!
BG: You know, when I joined Bitfarms it was my first time working for a public company, I thought the markets were much more sophisticated and rational than they are. The market is not sophisticated and strangely doesn’t seem to rebalance their portfolios and are instead highly loyal. Some companies have a lot of institutional players which hold a large chunk of the shares and a lot of companies have none, when it is all retail, and so valuations are all over the map. I don’t think that this is sustainable because that means there have to be undervalued and overvalued assets ready to arbitrage. Eventually a free market should sort that out and it should come out to a more leveled playing field. But until we have standard results, standard matrices, KPIs, even definitions for things…that is really hard to do. We have companies that can’t even agree on the definition of hash rate! Because we have got installed hash rate, operating hash rate, contracted hash rate, even one company has corporate owned maximum hash rate. We can’t even agree on the most basic definitions, so how are our investors supposed to sort through this? It becomes very difficult.
I: Future I: Is Bitfarms’ huge investment in Bitcoin mining a bet for the prosperous future of Bitcoin as a worldwide currency or wealth reserve? Do you consider that rather sooner than later Bitcoin will be accepted by the traditional financial system (recent ETFs pending approval by the SEC & banking sector providing BTC holding “wallets”). To put it into extremes: are we mining a rare jewel in the crown or are we mining the future currency of the world?
BG: Whether you are an investor in a public mining company you are investing in Bitcoin mining infrastructure and Bitcoin mining machines, like Bitfarms is doing. You are doing it because you believe in the future of Bitcoin. There is not a single reason in the world to invest in a Bitcoin mining machine or in a Bitcoin mining company if you think that Bitcoin price is going to stay flat or go down or become irrelevant or replaced. You absolutely wouldn’t do that. So believing in the future of Bitcoin is a prerequisite for becoming a miner: It is fundamental. When we look at our place in the world and our place in the investment universe we at Bitfarms have this concept of providing higher quality exposure to the asset. Like I have said before, we don’t have customers like Apple or Colgate does, what we have are shareholders and shareholders invest in Bitfarms because they expect the price of Bitcoin is going to go up and they expect that our shares are going to go up as a result. I think when we look at ourselves as a company our goal is to supply them with the best quality of exposure and there are numerous ways to do that, (so) we look at ourselves as stewards or custodians where we are going to use our expertise, our advantage our skill-sets and our strategies in order to help craft that exposure profile and that we are going help deliver those returns to investors who otherwise wouldn’t be able to navigate the market by themselves.
At least with our company, our function is very specific and is very unique: we are trying to provide high quality exposure to investors to one asset or asset class that for whatever reason, they can’t do for themselves or would find incredibly difficult to do by themselves. So, in that way, there is a concept in Bitcoin: decentralization and there is centralization (referring to the company). I like to think of the public company as decentralizing it’s hash rate amongst shareholders. At Bitfarms we have something around 80,000 retail investors around the world that own Bitfarms’ shares plus whatever institutional investors who own it and so we have now created effectively 80,000 new Bitcoin miners via the proxy that is our shares who otherwise, maybe they live in Manhattan or some place to expensive or impossible for them to to get in this space, but they still want to take a part, they still want to invest in this asset, they still want to secure the future of the network and the network of monetary policy and so, we are trying to be that steward that helps facilitate…
I: A proxy for mining…great!
I: Future II: Last, let’s go to the brainstorming and imagination realm: How can you imagine the future of Bitcoin after the last halving?
BG: Last halving! 2140! That’s honestly the situation that I outlined before except this is just much more integrated and advance: the key thing about electricity is you always need to have a greater supply than demand. It is the only supply & demand curve on the planet where the optimal supply demand is not equal! It has to be more. If electricity supply ever falls below demand you will have blackouts / brownouts and people can die these outages. That gap has been fundamental to the electricity industry since electricity was invented. Nobody ever thought that it was a solvable problem and Bitcoin mining does solve that because as a dispatchable load, it is a customer of last resort. It solves a very strong logistical problem with the flow of electrons and the payment of electrons and the value of those…and so the further out in time we go whether it is 2050 or 2150, what I think we will see is a greater and greater integration of the Bitcoin mining equipment in order to monetize this gaps wherever they exist. In 2050 I think that is probably going to be at energy generation sites: by energy generation sites, substations, critical points in the distribution and transmission network. By the time we get sound to 2150 it is probably going to be pushed out even further, it is probably going to be embedded in people’s homes, in other devices, there are going to be lots off applications, since your marginal cost is zero…there are huge amounts of need for heat…heat always has industrial and residential applications…there is always going to be a need for balancing out loads, to make sure the frequency on the lines stays within a very tight range and that is always going to be a thing. And I think eventually that free-market incentive will drive that balancing forward until a more granular level. And it is going to be integrated like a spiderweb, organically in a group system, where you have the main trunks but then it is going to branch out in smaller and smaller ways…It is going to be driven by that free market incentive.