Cloud Mining firms promise big profits, but is cloud mining a risky investment?

Cloud Mining firms promise big profits, but is cloud mining a risky investment?

Cloud Mining firms promise big profits, but is cloud mining a risky investment?

This article is going to discuss bitcoin cloud mining services and their profitability, the profitability of bitcoin mining in general along with the main factors that affect the profitability of a bitcoin mining venture, and evaluating the risk, when compared to buying bitcoin or trading bitcoin.

What is cloud mining?

Cloud Mining are services which claim to host bitcoin mining hardware which mines bitcoins. Someone then purchases a certain amount of mining power from the company who then pay out a certain amount based on the bitcoins mined. The idea is that the investor need not host mining hardware themselves, but can still profit from bitcoin mining.

Are cloud mining services legit?

This can be a tough question to answer, as there are some who host actual hardware, and some Ponzi type schemes. There are some companies, such as cex.io which do pay out. You purchase a certain amount of hashing power, which can either run for a year or a lifetime. The return you get is based on many variables, such as the difficulty of mining, bitcoin price fluctuations (if you choose to cash out).

There are also companies that operate as a Ponzi scheme and do not own any actual hardware. An example of this is a company called bit prompt. The methods used in a Ponzi type scheme involve paying previous investors with the money of new investors and pose as running mining hardware. Once new investors dry up, the last people to invest loose out and the scheme ends. Typically, the scammers take a large cut of the money invested over time.

The problem, even with cex.io is the lack of transparency. You cannot select your own mining pool to point your purchased hashing power to, and it is possible if the mining difficulty increases beyond a point where it does not cover the daily fee from the cloud provider that it voids your hash power, even a ‘lifetime’ hash power purchase. Also, if the company were to become insolvent, you have very little to show for it, apart from the earnings you already withdrew.

Rental hashing power

There is a second ‘cloud’ based alternative which involves renting hashing power and should not be confused with the above long term investment cloud mining. This is where you can rent mining gear to submit attempts to solve a block to any pool of your choice. These are typically more transparent in what you get for your money. These are commonly used by people trying their hands at mining, or timing it right to profit from their rental. Services such as Nicehash and Mining Rig Rentals are rental services. You can also find individuals renting out their gear on eBay, but typically you will not make a profit with these.

Nicehash and Mining Rig Rentals work by having users putting up their mining power to their pool, when someone rents the gear it diverts it to the renter’s pool. The rental provider then takes a small cut and the hardware owner gets a cut of the rental paid by the renter. When it is not being rented the hardware owner is earning from the pool.

Rental services are also used for solo mining, there is where you point the hashing power to a solo pool or node and mine to your own address. This is typically done by renting large amounts of hashing power for a short time, for example a few hours or days and hope to solve a block and score the entire block reward. An ‘investment’ of 1 bitcoin could easily turn into the 12.5 bitcoin block reward, but if you do not find a block you do not get any bitcoins from solo mining, so it is akin to gambling. The probability of finding blocks / earnings during mining change with the difficulty of mining. This is one way to see how bitcoin mining works cheaply, you could buy bitcoin online in a small quantity and rent a small amount of power for say a week to see how the pool pays out among other things.

Factors affecting profitability

There are many factors affecting the ability to profit, either through cloud mining or owning your own hardware. The following factors need to be considered:

  • Difficulty rising and falling
  • Bitcoin Exchange Rate
  • Cloud mining provider failure/mining hardware failure
  • Electricity costs (does not apply to cloud mining)
  • Upfront hardware cost
  • Hardware delivery time for pre-orders
  • Hardware becoming obsolete

The above factors are key working out if mining will be a profitable venture and each will be explained in more detail below. The difficulty typically rises and rarely falls by a significant value apart from under rare circumstances, which will be discussed below.

What is difficulty?

The bitcoin difficulty is how hard bitcoins are to mine. The bitcoin protocol is designed to, on average produce a new block every 10 minutes. All mining hardware is attempting to find a random hash value that meets the required difficulty, when someone finds it the block can be constructed. To keep the average block time at 10 minutes, the bitcoin network raises the required difficulty of the solved hash such that it keeps the average time a hash is found at 10 minutes. If more miners join the network, the higher the difficulty, if miners leave the network the difficulty will fall.

When knowledge of bitcoin increased with the wider public in 2012/2013 the difficulty skyrocketed, further increasing with the development of ASICs (Application Specific Integrated Circuits) which can perform the simple mining hashing function much faster than general purpose hardware can. The difficulty increased to a point where mining with general purpose computer hardware cannot produce a return anymore. In theory, as a single solution can solve a block there is a chance that one could solo mine 12.5 bitcoins on general purpose hardware, but the probability is many times worse than winning any lottery on earth.

As new more efficient ASICs are developed, the difficulty has been increasing. There has been a couple of drops in difficulty, a notable rare occasion was when a massive mining farm in Thailand caught fire due to lack of fire safety, this caused a significant drop in difficulty at the time. Every two weeks on average the difficulty level is recalculated.

As difficulty increases older hardware profits begin to drop to a point where it is no longer viable to run them, unless as a hobby. The difficulty is not something to worry about too much if you buy bitcoin, although higher prices of bitcoin mean older hardware is sometimes turned back on as it becomes profitable once more, increasing the difficulty, and vice versa.

See the below bitcoin wisdom graph for the difficulty from January 2016 - August 2016:

Minus the occasional drop, the average difficulty has been rising, network mining power has more than doubled in 9 months, meaning earnings would have dropped by more than half in that time.

Bitcoin Exchange Rate

The bitcoin exchange rate is the value of bitcoins in relation to hard currency such as the U.S Dollar. If you are looking to hold what you mine long term, or buy and sell at the ‘right’ times a profit can be had although there is a risk that the value could drop and not recover. The exchange rate varies wildly, it peaked at nearly 1,000 USD in 2014, before sharply dropping to less than half that in a short time, as shown by the below graph:

The price of mining hardware also is adjusted according to the exchange rate of bitcoin, so buying hardware during a price peak to then have the price fall and difficulty continuing to rise can render it difficult to return your investment.

Provider/Hardware failure

Due to the nature of cloud mining services, a provider becoming insolvent can cause the investor to lose what they have invested minus what they have withdrawn, and unless the investor stored their earnings outside of the provider’s internal wallet, that could also be lost. If purchasing hardware which typically has a 90-day warranty in the case of most new hardware out today with a projected ROI time of 350 days on the average UK electricity bill from personal experience at the current difficulty (which is rising continually), failure of the hardware after the 90-day mark would mean a loss is made.

Electricity Costs

This is a big variable by country and electricity provider. Mining gear consumes large quantities of power. Some countries subsidize power completely, some U.S states have cheaper power than others, many EU member states, and countries such as New Zealand have extremely high power costs. This puts people in cheaper electricity areas away from the equator at an advantage, such as China. Near the equator cooling must be taken into consideration.

This requires research and in some cases shopping around for the best power deal to maximize profits, although in some countries it can be nearly impossible to profit due to electricity costs. If you wished to mine for a lottery without using much power, you could solo mine with a small piece of hardware with a negligible power consumption in hopes to solo-mine a block.

Note, this does not apply to cloud mining or when you buy bitcoin online to invest.

Upfront Hardware/Service Cost

This is your initial investment, varying with the exchange rate, and the age of the hardware you are getting and/or the purchased cloud mining power. New hardware is considerably more expensive. Buying the latest model or latest cloud mining power to suddenly have a new piece of hardware on the market introduced and having the value of your gear/service reduced plus an increase in difficulty from the new gear means you should time purchases of large investments carefully. Mining for a few months and selling hardware at the right time before its price begins to fall can help. Some countries with high import taxes can further increase upfront hardware costs.

Pre-Order Delivery Times

Pre-Ordered hardware can sometimes ship late. In this event the later the shipping the greater the loss of mining time while the difficulty is still rising in the meantime. The KNC Neptune delay, which was bought at a high price at bitcoins 2014 price peak only shipped after the price had crashed a few months later than promised, costing investors thousands who never to this day returned their investment.

This does not apply to cloud mining.

Hardware becoming obsolete

Hardware becoming obsolete can reduce its profitability to a point where it costs more to run than it earns in bitcoins. The machine can either be switched to solo mining for luck, or powered down and sold for what it is worth to recoup what costs you can.

If you purchased a small amount of hashing power from a cloud provider, this amount of hashing power could if the difficulty rises high enough not even earn the cloud providers daily fee from the earnings, by which it is then no longer going to earn anything. If you have not returned your investment by this point, the money is lost. With hardware you can potentially resell it to recoup some cost.

Conclusion

Based on the above factors, cloud mining solutions are a very high risk investment at best, even with a genuine company. Buying hardware is better but unless you very carefully plan when you buy your hardware even that can also land you in hot water. A purchase of the latest generation just before the release of a new piece of hardware can reduce the probability of returning investments to zero. Cloud Mining services are typically not transparent, although renting can be more transparent than long term cloud mining investments. It is of a lower risk to purchase your own hardware, safe in the knowledge that you have a tangible asset you can resell. Failure of your mining hardware out of the short 90-day manufacturer’s warranty can leave you with a significant loss also.

The ever rising difficulty means that to make profit you are better off buying bitcoins online or trading bitcoins at the right moment, have cheap electricity or cheap access to hardware, or mining altcoins and exchanging them to bitcoin, in particular litecoin with the high end litecoin mining hardware which based on my research stands a better chance of making a profit due to the stable difficulty of litecoin and price of litecoin in relation to bitcoin. Buying litecoin online can also be done in the same way as with bitcoin and it works in the same way.

While not all cloud mining is an outright scam, the lack of transparency and the high chance of not returning your investment makes it a risk, and mining in and of itself is a high risk investment, be it through cloud mining or owning your own hardware, and one that should be approached with caution especially if large sums of money are involved. It should never be seen as a get rich quick scheme. As with any investment, do not invest what you cannot afford to lose. With that in mind, do your research carefully and happy mining!