Making Money with Crypto-Mining: Opportunities, Risks, Alternatives

bitcoin walletCryptocurrencies, especially Bitcoin, have been experiencing a – at times erratic – boom for some years now. In the past five years, virtual money has developed from an alternative means of payment to a popular speculative object.

The equivalent value in „real“ currency has risen in part exorbitantly, as has the desire of many people willing to invest to participate in the hype. After all, substantial profits are tempting even in short periods of time.

On closer inspection, however, it is not quite as easy to get your piece of the crypto-cake.

Crypto-Mining: The easy way to Wealth?

In theory, the concept of mining sounds quite simple: You get a computer with enough computing power, the necessary software and from that point on you can (theoretically) watch the so-called mining rig collect the money. What sounds like a possibility, with which even absolute technology laymen can land the big throw, proves to be a quite complex matter.

One reason for this is that the underlying block chain technology is already based on complexity. In order to be able to carry out transactions with its help, highly complex cryptographic algorithms must be resolved. In theory, this can also be done by standard computers. In fact, there are even smartphone apps in circulation that, without the owners‘ knowledge, exploit the computing capacity of the phones to mine bitcoins or other cryptocurrencies.

The biggest problem, however, lies in the nature of the technology itself – it is designed in such a way that as the number of transactions increases, so does the complexity of the algorithms to be solved. Anyone who really wants to earn money from mining under these conditions will therefore not be able to avoid making some investments. To make matters worse, Bitcoin and Co. belong to the type of investment where the return of investment depends on a number of variables.

The different ways – Proof of Work and Proof of Stake – to get the coveted Bitcoins do not change much. The factors that influence the price development and thus the revenues always remain the same.

First and foremost, the limited number of available Bitcoins, which has caused prices to skyrocket due to the drastic increase in demand. It is the effects of this simple supply-and-demand principle that are ultimately responsible for the ongoing run on virtual currencies.

This is because investors are speculating on a further increase in Bitcoin prices, which would allow the invested sums to be quickly recouped. Nevertheless, the only question that remains is whether it is really that simple.

Crypto-Mining: The Requirements

The basic prerequisite for being able to start digging for cryptocurrencies at all is an understanding of the interrelationships. Broken down to a very simple calculation, the situation is as follows: First and foremost, it’s a matter of converting electricity into money.

As the introductory section has already shown, this is a greatly simplified and shortened presentation of what actually happens in mining.

Basically, however, it’s the same: the resolution of the algorithms requires immense computing power, which in turn requires a large amount of electricity. In order to be able to earn money successfully under these conditions, the following factors must be taken into account:

  • a high megahash or gigahash performance per second
  • lowest possible electricity costs
  • the lowest possible power consumption per mega- or gigahash – or even per Bitcoin produced

It thus boils down to an equally simple cost-benefit calculation, in which the expenditure on electricity is the most important variable. Of course, it can be argued that financial success is always at the discretion of the miner anyway.

But even for those who would be satisfied with minimum yields, the increasing demands mean that at some point the time comes when mining is no longer even cost-covering.

Added to this are the necessary investments in hardware, as a standard computer at this point in time could hardly provide even remotely the computing power that it actually needs.

The Hardware

ASICs

In mining, profit maximisation only works by maximising computing power. This is a question of the hardware, which should be as well tuned as possible to solving the algorithms. The „simplest“ solution is so-called ASIC special chips, which stands for Application Specific Integrated Circuit. Translated this means that this type of chip has an application specific integrated circuit. This means that its function is defined after production and cannot be changed afterwards.

But this is also irrelevant for mining, because the adaptation ultimately ensures that ASICs can be used to work much more efficiently and quickly than solving the same tasks by software. Since the chips can indeed be manufactured entirely according to the needs of the user, they seem ideal for Bitcoin mining. However, precisely fitting production involves high investment costs for development – which could be offset by lower production costs.

However, if capital is only available for a small number of units, an investment may no longer be worthwhile. This is especially true in view of the fact that the development time is considerably longer than for other components.

Once chips have been developed and produced, they may no longer satisfy the demands of increasingly complex algorithms to the fullest satisfaction if they can be installed in the existing mining rigs.

Graphics cards

Another way to generate sufficient computing power with your rig is to use powerful graphics cards. Instead of creating detailed, realistic computer game worlds, graphics cards from AMD in particular can be used to mine Bitcoins. However, they still do not come close to the performance of the special chips, which is why further hardware is increasingly designed to integrate more than one graphics card into the system.

On a mainboard, however, this is again not feasible because the necessary slots are missing. In order to be able to access three or more graphics cards at the same time, PCIe-x1 adapters and corresponding cables are used instead, for example, in order to implement the connection nevertheless.

This results in another problem, however, since not only the mainboards but also the cases are not designed for such a number of graphics cards. If between six and eight graphics cards are to be connected to the mainboard, in principle only an open mounting frame remains as a viable alternative.

Of course, there are also smaller ones, various manufacturers have recognized the trend and deliver the finished special hardware to interested parties. This starts with the size of a USB stick, but can also be larger and thus more powerful if desired. As a potential miner, this saves you having to search for and build the necessary components.

This could possibly prove to be difficult anyway, because again and again we hear about such an excessive demand for certain graphics cards that the market situation is between supply bottlenecks and sellout. At the moment, however, the market for graphics cards looks more like a bit of a relaxation. The reason for this, however, is once again an ASIC developed for mining, with which Ethereum can now also be mined.

Secondary Market for Hardware

Due to demand, prices have therefore risen sharply, especially for graphics cards, which makes it even more difficult for private users to put together a cost-efficient mining rig. Alternatively, however, it is possible to purchase such rigs directly – also from home-made products. Analogous to the prices for the crypto currencies the prices for such computers have increased, which is why it has become a lucrative business to sell mining rigs via different sales portals.

This does not make it any cheaper for the end user, the prices are clearly in the four-digit range. The quick entry into mining therefore costs money and in the end it is always questionable whether this sum can be amortized within an acceptable period of time. After all, the investment in higher computing power also means higher follow-up costs for electricity.

Nevertheless, the market for newcomers who do not want to rely on their own hardware knowledge seems to exist. After all, work is currently underway to find new algorithms that will also make prospecting with standard hardware more efficient again.

Software, Pools and Clients

Unlike software, the demands on the software are comparatively low. Nevertheless, it has important tasks, such as monitoring the entire mining process, which includes not only the achieved hashrate and mining speeds, but also the fan and temperature control of the computer. Also be aware that there are some risks involved with mining pools, too. Otherwise the software is needed to

connect the Miner to the block chain (this applies to those who want to mine on their own);
establish a connection with the mining pool (this applies to those who prefer to mine in conjunction with others).

Wallets – Digital Wallets

In addition, the appropriate software for creating a so-called wallet must be installed (Note: There is, by the way, a synonymous use of wallets and clients. In some cases, wallet management is only one of the features that are part of the client’s functionality – for example, with the Bitcoin Core or BitcoinQT, which is the first Bitcoin client ever).

The eWallets serve as a virtual wallet in which the collected (or purchased, gift) Bitcoins or other crypto currency units are stored. Whereby this is not quite correct, in fact only the digital keys are stored in the Wallet to access the Bitcoins at all. The keys come in two variants, the public one is for receiving the Bitcoins, the private one can be used for payments.

There are several options for the wallets themselves, including

  • Desktop Wallets
  • Browser Wallets
  • Hardware Wallets
  • mobile apps

The different eWallets each make more or less sense under different conditions. The question is therefore, what exactly should be done with the wallets. To transfer Bitcoin amounts quickly and from anywhere, for example, an app for the smartphone is certainly the most sensible option. Hardware wallets that are not connected to the Internet (at least not permanently) are more suitable for back-ups.

Apart from the type of use, the question of what is expected of a wallet is of course to be answered individually – besides anonymity, usability or speed, security is a particularly important aspect. This applies not least to the possibility of being able to manage and store the private key locally. In fact, this is not possible with all providers; some rely instead on storing the keys on external servers.

The Mining Pool

Since the prospects of large profits for so-called standalone miners have deteriorated for various reasons (one of which is the much-cited difficulty of the block chain, i.e. the complexity of the algorithm), it is an easier alternative for many miners to join one of the numerous mining pools.

In such a pool, one’s own computing capacity is combined with that of other miners, which increases the overall chances of generating more units in the crypto currency of choice.

The merit is divided among the participating miners, which is usually done evenly according to the amount of work done to find a block in the chain. However, there are different methods for calculating the proportional reward. Basically, not much more is required to participate in a mining pool than to register with the preferred pool.

However, expectations should not be raised too high: Only sufficiently large pools can make a significant contribution to the overall mining, which means that the share will still be smaller again depending on the computing power contributed. Conversely, with smaller pools it is not to be expected that the total rewards received will reach the same level as with larger pools.

Alternative Cloud Mining?

Theoretically, it is even easier to do so without using your own hardware: In cloud mining, the computing capacity is rented from a corresponding provider in the cloud or possibly even purchased. The computing power (in hashes per second, usually in the gradations kilo, mega, tera or peta hashes) is contractually guaranteed, the term is usually one year.

The profit sharing is percentage-based, therefore higher hash values result in higher profits. Accordingly, it should be possible to recover the costs (i.e. initially the one-off payment for the contract) more or less quickly, depending on the computing power rented.
Taxes and other costs for cloud mining

However, this also depends on other costs (more on mining costs in general, see below) that are still to be incurred. Not uncommon, for example, are so-called maintenance fees, i.e. maintenance fees with which the providers cover their expenses for plant maintenance, electricity and personnel.

In addition, from a tax point of view, it is irrelevant whether the mining was carried out locally and personally or whether the necessary computing power was „borrowed“ from someone – „digital prospecting“ is taxable, just like any other type of mining (see below).

In addition, when choosing a provider, it is important to make sure that the provider can be considered serious. The principle is basically very simple: The provider purchases the necessary equipment and makes the computing power achieved with it available against payment. In order to be able to achieve such a computing power at all, under normal conditions regular mining farms are necessary.

Risks from dubious providers

However, they are not mandatory for the business model as such. There is definitely a danger of being left behind by a provider without its own mining hardware, who earns its money in a snowball system. The contributions of new customers are used to pay the profits of existing customers. A steady flow of such new customers (who are usually lured with much more favourable contract terms) ensures that the system is maintained at least for a certain period of time. However, it does not produce new bitcoins or units of other currencies at all.

Apart from that, the same difficulties apply to (serious) cloud mining as to all other variants: there is no guarantee that the investment can really be recovered within the contractually agreed period. Since the leased computing power does not change, but the requirements do, there is a good chance that the contract will become unprofitable before the end of the term. For such cases, some contracts therefore contain additional clauses that even suspend the contract. The invested money must then be booked as a loss.

Crypto-mining: the costs

But this should not be neglected: The pool operators charge a fee for participation in community mining. This is usually deducted from the distributed reward, but it is still a cost that can depress the final yield. The situation is similar with the fees for online wallets.

Expenses for Equipment

Of course, and this has been mentioned often enough in the meantime, these are not the decisive costs. The biggest items are and remain the hardware and the electricity. The expenses for a mining rig can possibly still be argued with the reference to the break-even point, i.e. the point in time when those very costs have been earned again by mining. At this point, the amortization is complete and all future revenues could be booked as profits.

The Problems with the Break-Even-Point

However, this calculation only works under certain conditions, primarily the profits earned with the available computing power would have to remain at an even level over the entire payback period. However, such an approach is quite optimistic for various reasons:

In view of the sometimes rapid development of the share price, such as that of Bitcoin, it cannot be assumed that the development will be even.
Even if there were no price drops, there is still the problem of increasing difficulty, which also places higher demands on computing power.

However, more computing power also means higher electricity costs. These costs are high enough anyway, because mining is only worthwhile if the mine is operated continuously. Anyone who does not exactly have an extremely favorable electricity tariff will have to suffer the greatest losses at this point.

Mining taxes

In addition, the virtual currency must be taxed in real terms: The European Court of Justice (ECJ) has ruled that the profits made are subject to income tax. However, the collection of taxes is not entirely unproblematic. There is no official regulation of the cryptocurrencies so far (which makes them so attractive for miners and investors), the registration by the tax authorities is difficult – especially if the transactions are carried out via foreign trading centres.

Nevertheless, following the ECJ ruling, there are a number of aspects to be considered when dealing with crypto currencies:

  • Profits are tax-free if they have been held over a period of one year. Otherwise they are subject to the respective income tax rate, including solidarity surcharge and church tax.
  • In contrast to shares or bonds, the final withholding tax is therefore not applicable.
  • There is also a considerable difference in taxation between mining operations that were only occasionally carried out privately and those that were carried out on a commercial basis – which would theoretically be fulfilled at the moment when the hardware was purchased for the purpose of mining.

All in all, one of the difficulties in tax handling is that taxation applies in a wide variety of situations. For example, even if Bitcoin is used to pay in a shop or restaurant or if the virtual currency is exchanged back into real euros – because this is considered a sale. So anyone who wants to be on safe ground in terms of tax law is well advised to carefully document all his transactions plus price-relevant data at all times.