3 Costs cryptocurrency miners need to know, and the 1 wildcard that can change everything — the motley fool electricity lessons for 5th grade

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Put simply, cryptocurrencies are doing things Wall Street and investors have never witnessed before. Last year, the aggregate value of all virtual currencies combined soared almost $600 billion to end the year around $613 billion. The aggregate gain of more than 3,300% represents possibly the greatest single-year return for any asset — and there’s a very good chance we won’t see anything like it again, at least during our lifetime.

This surge higher in cryptocurrencies has spawned numerous ways for enthusiasts to make money. Obviously, buying and holding virtual currencies (known as "hodling" among the crypto community) for long periods of time has worked wonders for investors. Bitcoin, which had once traded below $1 per token, surged to around $20,000 per coin in December 2017. Meanwhile, Ethereum and Ripple, which are second and third, respectively, in market cap behind bitcoin, surged by 9,383% and 35,564%, respectively, last year alone.

Another potentially profitable venture has been buying into publicly traded stocks that have exposure to the cryptocurrency market. For example, the Bitcoin Investment Trust owns a relatively fixed amount of bitcoin in its portfolio, allowing investors a roundabout way of loosely tracking the performance of bitcoin. I say "loosely" because the Bitcoin Investment Trust has often been valued at a 25% to 100% premium over the net value of its held tokens.

But perhaps the most intriguing means of making money has been through cryptocurrency mining. Cryptocurrency mining simply describes the process by which persons or businesses with high-powered computers and servers compete against one another to be the first to solve complex mathematical equations associated with a group of transactions (known as a "block"). These complex math equations are derived from the encryption that protects data on a blockchain network from hackers and other undesired parties. Once solved, a block of transactions is considered true — i.e., no virtual coins were spent twice — and it’s added to the previously resolved blocks, forming a chain. Thus the coined term "blockchain."

So, what’s in it for cryptocurrency miners to validate these transactions? Being the first to solve a block entitles the miner to a "block reward." This reward is paid out in the tokens of the cryptocurrency being validated, with the amount of the reward, and difficulty in achieving the reward, varying from one virtual currency to the next. For bitcoin, a block reward entitles the miner to 12.5 tokens, which, with bitcoin valued at around $9,400 per token, works out to a handsome $117,500 haul! Not too shabby. However, bitcoin’s rewards halve every 210,000 blocks, meaning the reward for mining bitcoin (and many other digital currencies) declines over time.

This is also a great time to point out that not all cryptocurrencies are mineable. While bitcoin, Ethereum, Bitcoin Cash, and Litecoin are mined, Ripple, EOS, Cardano, and Stellar are not. Validation of transactions is done in a different way for non-mined cryptocurrencies, which means new tokens aren’t created or rewarded. Three costs cryptocurrency miners must know about

Sitting back and relaxing while computers and servers do all the work might sound like a grand scheme to make money, but I assure you there are also some very grandiose expenses involved as well. Cryptocurrency miners need to be aware of three very prominent costs.

One of the more sizable costs miners will contend with is the electricity expense needed to run graphics processing units (GPUs) or specialized ASIC (application-specific integrated circuit) chips, along with servers and computers. The proof-of-work model, as cryptocurrency mining is also known, is very electricity-intensive, meaning lower kilowatt-per-hour (kWh) prices are favorable to the margins of miners.

What countries offer the lowest kWh costs? In a stroke of irony, some of the most attractive places to mine also happen to have stringent rules on cryptocurrencies. China, for example, has some of the lowest kWh costs in the world. However, China has also banned initial coin offerings and domestic cryptocurrency exchanges, and it has throttled back electricity usage for some of the country’s largest mining companies.

Recently, mining companies like HIVE Blockchain Technologies ( NASDAQOTH:HVBTF) have been turning to the Nordic region for cheaper electricity costs. HIVE is setting up mining centers in Sweden and Iceland, both of which have below-average electricity costs relative to the European average. What’s more, Nordic countries like Sweden are more heavily reliant on renewable energy, such as solar, wind, and hydroelectric power, to generate electricity, which helps keeps total kWh costs down.

Miners can be hit with hardware costs in two specific ways. First, there are the start-up costs of initially buying the hardware needed to mine cryptocurrencies. And second, miners get hit with the need to constantly upgrade their equipment in order to remain competitive against other mining farms.

Over the past year, NVIDIA ( NASDAQ:NVDA) and Advanced Micro Devices ( NASDAQ:AMD) have watched as cryptocurrency miners have gobbled up graphics cards for GPUs at an incredible pace, dramatically cutting supply and causing the price for graphics cards to skyrocket by 100% to 200%. While initially great news for NVIDIA and Advanced Micro, it’s sort of left these two giants in a bind. NVIDIA and Advanced Micro could choose to manufacture specific graphics cards for crypto miners, hurting their sudden surge in sales, or they could do nothing and risk alienating their core gaming customer who’s irritated by suddenly high graphics card prices. It’s really a no-win situation for either company, and it’s been a major source of expenditures for crypto miners.