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Original link:
https://hashrateindex.com/blog/bitcoin-mining-around-the-world-kazakhstan/
Kazakhstan, the energy superpower of Central Asia, quickly became the world's second largest Bitcoin mining country in 2021. However, the country's seemingly invincible bitcoin mining industry quickly encountered a bottleneck in its development and suddenly fell into a dire power rationing crisis. As a result, the country's global computing power fell from a peak of 18% in October 2021 to just 4% in May 2023.
Bitcoin miners in Kazakhstan are at a crossroads as a new Bitcoin mining regulation kicks in. Despite the strictness of the regulations, most desperate Kazakh miners welcome it, as they have been trapped in Kafkaesque bureaucratic chaos for more than a year and desperately need regulatory stability.
In this article, the peculiarities of Bitcoin mining in Kazakhstan will be explained and how new regulations will affect the industry will be analyzed. What other countries can learn from Kazakhstan's experience with political risk will also be discussed.
The Rise and Fall of Kazakhstan’s Bitcoin Mining Industry
Many people were surprised when Kazakhstan suddenly became the world's second largest bitcoin producer in 2021. In 2021, Kazakhstan's bitcoin mining capacity soared from 500MW in January to a peak of 1,500MW in October, and its share of global computing power surged from 6% to 18%. Kazakhstan has suddenly become a Bitcoin mining superpower.
However, Kazakhstan’s bitcoin mining extravaganza did not last long. The size of the industry has fallen sharply since its peak in October 2021, and now stands at just 400 MW, corresponding to only 4% of Bitcoin's computing power. Kazakhstan's once-great bitcoin mining industry has been crippled.
Source: CBECI, Kazakh Blockchain Technology Association, Hashrate Index
Let’s do a quick history lesson on Bitcoin mining in Kazakhstan to understand what caused the industry’s rapid growth and decline.
There are four factors contributing to the outstanding growth in 2020 and 2021. The most critical factor is massive access to cheap electricity. The government of Kazakhstan caps electricity prices between US$0.02 and US$0.03 per kWh. These price caps allow Kazakh miners to access globally competitive electricity prices.
Additionally, the low electricity price cap has incentivized Kazakh power plants to mine Bitcoin with their electricity, rather than sell it to the grid. If you, as a power plant owner, have the choice of earning $0.25 per kWh by mining Bitcoin, or $0.02 per kWh by selling electricity to the grid, the choice is easy, right? Faced with this choice, many Kazakh power plants installed Bitcoin mining farms directly on their facilities.
The second growth driver is the massive capital inflow of Western miners, looking for quick and cheap deployment of machines during the previous bull market. Kazakhstan is widely regarded as an affordable and relatively safe place to mine bitcoins, so Kazakh hosting providers don’t hesitate to fill their shelves with machines from US and European clients.
The third growth driver is China's ban on Bitcoin mining in May 2021. Shortly after China's ban, mining equipment began flowing into neighboring Kazakhstan, spurring the construction of more mining facilities to accommodate the influx of machines.
The fourth growth driver is Kazakhstan's loose regulation and tax breaks for IT companies. Kazakhstan is eager to diversify its commodity-based economy and offers IT companies several advantages. As pseudo-IT businesses, bitcoin miners were quick to take advantage of these tax breaks.
Cheap electricity, huge demand for mainframes during the bull market, abundant access to cheap Chinese machines, and loose regulation and tax breaks have provided the perfect breeding ground for Kazakhstan's mining industry to thrive. Unfortunately, rapid growth soon began to spiral out of control.
Even for a country as vast as Kazakhstan. The only way for the power system to safely accommodate such a huge Bitcoin mining load without a corresponding increase in power supply is to ensure that miners shut down their machines during times of peak demand. The concept is known as demand response, and allows more advanced power systems, such as those in Texas, to safely integrate hundreds of megawatts of miners, and even use the miners' demand flexibility to help balance the grid.
Unfortunately, Kazakhstan's Soviet-era power system does not have an advanced demand response system to accommodate sudden increases in mining demand. The first rolling blackout will occur in the summer of 2021 in the power-starved southern part of the country. Kazakh grid operator KEGOC was quick to warn that they may have to cut miners’ electricity consumption.
Beginning in September 2021, KEGOC began cutting electricity supply to bitcoin miners in the southern part of the country. Things will only get worse, and more and more miners will soon find themselves in a bitcoin miner's worst nightmare: power rationing. Miners can now only use imported electricity from Russia at inflated prices, causing many facilities to go bankrupt. Many remaining facilities are operating at limited capacity, only on weekends or evenings.
Kazakh miners have been struggling furiously for more than a year amid power rationing and unclear regulation. However, those miners who are still operating are more optimistic than they have been in a long time because of the recent introduction of a new law that provides clear regulation for the industry. Later in the article, I will explain this regulation in detail and discuss its impact on the mining industry.
Kazakhstan powered by stranded coal
Kazakhstan is an energy superpower with rich oil, natural gas, coal and uranium resources. The country is landlocked and thousands of kilometers from the nearest seaport, which makes transporting these energy resources challenging. Of these energy sources, coal has the lowest value density, so Kazakhstan uses it for internal power generation and exports most of its oil, gas and uranium output.
In 2021, 68% of the country's electricity will come from coal, 20% from natural gas, 8% from hydropower, and 4% from wind and solar.
Source: Our World in Data
Most of Kazakhstan's coal plants were built during the Soviet era, and they have now suffered from decades of wear and tear. Although the country is building several new coal plants to replace aging ones, the share of wind and solar is likely to increase in the coming years as the Kazakh government plans to build these resources aggressively. The vast wind-eroded grasslands have decent solar and excellent wind potential.
You might find it odd that the world's largest uranium producer has no nuclear power capabilities. However, the country has plans to build new nuclear power plants with a total capacity of 2.4 GW by 2035, which will be fueled by local uranium. Still, 2035 is still far in the future, especially for the high time preference Bitcoin mining industry. Coal will therefore continue to be the baseload power generation in Kazakhstan for the foreseeable future, despite a slight increase in the share of wind and solar.
KEGOC is a state-owned company that operates Kazakhstan's national grid, while several regional power companies handle distribution and sales. Private companies own most of the generation assets. Miners in Kazakhstan are encouraged to get their electricity from private coal and gas plants to save on transmission and distribution costs.
Kazakhstan is a vast country with vast distances. Most of the electricity generation is concentrated in a few industrial cities in the northeast of the country. These power generation and transmission hubs also attract the most mining capacity. These places include Karaganda, Pavlodar, Oskman and Ekibastuz.
Bitcoin mining hubs in Kazakhstan | Source: Compass
There is also some mining in the west, near oil and gas fields in the Caspian Sea. In this region, miners often generate their own electricity using associated natural gas or natural gas pipelines. The Kazakh mining industry may relocate to the region to take advantage of the associated gas from oil production, as this may be the only long-term solution to evade strict regulations. We may also see some miners using coal-produced associated gas in Karagandi.
Kazakh miners face tough new regulations
The runaway growth of the bitcoin mining industry eventually forced the government of Kazakhstan into action. After more than a year of uncertainty, the new “Law on Digital Assets of the Republic of Kazakhstan” was implemented on April 1. The government could have banned the industry, but instead sought to provide a stable environment through strict regulation — standard procedure for industries it deems critical.
The new law affects miners in four ways. First, miners need a license to operate. Second, miners can only use licensed cryptocurrency exchanges and mining pools. Third, miners will come last in terms of power supply. Fourth, the introduction of a mining-specific electricity tax.
In the following chapters, how all these factors affect the mining industry will be explained.
Miners can now only use licensed service providers
In addition to controlling the miners themselves through licensing requirements, the Kazakh government also aims to have a comprehensive picture of the flow of bitcoin from mining pools to miners to exchanges. As a result, the government has decided that all mining pools operating in Kazakhstan must obtain a license and report miners’ income to the Kazakh government for tax purposes.
Astana International Financial Center | Source: EBRD
Additionally, miners will have to sell their bitcoins on local licensed exchanges. The requirement will be implemented gradually, currently requiring 25% of bitcoins to be sold locally, 50% from 2024, and 75% from 2025. Miners now have seven licensed exchanges to choose from, including Binance, which is known to work closely with the Kazakh government.
All Kazakh mining pools and cryptocurrency exchanges must register with the Astana International Financial Center (AIFC), a regional financial and technology hub that opened in 2018. The Kazakh economy is heavily dependent on commodities, so the Kazakh government aims to diversify into the tech and financial sectors by attracting companies from these sectors to the AIFC.
Miners are now last in line for electricity supply
As mentioned earlier, the rapid increase in Bitcoin mining without a corresponding increase in power generation has caused problems with the grid. The Kazakh government wants to make sure this doesn’t happen again, and as a result, has imposed strict regulations on how miners purchase electricity.
Previously, miners could buy electricity like any other business. Under the new law, they will only be able to buy electricity through KOREM, the national electricity auction system, which will have an independent trading platform for miners only. National grid operator KEGOC will set a quota on the mining auction system based on the amount of electricity it determines is surplus at any given time. Miners will then compete for this "excess" power through an auction. The excess power may not be enough to feed all miners, which means this way of buying power may not be a viable long-term solution.
Another way to buy electricity is to import it from Russia, which costs between $0.07 and $0.09 per kWh. This price is too high to establish a sustainable bitcoin mining business. Why is anyone still mining in Kazakhstan with imported Russian electricity if they can set up shop across the border, pay less for electricity, and face less regulation?
The third, and possibly the only long-term viable way to purchase electricity is through direct contracts with energy producers. This energy can come from coal, natural gas, hydropower, wind or solar energy, or from natural gas or associated gases from coal production. As I will explain, there are tax advantages to solar and wind, but associated natural gas can be obtained more cheaply.
New electricity tax sets price floor for electricity
The new regulations will not only limit miners’ access to electricity, but also impose heavy taxes on electricity.
The level of the tax depends on how and at what price miners get their electricity. Taxes can be classified into three types. If miners buy electricity from the grid or import electricity from Russia through the KOREM auction system, the most exorbitant tax applies and will effectively set a floor price of 25 tenge ($0.055) per kWh.
This looks complicated, but let's look at an example. Assume that in the KOREM auction system, there is a large surplus of electricity for a period of time, and the price for a miner to buy electricity is only 5 tenge ($0.011) per kWh. The electricity tax would then be 20 tenge ($0.045) per kWh, bringing the total price to 25 tenge ($0.055) per kWh, as shown in the diagram below.
Source: The Government of Kazakhstan
This tax structure further reduces the likelihood of grid-connected mining in Kazakhstan. Even if miners have access to cheap grid power, heavy taxes will ensure that they pay relatively high rates after all.
It is no coincidence that the government has set the tax structure at a price floor of $0.055 per kWh. This amount is close to the breakeven cost of mining with moderately efficient machines in historical bear markets, so it appears the tax is designed to extract as much as possible from miners without killing them completely. One thing is for sure — the tax is not meant to optimize the efficiency of the industry, as it discourages miners from getting cheap electricity.
The second type of mining electricity tax applies to those who purchase off-grid electricity directly from non-renewable electricity producers. These miners will pay a flat electricity tax of 10 tenge ($0.022) per kWh. The government imposes this tax to prevent Kazakh power plants from mining without selling electricity to the grid.
Source: The Government of Kazakhstan
A flat tax of $0.022 per kWh is a lot. Off-grid miners in Kazakhstan have traditionally been able to buy electricity for around $0.03 per kWh. After adding the new tax, these miners will now pay about $0.052 per kWh, which is not very competitive globally. Furthermore, if a significant portion of these power plants continue to mine after the tax is implemented, the Kazakh government may increase the tax even further in an effort to squeeze the industry out. So I'm not entirely bullish on off-grid mining in Kazakhstan, but it's still a better option than grid-connected.
A softer electricity tax applies to miners who buy electricity directly from wind or solar farms. These miners only pay 1 tenge ($0.0022) per kWh. Such a tax is affordable, but the problem is that wind and solar are usually the most expensive in Kazakhstan. Additionally, there is currently not enough wind and solar power to meet the high demand of mining, as they account for only 4% of total electricity generation. Therefore, miners must build their own wind and solar power stations to take advantage of this opportunity.
Operating conditions for miners in Kazakhstan
A critical but often downplayed consideration in Bitcoin mining is climatic conditions. In general, a cooler operating environment allows you to overclock more frequently with firmware like LuxOS, increasing your uptime, reducing cooling infrastructure requirements, increasing the lifespan of your machine, reducing maintenance requirements, and ultimately increasing your bitcoin production and operational efficiency.
Kazakhstan has warm summers and icy winters. In the north, where most of the mining industry is located, average daily temperatures range from -15°C (6°F) to 21°C (70°F) during the coldest and hottest months. Most miners use water curtains for cooling in summer. During winter, icy weather can pose a challenge for miners, but miners solve this problem by reducing air circulation. Overall, Kazakhstan offers decent climatic mining conditions, at least compared to mining centers such as Texas in the US.
Another operational advantage of mining in Kazakhstan is the good availability of labor. Kazakhstan has a young, hardworking population with good IT knowledge. Therefore, generally speaking, it is easy to find qualified workers. Labor costs are also very cheap.
The Future of Bitcoin Mining in Kazakhstan Is Uncertain
Kazakhstan’s bitcoin mining industry is at a crossroads with the implementation of new laws. Either the law will provide the stable regulatory environment the industry needs to grow sustainably, or its strict tax and power purchase rules will euthanize what's left of the industry. How the regulation will affect the industry remains to be seen, and I will update this post when things become clearer.
To be sure, Kazakhstan has a power shortage that must be addressed before the country’s bitcoin mining industry can return to its former gigawatt glory. The only way for Kazakhstan’s bitcoin mining industry to grow significantly in the coming years is if miners develop their own power generation capabilities. This can come from a variety of sources, but the greatest potential is associated natural gas, wind and solar.
Another challenge Kazakhstan’s bitcoin mining industry has to overcome is the closure of foreign capital spigots. After what happened in the past year, it will be difficult to find a foreigner who wants to invest in mining in Kazakhstan. The problem is exacerbated by better mining opportunities in Russia across the border.
Due to these challenges, the growth of Bitcoin mining in Kazakhstan will be limited for the foreseeable future. Nonetheless, the long-term potential for mining in Kazakhstan is enormous, and I am sure the country will always be a significant Haslet producer.
So, what can we learn from the sudden rise and fall of Bitcoin mining in Kazakhstan? There are two things. First, political risk always looms large in bitcoin mining. At the end of 2020 and the beginning of 2021, most people think that Bitcoin mining in Kazakhstan is safe, and the Kazakh government is friendly to the industry. Many foreigners put their machines there only to find that it is not safe after all. I think the political risk for miners is high in all countries, especially in developing countries. Paraguay and Argentina may feel safe now, but who knows what will happen.
The key takeaway is that miners should avoid subsidized or price-capped electricity, especially in vulnerable electricity systems. Using subsidized electricity to mine bitcoin has drawn the ire of many governments, including neighboring Kyrgyzstan. Electricity systems with subsidies or price caps are also often vulnerable due to underinvestment. The advice to miners operating in these countries is to never operate off the grid.
