BLOK - Macro Headwinds And Broad Diversification Are A Stumbling BLOK

• BLOK, the Amplify Transformational Data Sharing ETF, is a broadly diversified crypto equities (and debt) exchange-traded fund.
• Fed action, the bubble hangover, crypto winter, and the (likely) attendant recession are keeping me on the sidelines with respect to crypto investments, including BLOK.
• When crypto winter fades, crypto mining exposure will, in my view, be key to investing success.

Background

During the crypto bull run, my go-to for blockchain equity exposure had been the Amplify Transformational Data Sharing ETF ( BLOK ) (referred to as "BLOK" herein). Per its website:

BLOK . . . invests in companies actively involved in the development and utilization of blockchain technology. BLOK is also comprised of companies that are partnering with and/or directly investing in companies that are actively engaged in this technology, as well as companies acting as members of multiple consortiums dedicated to this technology.

BLOK is an actively managed ETF that seeks to provide total return by investing at least 80% of its net assets in equity securities of companies actively involved in the development and utilization of blockchain technologies."

In 2021, I traded BLOK reasonably well, realizing more than $10,000 in gains ( BLOK_2021_TRANSACTIONS.pdf) . In early 2022, I sold my remaining positions in BLOK, realizing a roughly $1,200 loss in the process ( BLOK_2022_Transactions.pdf ). On a relative basis, however, BLOK was never a particularly large portion of my crypto portfolio, even during the (bubble) bull run.

Crypto and BLOK View

At the moment, I remain BEARISH on BLOK and crypto in general and am waiting patiently to enter back into the space.

Based on proprietary indicators I follow (i.e., paid research subscription), I am currently expecting crypto bearishness to extend through the 3rd and 4th quarters of 2022. The space experienced an epic bubble and it will take time (and likely more pain) before the space is investable again (bear market rallies notwithstanding), particularly with the Fed raising rates and engaging in quantitative tightening, not to mention the recession that will come with the bubble hangover.

While bearish on the ETF, I am revisiting BLOK from the perspective of whether I will want to invest in this security when the crypto winter ends. Currently, my view (which can change) is that its broad diversification may prove to be a shortcoming.

Portfolio Matters

My first bubble was the 2000-2001 tech bubble. I was in my late-twenties and I got involved in the bubble in the late innings (selling future value stock winners to buy tech darlings like WorldCom, Global Grossing, and WebVan, among other losers) and got " rekt" in the ensuing carnage. Fortunately I did not have a lot of money to lose.

In this latest bubble, however, I got involved in the middle innings, made some nice profits in 2020 and 2021, and did a reasonably good job of leaving the party in late 2021/early 2022. At the midway point of 2022, my broad portfolio consists of a lot of cash, hedged equity exposure and some opportunistic bond holdings, with a very small (3%) allocation to crypto (largely Bitcoin ( BTC-USD ), Ethereum ( ETH-USD ) and Argo Blockchain notes ( ARBKL ). Notably, since my last article on crypto and ARBKL, I sold nearly all of my other crypto holdings when LUNA began its epic descent.

Crypto Miners

When the tide turns and crypto winter ends, I have been giving a lot of thought as to how I want to add portfolio exposure. In this discernment process, I have determined that the best way [FOR ME] to do so will be via the crypto miners. I am done with wallets (it's an age thing, being in my 50's), I am done with the exorbitant fees of Coinbase ( COIN ), the regulatory issues of BlockFi, the bankruptcy of Voyager, and so on an so forth with respect to the centralized crypto exchanges. The miners, on the other hand, are leveraged to crypto, Bitcoin in particular, and I can trade them via my brokerage account without any fees and without administrative and tax headaches.

With the foregoing in mind, over the next several months I intend to discern which miners are the strongest and which crypto exchange-traded funds ("ETFs") will provide the best exposure to the industry. Even if the miners only recover 50% (and, or course, that's a big if) from their bubble highs, such gains will be 5-baggers. In the discernment process, I will be reconsidering some prior articles on crypto miners, including Bitfarms ( BITF ), Hut 8 Mining ( HUT ) and Hive Blockchain ( HIVE ).

BLOK's View of the Miners

In terms of gaining exposure to the crypto miners, BLOK's active management strategy is not particularly helpful, as its exposure to miners varies widely. For example, at its peak, crypto mining exposure was roughly one-third of its portfolio, while today it has fallen below 20%.

In some sense, and certainly through no fault of the managers, BLOK may not be the best vehicle to gain direct concentrated exposure to the miners given the diversification of its portfolio (more on that below). Moreover, BLOK's active management also means that the BLOK managers will have to get the timing right in terms of increasing their exposure to crypto miners.

That said, as first movers in this ETF space, the BLOK managers have a good understanding of the industry and their insights and miner stock picks are worth reviewing and analyzing.

From BLOK's July 2022 reporting piece we learn the following regarding its view of the miners, which I found insightful:

In June, we took a hard look at our exposure to the stocks in the Crypto mining category. This involves multiple visits to the RIOT Blockchain facility and a visit to the new Argo facility in Dickens County. Both RIOT and Argo are taking a leadership position in the technology innovation called Immersion. Immersion is extremely quiet and more efficient in terms of bitcoin mining optimization than the traditional manner....

The stocks in the mining category are down in market value in the range of 84-92% from their all-time highs. Bitcoin cannot exist without these companies, so they are an essential part of our pick and-shovel strategy. They are also highly correlated with the price action of bitcoin with good reason. The position in the group is at the low end of the historical exposure, at about 16.4%, and this also includes a 10% Senior Convertible Note that we hold from Core Scientific. We have taken profits along the way in the group, which was around 34% of the portfolio at its peak. [Emphasis Added]

We believe that the original Whitepaper written by Satoshi will continue to make the cycles for bitcoin miners a thriving, moatlike business. As a reminder, the incentive structure behind the formula rewards miners for protecting the security of the system and making sure it works efficiently. When the price of bitcoin goes below a certain level, not all miners can operate profitably. Therefore, miners who have weak capital structures go offline, and this contraction of capacity leads to greater productivity for the larger miners. We believe that level is around $15,000 to $20,000, but certain companies have also taken prudent steps to strengthen their balance sheets through the monetization of their bitcoin or Ethereum holdings. As an example, Core Scientific, which produces about 1,000 bitcoin a month, recently raised $167 million by selling 7,200 bitcoin. Other companies in the portfolio, such as RIOT Blockchain, HUT 8 and HIVE are positioned with net cash positions and are looking to buy equipment (hash power) on the cheap into this weakness. Bitfarms recently reduced its debt through the sale of 3,000 bitcoin. Equipment prices have declined dramatically similar to the decline in bitcoin, which is no surprise.

Business execution has not all been the same, and most miners have proven to be overly zealous in their plans to build out facility capacity. To that point, as an example, Marathon Digital Holdings has almost 199,000 bitcoin miners in storage and on order, and leverage of about $650 million in a 1% Senior Convertible 2026 debt. Marathon was smart in tapping the debt markets with a 1% coupon last year. Fortunately, they also have 10,055 bitcoin. Argo Blockchain also has public debt outstanding, but with its new facility just coming online and a coupon of 8.25%, we think this debt has held up better."

BLOK's Top Holdings

Notably, BLOK's top 10 holdings as of June 30, 2022 (See Fact Sheet ) included IBM ( IBM ) at 5.8%; CME Group ( CME ) at 5.4%; Accenture PLC Ireland ( ACN ) at 5.2%, SBI Holdings (SBHGF) at 4.9%; and Overstock.com ( OSTK ) at 4.7%. The stock prices of many of these names, which make up upwards of 25% of the current BLOK portfolio in aggregate, are not directly linked to the crypto markets.

The point being that, as an initial foray into crypto related equities, the broad diversification of BLOK is probably a plus (and likely helped mitigate the downside, even if BLOK's 1-year decline still exceeded 50%). However, as I seek more concentrated bets in the crypto mining space, this ETF is not likely to meet my needs in the same way that it once did.

Summary

I am Bearish on BLOK (trading near $22 as I write) and crypto in general due to the Fed action, the bubble hangover, and the attendant recession. As I wait for the crypto winter to fade, I will be researching the crypto miners and trying to discern the best individual crypto miners and best ETFs to gain exposure to the crypto mining industry.

Cheers!

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