2023-07-27 07:18:27 ET
Summary
- This article details our view on investors' implications when investing in Bitcoin mining companies.
- We discuss why the Bitcoin halving cycle is bullish for Bitcoin but it may have devastating implications for Bitcoin mining companies.
- We conduct scenario analysis to suggest our ideal investment strategy for the best risk-adjusted return.
Introduction
We're getting increasingly excited about the crypto sector as it edges closer to the 2024 Bitcoin ( BTC-USD ) halving event.
We published our initial thesis back in May 2021 that the Bitcoin price typically follows a 3-stage 4-year cycle. We observed that the Bitcoin halving event typically marks the beginning of a 1-year bull market where Bitcoin surpasses previous all-time highs to reach a new all-time high, followed by a 1-year bear market, then a 2-year slow recovery period back to the all-time high.
There are also distinctive sequences of events during each stage. For instance, during the past bear markets, the Bitcoin price bottomed out after completing 5 sequences of events , namely:
- Reversal pattern
- 50% decline from peak
- Rebound back to 20% from peak
- Another decline to 70% from peak
- Bottom out at 85% from peak
We've supported these observations with fundamental analysis and economic analysis. Overall, our thesis has helped us navigate Bitcoin's uncertainty, volatility, and price swings.
Based on our thesis and predictions, the Bitcoin price has completed 4.5 out of the 5 predicted bear market sequence of events. But most importantly, we perceive Bitcoin to be in the recovery phase now and is on track for the next Bitcoin bull market to reach our predicted $100,000 price target before April 2025.
All these observations are bullish for Bitcoin and altcoins. However, this bullishness may not translate to bullishness for the broader crypto sector, especially the Bitcoin mining sector.
In our past articles, we constantly reiterate that we prefer Bitcoin over Bitcoin miners due to additional business risks even though Bitcoin miners can outperform Bitcoin. While many Bitcoin mining company investors can rejoice now, those who have exposure to the likes of Core Scientific, Celsius Mining, or Compute North won't be.
Therefore, in this article, we're going further echo our preference for Bitcoin over Bitcoin mining companies by discussing the potential of de-anchoring between the share price of Bitcoin mining companies and the Bitcoin price in the coming halving cycle.
Implications of Investing In Bitcoin Miners
The upcoming Bitcoin halving event is expected to take place around April 2024 . After this event, the reward for Bitcoin mining will be halved. Theoretically, this would increase the price of Bitcoin as supply decrease and demand remain unchanged.
Overall, this event is bullish for Bitcoin investors. However, this is very dangerous for Bitcoin mining companies because Bitcoin mining revenue will be halved if the Bitcoin price does not change. Even if the Bitcoin price doubles, profitability will remain the same.
On the other hand, Bitcoin mining companies can try to increase mining capacity to maintain Bitcoin production and revenue. But this strategy may not maintain profitability due to additional operating costs from the increased mining capacity (electricity, depreciation, administrative personnel, etc) as well. Therefore, the halving event may not be bullish for Bitcoin mining companies.
Therefore, we think that investing in Bitcoin mining companies implies that if the investor believes that the Bitcoin price will more than double after the halving event, the mining company can increase sufficient capacity to compensate for the reduced Bitcoin production or anything in between. To us, it is a risky bet even if the investment is diversified across multiple Bitcoin mining companies.
Here's why.
What Will Happen If Mining Reward Is Halved Right Now?
If the mining reward is halved now, not many Bitcoin mining companies will survive.
At $30,000 per Bitcoin, most Bitcoin mining companies are already operating at a loss. Table 1 shows the all-in business cost per Bitcoin of several Bitcoin mining companies in 2023Q1. We can observe that other than Bitfarms ( BITF ) and CleanSpark ( CLSK ), other Bitcoin mining companies are operating at a loss when Bitcoin is below $40,000.
Table 1. Historical All-in Business Cost per BTC
2022Q2 | 2022Q3 | 2022Q4 | 2023Q1 | Trailing Average | |
RIOT | 35,300 | 55,000 | 53,150 | 46,200 | 47,413 |
MARA | 81,683 | 91,200 | 44,400 | 32,100 | 62,346 |
CLSK | 37,600 | 35,627 | 30,500 | 33,276 | 34,251 |
IREN | 51,605 | 34,871 | 58,171 | - | 48,216 |
BITF | 27,155 | 25,900 | 34,200 | 26,600 | 28,464 |
HUT | 49,472 | 44,800 | 59,900 | 70,900 | 56,268 |
Source: Author
So why are Bitcoin mining companies still mining Bitcoin at a loss? That is because gross profits are still positive. Gross profit is the revenue from Bitcoin mining net of electricity and hosting costs, which usually averages at the low $10,000 (Table 2). Therefore, it still makes sense to continue operation.
Table 2. Historical Cost of Revue (excl. Depreciation) per BTC
2022Q2 | 2022Q3 | 2022Q4 | 2023Q1 | Trailing Average | |
RIOT | 10,355 | 13,201 | 14,107 | 12,903 | 12,642 |
MARA | 15,206 | 22,061 | 22,403 | 23,479 | 20,787 |
CLSK | 11,812 | 13,338 | 8,143 | 10,685 | 10,994 |
IREN | 10,388 | 8,462 | 8,716 | 9,188 | |
BITF | 13,107 | 12,144 | 10,231 | 11,051 | 11,633 |
HUT | 22,737 | 15,645 | 15,479 | 20,190 | 18,513 |
Source: Author
That being said, many Bitcoin mining companies have been funded by their loss-making Bitcoin mining businesses and expansion through debt and equity offerings. For instance, Riot Platforms ( RIOT ) Marathon Digital Holdings ( MARA ), BITF, and CLSK diluted shareholders by 100%, 68%, 66%, and 187% respectively (Table 3). CLSK in particular, has also increased its authorized shares 2 times from 50mil shares to 300mil shares over the past 2 years.
Constant dilution is a sign that the Bitcoin mining business is exactly sustainable, regardless of whether the capital is used to cover operation costs or to expand. Remember that Bitcoin mining companies must constantly expand just to maintain their share in the Bitcoin network to maintain Bitcoin production.
Table 3. Shareholder Dilution of Bitcoin Mining Companies Since 2021
RIOT | MARA | BITF | CLSK | |
2023Q1 | 167 | 167.26 | 240,262,000 | 96,950,555 |
2022Q4 | 167.75 | 145.567 | 224,200,000 | 71,743,930 |
2022Q3 | 167.3 | 116.8 | 215,711,000 | 55,661,337 |
2022Q2 | 148 | 113.865 | 206,339,320 | 41,300,241 |
2022Q1 | 117.3 | 103.12 | 201,626,602 | 41,290,587 |
2021Q4 | 116.75 | 102.7 | 194,805,893 | 41,474,062 |
2021Q3 | 97.2 | 102.5 | 174,445,684 | 37,395,945 |
2021Q2 | 95.95 | 99.6 | 162,083,352 | 34,697,943 |
2021Q1 | 84.12 | 99.4 | 145,016,864 | 33,874,152 |
Source: Author
Therefore, if Bitcoin mining rewards were to halve now, not only investors of Bitcoin mining companies risk more severe dilution, Bitcoin mining itself may become unfeasible for corporate Bitcoin mining companies. Remember there was a time when 90% of MARA's expenses were derived from compensation to its management.
Scenario Analysis
Back to reality. When the Bitcoin halving event takes place in 2024, mining rewards will be halved.
Scenario A: Invest in Bitcoin
- The supply of Bitcoin decreased while demand remain constant. Reduced supply is a positive driver of the Bitcoin price.
- Potential approval for Bitcoin ETF is another driver of the Bitcoin price.
- According to our thesis, Bitcoin is expected to reach $100,000, which will provide a 230% return at today's price.
Scenario B: Invest in Bitcoin mining companies
- Outcome 1: If Bitcoin reaches $100,000
- Bitcoin mining companies could outperform Bitcoin solely based on their sensitivity to the Bitcoin prince. But fundamentally, revenue would only increase by 60%. Based on our models, most Bitcoin mining companies would be overvalued (Table 4).
- Outcome 2: If Bitcoin 2x today's price
- Revenue and profitability would remain unchanged hence does not justify any share price appreciation from today's price. Hence, we should see no positive upside.
- On the other hand, Bitcoin would've been 2x from today's price.
- Outcome 3: If the Bitcoin price remained unchanged
- Based on the cost structure presented in Table 1, none of the Bitcoin mining companies listed will be profitable.
- Mining operations of MARA and HUT would be unfeasible as Bitcoin revenue will be less than the cost of revenue (excluding depreciation).
- Other miners would barely survive.
Does this mean that all Bitcoin mining companies are uninvestable? No. Let's look at what will our strategy be if we were to invest in Bitcoin mining companies.
Evaluating Trading Strategies
We perceive the safer option is to directly invest in Bitcoin. We identified multiple drivers for price appreciation (potential ETF approval, and the halving cycle), which can be hedged via ProShares Bitcoin Strategy ETF (BITO) put options, and can be staked for additional passive income. From a risk-adjusted perspective, we think that this is an ideal strategy, which is also our current strategy.
If one intends to invest in Bitcoin mining companies, there's still a silver lining. Pick the one that is the fittest: lowest mining/business cost, has the highest adjusted net asset value for liquidity, and which clear path and guidance for future expansion plans.
This is what we think will play out if Bitcoin does not double fast enough after its halving event. The profitability of Bitcoin mining will reduce drastically, many Bitcoin mining companies will become insolvent like CoreScientific, efficient mining companies with larger balance sheets will survive and acquire competitors pennies on dollar, new equilibrium (mining difficulty) will be established, the ones that survive will enjoy massive upside potential.
The new equilibrium in mining difficulty refers to the potential reduction of mining difficulty which reflects a reduction in mining rigs online after the "bloodbath" (insolvency of many Bitcoin mining companies). The reduced mining difficulty will increase Bitcoin production. Bitcoin mining companies that survived will enjoy both increased mining capacity and decreased mining difficulty which will result in an exponential increase in profitability.
Therefore, if one intends to invest in Bitcoin mining companies, it'll be a game of stock picking. Based on the 3 criteria we stated, CLSK would be our prime, with BITF in a distant second.
Firstly, CLSK and BITF showed stability and efficiency in their mining cost and business costs. Secondly, CLSK and BITF are trading closer to their adjusted NAV than comps. At this point, we would be late to the party because when we issued our buy rating for CLSK, both CLSK, and BITF were trading below their adjusted NAV. Thirdly, CLSK is expected to have about 3x BITF's mining capacity. At 16 EH/s by the end of 2023, CLSK would beat RIOT ( 12.5 EH/s ), the largest Bitcoin mining company (at $3.2bn market cap), and trail only MARA ( 23 EH/s ), the second largest Bitcoin mining company, in terms of mining capacity. Here's our pre-halving full thesis on CLSK.
Final Remarks
In this article, we take the opportunity to present a thesis to reflect our long-time stance to invest directly in Bitcoin. We also showed that if we were to speculate on Bitcoin mining companies, CLSK would be our best bet.
As a closing remark, we would like to say that the Bitcoin halving cycle depicted in Figure 1 is meant to be broken as the set of support resistance is only sufficient to guide Bitcoin up to $100,000.
Once the $100,000 price level is broken, the resistance will turn to support which will mark a new era for Bitcoin and the entire crypto sector. We think that this is the golden opportunity to invest in Bitcoin because we're presented with a decade-old cycle to help navigate this highly uncertain asset class.
We hope we contributed to your investing journey. We look forward to engaging with you in the comment section and future works as well.
Take care.
For further details see:
Evaluating The Best Strategy For The 2024 Halving Event: Bitcoin Vs. Bitcoin Miners