Discovering the Bitcoin Miner opportunity, as BTC passes $60,000
Spot Bitcoin ETFs amass $5.5B in net inflows, heralding crypto's mainstream acceptance
I have a special treat for all of you today. I have been studying Bitcoin (BTC) mining industry for the last few months and this is my industry analysis highlighting the $100B+ industry potential, key players and key metrics to watch.
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Bitcoin is Back
Finally. 2024 has been a watershed moment for digital assets, particularly Bitcoin, now trading at $60,000. Our attention today will focus on the behind-the-scenes actors powering the network — Bitcoin miners.
It is hard to believe, but we are on the other side of the bear market. Let’s appreciate that, despite being only two months into the year, 2024 has already earned its place in finance history. Led by BlackRock and Fidelity, the industry rolled out *11* spot Bitcoin ETFs, which officially knights crypto as an alternative asset class within the asset allocation supply chain of the finance industry.
However, it is easy to underestimate just how much of an opportunity this is for asset managers. Just six weeks since SEC approval, the ETFs have seen an aggregate $5.5B in net inflows — $13B if you exclude the -$7.4B in outflows from GrayScale’s GBTC ETF — and $50B+ in cumulative trading volume. These results dwarf the launches of other major ETFs.
Unfortunately, a multi-year purge of bad actors (e.g., FTX, Celsius, Voyager, Genesis, 3 Arrows Capital) and an SEC humbled by the courts to engage constructively after numerous attempts to discredit the asset, were necessary to bring us to this point. The bear market tested both retail and institutional conviction, whereas 2024 brought about a reversal that has generated massive returns for correlated assets. This resurgence revitalized investor enthusiasm, in particular for Bitcoin proxies like miners, which trade at a high beta to the underlying.
The best-performing miners in 2023 were Marathon Digital (591%), Bitfarms (582%), Bit Digital (553%), Cipher Mining (546%), and Iris Energy (501%), to name a few. Taking the average return of the five, +554%, and Bitcoin’s +154%, miners overperformed BTC returns with a multiple of 3.6x. If Bitcoin achieves the $150,000 price target expected by analysts in the space, this would generate a 240% return in 2024 with an even higher potential return for miners.
The $100B+ Industry Potential
Similar excitement can be found for the Bitcoin mining industry, currently valued at $25B, or 2.10% of the Bitcoin market cap. Currently, the space is dominated by participants in the US, China, and Russia. Reminder that China had shut down 90% of its Bitcoin mining capacity and thereby opened the market up for the rest of the world — an unintended consequence of regulatory response.
New entrants in Africa and the Middle East are now beginning to expand their presence. Ethiopia plans to establish a $250MM bitcoin mining and AI data center and UAE-based miner, Phoenix Group, recently announced a $380MM deal for sustainable hydro-powered mining, in addition to an acquisition of $187MM for mining machines last month. The net result could be a $100B+ industry in the next 3-5 years, if not sooner.
Until recently, Wall Street has been largely unable to participate in the profits of previous crypto cycles, or get clean exposure to Bitcoin. To get their fill, they’ve had to dabble in leveraged futures or proxies like Bitcoin miners. Now that spot exposure is available via the ETF, the asset class is on its journey toward maturity. Further, we are seeing less volatility than in prior years, consistent with a downward trend.
I have also observed institutional ownership start to flood into Bitcoin miners. Here is a look at the acceleration of institution capital over the last few months across the 3 largest miners by market cap — Marathon Digital, CleanSpark, and Riot Blockchain.
What is Bitcoin mining?
Bitcoin mining is the competition for the scarce resource of BTC block rewards that generates cryptographic security for the network. Much like in gold mining, there is a fixed supply of the commodity — a cap of 21 million Bitcoin.
Miners use powerful high-speed computers that operate 24/7 to solve, verify, and secure new transactions on the Bitcoin blockchain. Each participant tries to solve a complex mathematical puzzle. When they solve it, they get to add a new block of transactions to the blockchain and earn Bitcoin as a reward. Currently, the “block” rewards are 6.25 Bitcoin, but this number will be reduced by half in 2024, and every four years thereafter. As the difficulty of mining increases, the reward will keep decreasing until there are no more left to be mined. I was surprised to see that there is only 6.6% of Bitcoin supply remaining.
Once the last Bitcoin is mined, miners will no longer rely on newly issued coins as reward, but instead on the fees they charge for including transactions in blocks. Until then, miners generate most of their revenue from the Bitcoin subsidies received as an incentive to maintain the network, in addition to transaction fees.
As the network has grown, the computational power to maintain it has increased, also known as the “hashrate”. This can be considered as the number of attempts miners make in aggregate, per second, to find a valid block hash. The observed hashrate is generated by millions of ASIC machines computing many trillions of SHA-256 hashes each second.
This is essentially an expression of both mining participation, and the efficiency of operational ASIC rigs in the fleet. More miners in the network means more competition for rewards. But the higher the hashrate, the more difficult it becomes for miners to run an efficient and profitable operation. Currently, Bitcoin is at an-all-time high in network-wide hashrate, which implies that the competition for Bitcoin block rewards has never been more intense.
Mining Economics and Miner Survival
To evaluate who could be the industry winners and losers, I looked at metrics such as total miner Bitcoin holdings, rate of Bitcoin mined every month, post-halving cash-cost per coin mined, and other traditional metrics such as cash held based on data I could access.
What caught my attention was the decline of Bitcoin reserves. I believe this was due to the anticipated reduction in revenue that miners are expecting as a result of the halving. Running a mining facility is capital intensive — you need to have advanced land acquisition, building design, heat engineering, machine procurement, maintenance, and regulatory functions in the business.
In 2022 and during the bull run of 2021, public miners largely adopted a HODL strategy, i.e., holding and not selling, with their production. As the market turned and BTC price declined, many of these public miners became forced sellers in order to deleverage their balance sheets and cover operating costs. It is a game of survival of the fittest. With margins expected to be severed when block rewards are halved come April, scale will be all that matters.
The math to be a profitable miner is simple — (1) value of earned coins must be > higher than (2) the cost to mine those coins. Miners with a Cash-Cost per Bitcoin (post-halving) close to the actual price of Bitcoin will simply not make it without having to issue shares, bring on debt, or burn cash to survive. Words that for shareholders are a death by a thousand cuts.
A fantastic report from Coinshares dives into the unit economics.
One of the largest costs associated with mining is electricity, and while efficiency of the hardware is increasing, the competition for rewards matches that increase. Other categories like SG&A are also shown above. It is concerning for us when close to half of the company costs are associated with admin spend — Cipher Mining, Riot Blockchain, Argo, and Stronghold are a few. CleanSpark and BitFarms appear to be operating the most lean mining facilities. Also, high costs associated with interest expenses are a big red flag. In the current rate environment, it is hard to remain afloat and survive having to service expensive debt.
Conclusion
The bitcoin mining industry has shown that it is more than difficult to run a top class mining farm and maintain healthy mining economics. Virtually all mining is performed by specialized companies who can acquire state-of-the-art mining hardware and resources to operate at massive scale.
The good news is that regulation is becoming more favorable. FASB updated its guidance in December, allowing publicly traded miners to recognize Bitcoin held at fair value, with the remeasurement recorded in net income. Before this, a miner’s Bitcoin holdings were accounted for as intangible assets, using the lowest observable fair value within a reporting period.
Miners can begin to implement the changes in the first quarter of their calendar year. This is a profound change for the industry, as balance sheets can now reflect full asset value. CleanSpark was the first to utilize the new guidance, resulting in Q124 net margins of +35% and net income of $25.9MM (Q423 net income was -$137MM).
I expect miner financials to see a strong improvement as a result of this change, as it reinforces the importance of holding BTC bitcoin on the balance sheet, rather than selling it to finance operations.
I combined these metrics below into a screener of the current ecosystem. According to this approach, CleanSpark, BitFarms and Cipher Mining appear to be the best equipped post-halving to maintain a high profit margin per BTC mined. I also highlight the profit per coin mined post the halving event.
Bitcoin miners are some of the most innovative energy infrastructure companies that exist today, finding novel ways to access energy and turn it into financial assets. Yet, not all will survive, given the cost base involved and the nature of rewards.
I also believe large energy companies may be interested in miners as a strategic asset down the line, leading to potential M&A as well. The access to energy sources and capital reserves offered by the likes of Exxon, Chevron, or Shell could be leveraged to drive efficiency improvements for struggling mining operations or scale up existing ones. In this way, Bitcoin may be performing some of the intended functions of the carbon credit markets, subsidizing the search for more affordable and long-lasting power.
Is there a widely known ETF for the above Bitcoin mining companies?