Summary Contagion has swept the industry. Crypto Exchanges, Banks, and Dealers have collapsed; this might be the perfect time to buy. HIVE has managed its balance sheet well, escaped the contagion risk relatively unscathed, and lives to fight on. Momentum is changing. Bitcoin is up in value this year. Strategic investors might be able to buy at the bottom. Momentum may have changed for the Bitcoin (BTC-USD) miners and perhaps the Blockchain industry. I track 15 disruptive technologies and break them down into 42 different industry sectors. I pivot my investments in and out of sectors as they gain and lose momentum. The change in momentum is often purely market-based; sometimes, it reflects a change in business fundamentals. I last traded the Blockchain sector in 2021; however, one of its subsectors has come back into focus. At the end of 2022, the Bitcoin Miners Sector started flashing buy on my dashboard and has made significant gains since then. 7 of the 17 miners I track are up more than 100% in 2023. Bitcoin Mining Segment (Author Database) 2022 A Painful Crypto Winter It all began with the Terra Luna (LUNA) collapse, and contagion quickly spread throughout the industry. Some of the largest names were brought down, and many others were mortally wounded. BlockFi (private company) is a crypto lender with a sizable mining operation and has filed for bankruptcy; it blamed the FTX (FTT-USD) collapse for its problems . For more on FTX and its problems, see this series of articles . BlockFi has an unpaid $275 million debt due from FTX and a further $1 billion in uncollateralized debt to other industry borrowers. $54 million is due from the bankrupt Core Scientific (CORZQ). Core was mining 47 Bitcoins a day, but rising energy costs made this an unprofitable business, and a whole stack of cards came falling down. Core continues to expand its mining operation post-bankruptcy . The contagion just kept spreading. Core Scientific filed for chapter 11 in December and followed Celsius Network LLC, which had plans for an IPO but is now working out a restructuring plan . Mawson (MIGI) signed a $20 million debt agreement with Celsius, paying nearly 4 million warrants. Celsius had invested a total of $300 million in Bitcoin mining operations. Two of the miners on my list that I had invested in before and looked at as candidates this time have, in my opinion, not had the best of times, and I worry about their ability to continue going forward. Marathon Digital Holdings (MARA) disclosed $80 million of exposure to the now-bust Compute North. Shareholders suffered a 60% dilution in 2022. Total debt was zero in 2021 but is now more than 200% of equity. MARA debt v equity over time (Author Database) Argo Blockchain Plc (ARBKF) accidentally posted bankruptcy papers on its website . Argo got a bailout to avoid bankruptcy from Galaxy Digital Holdings (BRPHF); it looks very temporary to me. Argo has rising debt, falling equity value, and falling cash reserves; it must take action to reverse this situation. With negative income, its debt repayments are not well covered. Argo debt v equity over time (Author Database) Choosing Whom to Buy Crypto Mining companies are showing significant gains, but the contagion risk and the exposure to the industry and Bitcoin make them very high risk. Strategic investing is about deciding whom to buy. More importantly, it is deciding who not to buy and when to stay on the sidelines. The contagion in the crypto market makes the strategic decision even more critical. Is now the time to buy a crypto miner, and if so, which one? Bitcoin Mining Bitcoin mining should be a relatively simple operation. Bitcoin miners buy mining computers, put them in buildings, power them with electricity, and mine Bitcoins (that means maintaining the ledger of Bitcoin activity). Bitcoin miners receive payment for maintaining the ledger in Bitcoins (that's a real oversimplification, but we need to distill the industry down to a business we can understand and compare, so bear with me). The volatility of the price of Bitcoin and the steep gains it was making in 2021 convinced many miners to hold onto their mined Bitcoins. They put them on their balance sheet as an asset and used the high asset value to borrow money/ raise capital to pay for their costs. This was all fine until the price of a Bitcoin collapsed, and the electricity cost grew beyond the coin's value. The highly leveraged miners have run into difficulty, those who did not carefully source their energy have become unprofitable, and those that used their Bitcoins as collateral or placed them with exchanges have run into contagion risk. A miner's profit should be the price they get for selling the Bitcoin minus the price it costs to produce them. The market sets the Bitcoin price and is very volatile. The cost of production is a function of the company's hash rate and the network hash rate (that gives the mining difficulty), which decides how much computing power is needed. The cost per kWh of electricity will provide the cost of that energy. Profits then have two key drivers the price of Bitcoins and the electricity cost needed to produce each coin. Mining Profits Have Returned Ark Invest publishes "The Bitcoin Monthly," which tracks vital metrics affecting the Bitcoin industry. In January, it became clear that the mining profitability dynamics had changed significantly. Bitcoin Fundamentals (ARK Invest) For much of 2022, the price of a Bitcoin was less than its realized cost. In 2015 and 2019, we had similar periods of unprofitability. This sudden uptick is a fundamental change that could, if maintained, drive Mining profits for the next few years and will likely account for the shift in momentum identified at the beginning of this piece. ARK has remained a firm believer in BTC. Their Big Ideas 2023 publication renewed the 2030 bull case price target of $1.5 million per Bitcoin with a base case of $680K. (P65) Energy costs are forecast to continue to fall throughout 2023. If Bitcoin can hold the low it found late last year, the miners will have a profitable year, and investors will receive a good return. The fundamental of Price v Cost looks promising in the near to medium term. Which Miner Should We Buy? From a technical viewpoint, the three standout candidates are Cipher Mining Inc (CIFR), HIVE Blockchain Technologies Ltd (HIVE), and Hut 8 Mining Corp. (HUT). Bitcoin Miners 12 Month share price (Author Database) The sector remains depressed, but these three appear to have found a bottom with Bitcoin and broken higher. (sector performance is a simple average of share price; it is not weighted and includes only the shares I track, in this case, those on the first graphic of this article) I will write about Hut 8 and Cipher in the coming weeks, but this article will focus on HIVE. HIVE: The Basics HIVE was the first miner to go public in 2017; they have pursued a policy of owning their data centers and placed them to meet their chosen strategy (placed is used loosely; they bought existing facilities in place). HIVE sites are in colder environments (which reduces the need for air-conditioning to cool the mining machines) and close to green energy sites. Being close to green energy means they can act as a network balancing device. When the wind blows/the sun shines/the water falls, they use excess energy and have to reduce activity when it does not. HIVE has operations in Canada, Iceland, and Sweden. The Canada site is in Quebec, where HIVE owns a 30MW site powered entirely by green energy. In Sweden, their 17MW site is hydroelectricity powered, and the 4 MW site in Iceland is geothermally powered. These three sites lead to a total production cost of $13,634 (earnings call) per Bitcoin against a current price of $25,000. (total production includes energy, maintenance and rent fees). This cost structure gives HIVE a positive gross profit at every Bitcoin price throughout the recent downturn. HIVE Electricity Electricity is the key, in most cases, the only significant cost of a Bitcoin miner. How they deal with it determines their success or failure as a business. Theoretically, they should turn the machines off when electricity costs are high or have some deal to average them. The three miners I am considering are attempting to use their assets to generate additional revenue streams. These different streams may improve their sites' productivity and reduce the perceived income volatility of Bitcoin mining. The way they are attempting this will likely be a key differentiator. HIVE has managed to keep its cost of electricity extremely low; they do it by stopping operations when electricity becomes expensive. This means a drop in production, but what is the point of producing anything if you lose money doing it? "Now you might notice, okay, we produced 44% less coins, but we did that very strategically. And the reason why is because when any of our indexed power costs went up, we would curtail that production strategically to avoid incurring any unprofitable production" ( HIVE: 2023 Earnings call 3 2023 Transcript, 2023-2-28 ) A little later in the same call, HIVE explained that last quarter they dropped energy consumption from a maximum of 220 million kilowatt-hours to an average of only 100 million. They ran at less than half capacity for the quarter and reported a cost of electricity of $0.034 per kilowatt-hour. The average price of electricity in the US in January was $0.15 per kilowatt hour . HIVE is doing a great job of minimizing its cost of electricity. HIVE is developing a market for the heat produced by its miners. Of the three operational sites, two have a policy in place for selling the heat. They are in cold regions, so heat is a valuable commodity. In the Lachute site, Quebec, Canada, they use heat to an adjacent building. From the same earnings call. "So people thought we were just piping cold -- warm air from the Bitcoin miners. No, we actually have a glycol heat exchange. It's a very advanced system. And so what we're doing is we're heating our industrial neighbor. That's a 200,000-square-foot swimming pool manufacturer. And you can see on the right here, that's actually the heat exchanger. And so what it's doing is that's getting the warm air for the Bitcoin miners, that's been heat warming the heat exchange fluid, and that fluid gets pumped into our neighbor's building. And you could see the entire very sophisticated heat exchange hardware her, that's how we actually heat." In Sweden, HIVE plans to use the heat generated at its site to power a controlled environment agriculture site. This is another area of disruption that I follow. The dashboard is flashing sell for this sector; however, I remain committed. Climate change, political instability, and supply chain issues are causing food supply problems in many countries. Supermarkets in the UK have been forced to ration a range of food products in recent months for the first time since the second world war. HIVE plans to build a large greenhouse adjacent to their mining site, use the heat generated to grow salad greens and vegetables, and then sell them to local communities. HIVE is building a 9,000-square-foot Greenhouse at the Boden site in Sweden ( Slide 19 investor presentation ) "So, this is our partnership with Agtira to do the greenhouse in Sweden. So, we've got some early indication that we believe this 4,000 square meter greenhouse can do about 800 tons of cucumbers or 320 tons of tomatoes per year. And we're looking to become the cucumber kings in Sweden" ( HIVE: 2022 Earnings call 2 2023 Transcript, 2022-11-15 ) Agtira is traded on the Swedish exchange and is a controlled agriculture leader in the area, its sites include greenhouses as well as aquaponics, and indoor/vertical farms. This should add revenue to the HIVE mining operation. We will have to wait to see if it adds to profit. "The co-creation of this project aids in food sustainability efforts. Boden is in discussion of the greenhouse at Boden. We hope to be completing this transaction shortly. This company is already building now. We've been doing our due diligence in other buildings." ( HIVE: 2023 Earnings call 3 2023 Transcript, 2023-2-28 ) HIVE Financials Using the same graph as I did for Marathon and Argo shows how well HIVE has managed its balance sheet in comparison. Equity is down, but debt is relatively flat and just above Cash. In my view, it is in a much stronger position and more investable. Hive debt v equity over time (Author Database) There is currently no approved and accepted accounting principle for recording the value of digital currency from a mining operation. Contagion has been a massive problem in the crypto industry, and we have to look into each set of accounts to establish the possibility of a problem. With most companies, assets held at a bank are easily valued and can be drawn at any time; however, if those assets are crypto coins held on a crypto exchange, they are not the same. As a result, it is necessary to look into each company's accounts rather than rely on the standardized financials supplied by most websites. The following comes from the HIVE accounts for the nine months ending Dec 31st, 2022 HIVE values the coin on the date mined (note 3) and then puts the coin on the balance sheet as an intangible asset. The coins are revalued every time accounts are produced. The difference is placed in the profit and loss account, this is a fair way to deal with these assets, but it significantly impacts the perceived profit and loss account. Revaluing coins caused a paper loss of $79 million for the 9 months ending Dec 31st, 2021, and a profit of $95 million for the same period ending in 2022. HIVE holds Bitcoin, Ethereum (ETH-USD), and Ethereum Classic (ETC-USD) coins on its balance sheet. $38.8 million is in Bitcoin, $0.89 million is in Ethereum Classic, and $40 is in Ethereum. During the period, HIVE sold coins raising $103 million, and recorded a loss of $22 million on those sales. The coins are held with two institutions, one in the US and one in Liechtenstein. These institutions are not named in the accounts; however HIVE uses the Fireblocks' platform to maintain the safety of these assets. Fireblocks has no known security breaches and insurance to cover future breaches. HIVE accounts for the purchase of mining equipment as an investing activity rather than capex so that they can be revalued yearly rather than depreciated. HIVE registered an impairment charge against the mining equipment of $71 million for the nine months ending Dec 31st, 2022. (note 9) states the reasons as a change in replacement cost and the Ethereum merger. HIVE also reduced the useful life of its equipment from 4 years to 2 years resulting in an accelerated depreciation cost on other assets. HIVE has pre-paid for significant quantities of Mining equipment. It did this to secure equipment and delivery dates; however, these deposits are a contagion risk. In the latest accounts, HIVE recorded a provision of $27 million against the total deposits paid of $37 million. That is a significant hit. (page 11) The Company attempts to mitigate this risk by procuring mining hardware from the larger more established suppliers The only other contagion risk is an investment on the balance sheet of $4.5 million, this investment in Valour inc was originally for $16 million, but an unrealized loss of $11.5 million has already been put into the accounts (Note 6). In total, HIVE has accounted for almost $40 million in losses due to contagion risk, a significant amount of money lost from the business. HIVE has a related party derivative position (Note 11). In 2021 it received $15 million from US Global Investors inc for debentures that can be converted into shares, and US Global received 5 million warrants as a fee. The debentures carry an 8% interest rate and are considered a derivative because of the currency risk between US$ and CND$. Frank Holmes is the executive chairman of HIVE, and he bought US Global Investors in 1989 when following an SEC investigation into the company. I do not see any problem here, Frank is a respected long-term investor with an excellent track record. Dilution In May 2022, HIVE conducted a 5 for 1 stock consolidation and issued 1.3 million shares ATM with an average price of C$4.01. HIVE has 83% of its shares owned by the general public, which adds to the likely hood of volatility. The only major institution involved is Invesco, with a 5% holding. HIVE ownership (Simplywall.st) The balance sheet is somewhat precarious; The short-term assets do not cover all liabilities, and the cash on hand does not cover current liabilities. However, it is surprisingly solid, considering the paper losses taken in the last set of accounts. The coins have increased to $58 million since the accounting date. It is a difficult question for these companies when they should sell the coins. They risk losing out on significant appreciation when they go up in value but run the risk of Chapter 11 if the price falls. HIVE Balance Sheet (Author Database) Conclusion HIVE currently has one income stream, Mining Bitcoin. The Ethereum merger took away the income from mining on that Blockchain. The barrier to entry for new Bitcoin miners is low, and additional capacity on the network grew throughout 2022, despite the fall in the price of BTC. The Bitcoin amount per hash unit decreases as capacity or hash rate grows. This reduces HIVE's income and may require ongoing investment in new mining power. HIVE, like other miners, is looking for new income streams. It has chosen to use its heat to develop a controlled agriculture site and to heat an adjacent building. Neither of these ventures is scalable, and the controlled agriculture companies I follow are not doing well. HIVE is managing its balance sheet well with limited dilution and has sold the Bitcoins it has mined to fund its operation, which I like. It has booked significant impairment costs against future mining equipment and on investments in other companies but hopefully will not repeat that error. I like how HIVE throttles back its operation when the price of energy rises and how they have sites in colder regions. A good year for Bitcoin will likely mean a good year for HIVE; however, they are not my chosen miner to invest in. I do not believe their attempts to produce extra income from the greenhouse and the swimming pool manufacturer are significantly scalable to make a real difference to this company. In the long term, mining will become ever more difficult, and the income from each mining rig will get smaller. HIVE will continue to follow the Boom and Bust of Bitcoin as it has no other income stream. I want to invest in a miner that makes a lot out of the Boom but has something else in line for the bust.
