This is an opinion editorial by Glyn Jones, founder and CEO of Icebreaker Finance, a specialist capital advisory business with focus on private credit, DeFi and Bitcoin mining.
Bitcoin mining, an essential aspect of the cryptocurrency industry and an increasingly-important contributor to economic development in the United States, faced fierce market conditions in 2022. The capital-fueled “growth at all costs” strategy pursued by many miners in 2021 and 2022 led to a wave of failures and uncertainty amid a prolonged crypto winter.
While 2023 has so far witnessed modest improvements in unit profitability as bitcoin price growth has outpaced the growth in the network, the path forward remains uncertain. It is reasonable to presume that in a situation where the bitcoin price continues its rally through 2023, capital will quickly flow to Bitcoin miners, thereby lifting hash rate and reducing miner unit revenue (a commonly-preferred metric for understanding unit revenue is “hash price”). The questions for miners is how likely such a BTC rally is and how long will it take for sufficient capital expenditures to be deployed, such that hash price reverts to its equilibrium.
At Icebreaker Finance, our view is that only those miners who generate attractive profits at the “equilibrium” hash price offer opportunities for long-term investors. While hash price has seemingly found its equilibrium at about 6 cents to about 8 cents per terahash per day, many miners continue to generate insufficient cash flow to meet their fiat-denominated general-operations and debt-servicing costs. In many situations, lenders are rolling over existing facilities at uneconomic terms as a more favorable outcome than default. Amid this situation, ASIC manufacturers continue to bring stock to market and in many cases are deploying “unsold” new ASICs to self-mine through substantial hosting agreements.
Public equity markets reflect this pessimism. Many public miners are now more than 90% below their peaks and trade at valuations that attribute very little intrinsic value to their businesses. However, they remain highly volatile and have close correlations with the price of bitcoin.
In such a challenging environment, many have described the industry as “uninvestable.” Our view is different. Dispersion of performance has grown dramatically and publicly-traded miners offer an incomplete reflection on just how wide that dispersion is. To better understand the relative strength of miners in this environment, we segment the varying business models within the industry using a barbell analogy.
At one end, we have those miners who operate at scale and are vertically integrated to the underlying mineral rights and energy generation. These firms are “behind the meter,” where Bitcoin mining can enhance the economics of their existing business of monetizing capacity to source, generate and distribute energy. Such participants have not been significant players in the Bitcoin mining industry thus far. If Bitcoin gains broader adoption and regulatory support for the role Bitcoin mining can play in improving grid resilience and decarbonization grows, we should expect energy majors to enter Bitcoin mining at scale with profound implications for the equilibrium hash price.
In the middle of the barbell are miners who operate at scale “on grid” or “in front of the meter” and own infrastructure assets but not power-generation assets. A wide range of outcomes is expected for these participants, such that it is likely that only a small minority will be able to generate attractive returns for debt and equity investors through the cycle. Many participants in this segment of the industry, and particularly those who utilize fiat-denominated leverage in their capital structure, may fail, even if they gain short-term relief from short-term improvements in hash prices. The winners in this group need to be extremely sophisticated in site selection, energy contracting and financial practices.
At the other end of the barbell are niche operators who typically operate “behind the meter” on smaller sites to monetize truly stranded energy, making them an exciting long-term prospect for investors. They are often early in their business evolution and monetize stranded gas, flared gas, methane from landfills or partner with renewable energy providers for off-take agreements. Identifying suitable sites and operating them off grid requires miners to perfect a challenging set of multi-disciplinary competencies which suggests that execution risk will be high. It can also be a challenging business to scale, which may limit the size of this segment of the industry, even with favorable tailwinds from the ESG value of the activity.
Alongside such niche operators, we also expect to see substantial growth in “industrial augmentation” use cases where Bitcoin mining is introduced into the value chain of complementary industries. These are any companies that consume large amounts of energy and where there is an opportunity to monetize the heat generated from mining for other purposes or to monetize energy that is otherwise wasted. Greenhouses are an example of the industrial augmentation thesis, where water scarcity may drive greater penetration in greenhouse production in agriculture. At this end of the barbell, whether it be the niche operators or the industrial augmentation players, many participants are actively exploring ways to monetize the nascent carbon credit markets. Like all players entering the market now, infrastructure can be purchased at favorable prices.
For miners who do have a truly-differentiated energy and engineering proposition — which can occur anywhere across the barbell and particularly at either end — which places them in the top quartile of the network cost of production, the current market is a time for growth. Growth requires capital, and in some situations, modest amounts of debt may be suitable. In such situations, miners are understandably searching for as much tenor as possible and favorable loan-to-value ratios, while lenders are searching for a security package that includes uncorrelated assets and the ability to introduce risk sharing into loans so that lenders can also benefit from a situation where hash price improves while protecting the cash flows of the miner during periods of equilibrium hash price.
This is a guest post by Glyn Jones. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.